He Said, She Said

Beginning in 1969 and carrying over into the early seventies, there were a number of brokerage house bankruptcies. Here, we compare two versions of the explanation.

...in the early 1970s when the New York Stock Exchange had to shorten its trading hours to reduce the number of transactions occurring in a day--just so the firms could keep up with the paperwork.

During this time, many firms went out of business not because they ran out of money but because they couldn't keep up with the mountains of paperwork created by the cash and carry system of settlement. Clearly a new system was needed.

What we have above might be called the popular theory of brokerage bankruptcy; the voice that echoes it there is Stuart R. Veale in a book called "Stocks, Bonds, Options, Futures" (2^nd Edition, Ch.7, p.102, 2001). Contrast with:

The first financial troubles of the brokerage houses (in 1969) were attributed to the increase in volume itself. This, it was claimed, overtaxed their facilities, increased their overhead, and produced many troubles in making financial settlements. It should be pointed out this was probably the first time in history that important enterprises have gone broke because they had more business than they could handle. In 1970, as brokerage failures increased, they were blamed chiefly on the "falling off in volume." A strange complaint when one reflects that the turnover of the NYSE in 1970 totaled 2,937 million shares, the largest volume in its history and well over twice as large as in any year before 1965. During the 15 years of the bull market ending in 1964 the annual volume had averaged "only" 712 million shares--one quarter the 1970 figure--but the brokerage business had enjoyed the greatest prosperity in its history. If, as it appears, the member firms as a whole had allowed their overhead and other expenses to increase at a rate that could not sustain even a mild reduction in volume during part of a year, this does not speak well for either their business acumen or their financial conservatism.

A third explanation of the financial trouble finally emerged out of a mist of concealment, and we suspect that it is the most plausible and significant of the three. It seems that a good part of the capital of certain brokerage houses was held in the form of common stocks owned by the individual partners. Some of these seem to have been highly speculative and carried at inflated values. When the market declined in 1969 the quotations of such securities fell drastically and a substantial part of the capital of the firms vanished with them. In effect, the partners were speculating with the capital that was supposed to protect the customers against the ordinary financial hazards of the brokerage business, in order to make a double proft thereon. This was inexecusable; we refrain from saying any more.

Above, the voice of Benjamin Graham from the 1973 edition of "The Intelligent Investor" (Ch. 10, p.139).

It appears that Mr Veale has hitched his wagon to the popular version of events and that his two sentence analysis is better accepted today than Graham's two paragraphs. Seriously though, reading them, which one sounds more plausible?