Wednesday, February 02, 2005

Are jobs being sacrificed for greater technology? - Part II

It wasn't hard to solve United's paper shuffle. In fact, the technology had been around for over a decade -- the same stuff that saved Wall Street.

It was the modern computer that helped create the modern stock market. In fact, they grew up together: Wall Street provided the capital for the computer industry to create faster machines to handle Wall Street's growing computing needs. Wall Street used to be a collection of people, but as computers insinuated their way into every crack and crevice, it changed the business of raising and managing risk capital.

In 1949, punch cards, introduced by Herman Hollerith as a record-keeping unit to speed up the 1890 census, were finally used to record trades. Can you hear IBM salivating? In 1950, electronic computers started doing the sorting of trades; in 1961 magnetic tape stored data; in 1964 computers were used to clear certain trades by matching records. IBM computers were indispensable to Wall Street, and Wall Street bid their stock up to provide IBM as much capital as it needed to grow.

As volume and profits grew, more Wall Street partnerships were created to get in on the game. By the 1960s, electronic message switchboards replaced those pneumatic tubes of 1918 so order entry and execution confirmation could happen in something close to real time. Of course, this was to the advantage of the traders -- to be able to get the most current feel for the market; customers were still out of that loop. But the back office was neglected, stock certificates still had to be collected and distributed. Wall Street hit a wall in 1968, and for many it was fatal. Electronics facilitated trading but did nothing to help clearing and making sure buyers got certificates from the sellers.

As volume increased, by some 30% a year in both 1967 and 1968, the people-intensive clearing process took forever. Certificates piled up to the ceiling tiles at brokerage firms, either awaiting payment or as errors and bad trades yet to be reconciled. Hiring more people barely helped. Firms would work 24 hours a day, 7 days a week and still fall behind. Customers simply stopped paying since they stopped getting their certificates. The NYSE began closing one day a week to catch up. They mandated a Central Certificate Service that created electronic certificates for a few stocks so settlement and clearing could happen without handling physical certificates. It was too little, too late. 160 NYSE member firms went belly up in 1969 and 1970, their credit squeezed as it took so long to process the volume of trades, victims of their own success. It was a big problem for those not tech savvy.

* * *

Small companies, who couldn't afford the NYSE or didn't have the size or pristine balance sheets needed to be listed, could have their stocks traded off-exchange, or OTC, over-the-counter. Until 1961, it was a pretty sleazy business: trading was thin, quotes were by appointment, spreads were at the whim of one or two traders. In 1961, the SEC empowered the National Association of Security Dealers or NASD to automate the trading of these OTC stocks. Pretty impressive for 1961. (Of course, it took until 1971 for the first NASDAQ stock to trade, as lots of new technology clearly needed to be invented.)

But capital raising on Wall Street was typically for blue chips only. It merely required a handful of phone calls. "We are raising $200 million for a new line of yellow cheese for Kraft, how many shares can I write you down for?" Tech deals were almost impossible to sell that way. It's not so much that investors wanted equal access, it's that the only way high tech could be sold was to explain it face to face.

One neat company was waltzed around that made these strange devices named I2102s, which were one kilobit of static memory made with a planar process; these static memory units were rapidly replacing core memory in IBM computers.This company also had a new "micro" processor used in some Japanese calculators. Yup, in 1971, Intel had a lot of explaining to do.

The phone didn't cut it, and so they had to visit institutional investors in their offices across the country to sell their Initial Public Offering. The IPO road show was thus invented by C.E. Unterberg Towbin to raise money for futuristic and hard-to-explain technology companies. Now all companies have to go through this grueling ritual. But Wall Street was all too happy to take these new companies out -- IPOs paid 7% fees, and still do.

In May 1973, a new entity took over the clearing process: The Depository Trust Company, or DTC, with the help of IBM using cheaper Intel memory, quickly created a system of electronic record transfer of ownership, replacing the sorting tables. 16 million shares were trading every day, 4,729 different companies had their shares registered with the DTC, and the back-office paper crunch soon ended. With an automated back office, liquidity went up and the risk of investing on Wall Street went down. This is a subtle and critical point, but lower risk on Wall Street meant more risk capital could be deployed in the economy and Silicon Valley started heading down the runway for takeoff.

* * *

For 25 more years, most traditional investors missed the big move in technology stocks, until they all rushed in on the same day in January, 1999. Hedge funds were too busy playing with currencies, especially a lucrative yen-carry trade that blew up in October 1998. Julian Robertson's Tiger Fund had only one saving grace in 1999 -- a huge position in US Air. It was a value stock, and Julian Robertson had bought it right. By May of 2000, United Airlines had made a $60 cash bid for US Scare-lines. Tiger was sitting pretty, despite a tough year of withdrawals: $20 billion in assets dropped to about $6 billion. But with the airline merger, Tiger showed a gain for 1999. But, Julian Robertson joined a long line of old dogs chasing fire hydrants. Once deregulated, airlines were protected by the complexity of their back office. Anyone could refuel and fly a plane, but it took a special organization to sort the paper tickets. In fact, like United, you could buy other airlines and sort their tickets too, saving zillions.

But when technology ended the paper trail and e-tickets came of age, it wasn't the existing airlines that benefited. New players like Southwest and JetBlue could enter the business cheaply. A couple of million bucks in servers and broadband was all the back office they needed. Tthe sorting tables were a thing of the past. It was like taking candy from a baby for these new guys to take market share from unionized United or US Air with their Vietnam-era pilots and aging battle-ax flight attendants.

Withdrawals were relentless, so Julian Robertson closed Tiger in March of 2000, holding onto a few shares he thought would do well, like US Air. Oopsy - US Airline filed for bankruptcy in August of 2002, its stock a children's shoe size of 2 or 3 compared to the mature $60 United offered and withdrew. He should have paid attention to those folks in Silicon Valley.

JFK: Winter 2003

The Van Wyck was backed up, as usual. I hated the trip out of Manhattan to JFK, except I was headed back to SFO. I was running late, it was raining, I was lucky to even get a cab at all, and now I'm crawling down what should never have been named an Expressway. Most cabbies know how to cut through the borough by taking Woodhaven Boulevard. My grandmother used to live somewhere along it, near Cross Bay Boulevard, but I would lose at Queens Monopoly.

We finally hit JFK, and I threw $50 to the driver and ran out to check in. I think I had just enough time to get frisked by airport security, buy a NY Post, and get on the plane. I just hope there was no line at check in. I always got stuck behind some family headed to Moomba via Dallas and Frankfurt.

But just inside the door, instead of a line, there were five kiosks. Nice touch screen displays lined up in a row with United's logo blinking away. This I had never seen before. It prompted for my United Mileage Plus card, which I kept handy for upgrades to First Class. I swiped away and my reservation instantly popped up.

"Do you need any help?"

"Excuse me?"

A nice middle-aged woman with a Queens accent smiled. "I just wanted to know if you needed any help with these machines."

"No, I've got it figured out." I had read somewhere that with these kiosks, United dropped the cost of ticket handling from $20 to under $1.

"Well, don't figure it out too well. Some of us need the work." She smiled again, but I could tell she would just have soon picked up a nearby fire extinguisher and smashed all five kiosks in a heartbeat.

"I understand." I nodded. It had been not quite twenty years since was a stowaway in United First Class under the pretext of an interview, saw the groaning tables in Chicago.

"Well, welcome to the Friendly Skies."

She smiled again and didn't give me any grief about wearing jeans.


Who is Andy Kessler??

You can find more about "Running Money" on -


millihelen, n.: The amount of beauty required to launch one ship. (Courtesey /. )


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