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Nervous System: How Computers Saved Wall Street

David Kalat

May 3, 2023

A “Paperwork Crisis” forced Wall Street to change the way it did business, ushering in automation and hastening the business world’s transition to the Computer Age.

In the late 1960s, the paperwork-based systems used by US securities brokers became overwhelmed by increased trading volumes. Average trading volume doubled over just three years. Such growth came with a painful cost. Approximately one-third of investors experienced lost or late-delivered securities; and one-sixth of the members of the New York Stock Exchange (NYSE) failed or were either swallowed up or disbanded.

The problem was the quaint reliance on an old-fashioned way of doing business. What ultimately saved Wall Street was a comprehensive pivot to computerized systems.

For generations, the trading of securities meant the literal exchange of actual paper certificates. Clearing a trade meant physically moving a piece of paper from one location to another. The market employed armies of couriers whose sole function was to move paper around. It was inefficient and responded poorly to growth.

In 1946 the Securities and Exchange Commission (SEC) had allowed two days to settle a trade. By the 1960s this had bloated to five days, and even then few firms could manage it.

By 1968 daily trading volumes exceeded 12 million shares a day. Physically accounting for all that paper was too much for the brokerages to handle, and trades were routinely backlogged. Stock certificates were piled in disorderly stacks in offices, waiting their turn for overworked staffers to attend to them. Many were never sent, some were sent to the wrong places, quite a few were outright stolen, and almost none were settled within the supposed five-day deadline.

Losses escalated for both traders and brokerages. They called it the “Paperwork Crisis.”

The SEC tried to intervene. The first plan was to shorten the trading day and close outright every Wednesday to give firms extra time to catch up. This shortened week, in effect from late 1967 to early 1968, did not seem to help. The SEC then tried imposing surcharges on commissions of small trades, with the intent of providing cash flow to struggling brokerages.

These mitigation measures only nibbled at the edges of the core problem. From 1965 to 1968, trading had tripled from 5 million to 12 million shares a day. Then, from 1969 to 1970, trading volume had declined sharply. Brokerages had been rocked by both developments. The firms’ attempts to cope with increased trading introduced unexpected costs, while the decreased trading starved them of income. It seemed like they could no longer cope with any level of trading.

The reliance on manual transactions was simply untenable for anything at a significant scale. There are a limited number of hours in a day, and a human being can do only a limited number of things in those hours—much less do correctly. As the scale of trading multiplied, it inevitably reached a point where the needs exceeded how many people could fit in a room and how many things could be done in a day.

This was not a novel observation. The RAND Corporation had advised the securities industry to abandon paper trades in favor of electronic record keeping, and NYSE President Robert W. Haack had been fervently advocating for the industry to switch to computerized punch cards for the electronic relay of information, not objects. In 1968 Haack had set a “top priority” of replacing physical certificates with electronic databases.

The first iteration of that database was a “central stock certificate system” to manage electronic clearance and settlement of trades. It was a voluntary system riddled with bugs and growing pains. Its main failure, though, came from the reluctance of NYSE member firms to change the way they did business.

The Paperwork Crisis forced their hands.

Hundreds of firms simply went out of business. Few of the survivors remained profitable, and even those were burdened by millions of dollars of failed trades.

The situation forced firms to automate. Human workers could not keep up, so machines had to be deployed. The investment in computerized data systems was steep and would not have been undertaken so swiftly and decisively without the urgency imposed by an existential crisis.

The moment led to the 1973 creation of the Depository Trust Corporation, a centralized data system that member firms were now required to implement.

Because of the significant costs associated with automation, only firms with the ability to invest in the new digital future would survive. Having done so, they would find incentives to deploy those newly purchased computers on newly diversified business lines to help justify the expense. Ironically, this meant that the solution to untenable growth was yet more growth. The shift to computerized clearing of trades was incentivized by the seemingly overwhelming trading volume of 12 million shares a day, but once the computerized systems were in place, they had the capacity to handle a great deal more. It is now common for NYSE daily trading to exceed two billion shares.

Wall Street survived the Paperwork Crisis and, in doing so, helped hasten the business world’s transition to the Computer Age.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

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David Kalat