Good Derivatives: A Story of Financial and Environmental Innovation

Chapter 5

The Chicago Board of Trade Years

Financial Futures Contract

Yes, we're boys, always playing with tongue or with pen and I sometimes have asked, “Shall we ever be men?”

—The Boys, Oliver Wendell Holmes, 1859

I stepped into Warren Lebeck's small office in May 1972 and noticed that it was as fastidious as the man himself. I was joining the exchange as a consultant, just two months prior to my appointment as chief economist. The purpose of the meeting was to brief Warren on the potential of interest rate futures. He surprised me by announcing, “I rented a conference room in the Palmer House and we're going over there to draft the first GNMA futures contract.” Given my limited knowledge of the process, I was terrified by the prospect of having to write the contract on the spot.

A large oak table covered in emerald-green cloth awaited us in the modest-sized conference room. I took out a folder that contained my notes of interviews with mortgage bankers, savings and loan executives, and Government National Mortgage Association Mortgage-Backed Securities (GNMA MBS) market data, while Warren brought out the rules and regulations from the CBOT. Meticulous as ever, he had also brought along a pair of scissors and Scotch tape. When I asked him what they were for, he answered, “To copy and paste from the rulebook.”

A GNMA is a mortgage-backed security that is collateralized by mortgages guaranteed by two agencies of the U.S. government. These mortgages are pooled into one security. ...