The Birth of Stock Exchanges

When people talk stocks, they are usually talking about companies listed on the major stock exchanges like the New York Stock Exchange (NYSE) or the NASDAQ. The major American companies are listed on the NYSE, and it can be difficult for investors to imagine a time when the NYSE wasn't synonymous with investing. But, of course, it wasn't always this way; there were many steps along the road to our current system of exchange. You may be surprised to learn that the first stock exchange thrived for decades without a single stock being traded.

In this article, we will look at the evolution of stock exchanges, from the Venetian States to the British coffeehouses, and finally to the NYSE and its brethren. (To skip the history lesson and jump straight into current events, check out Getting To Know Stock Exchanges.)

The Real Merchants of Venice

The money lenders of Europe filled important gaps left by the larger banks. Moneylenders traded debts between each other; a lender looking to unload a high-risk, high-interest loan might exchange it for a different loan with another lender. These lenders also bought government debt issues. As the natural evolution of their business continued, the lenders began to sell debt issues to customers - the first individual investors.

In the 1300's, the Venetians were the leaders in the field and the first to start trading the securities from other governments. They would carry slates with information on the various issues for sale and meet with clients, much like a broker does today. (To learn more about the history of money lending, see The Evolution Of Banking.)

The First Stock Exchange - Sans the Stock

Belgium boasted a stock exchange as far back as 1531, in Antwerp. Brokers and moneylenders would meet there to deal with business, government and even individual debt issues. It is odd to think of a stock exchange that dealt exclusively in promissory notes and bonds, but in the 1500's there were no real stocks. There were many flavors of business-financier partnerships that produced income like stocks do, but there was no official share that changed hands.

All Those East India Companies

In the 1600's, the Dutch, British, and French governments all gave charters to companies with East India in their names. On the cusp of imperialism's high point, it seems like everyone had a stake in the profits from the East Indies and Asia except the people living there. Sea voyages that brought back goods from the East were extremely risky - on top of Barbary pirates, there were the more common risks of weather and poor navigation.

To lessen the risk of a lost ship ruining their fortunes, ship owners had long been in the practice of seeking investors who would put up money for the voyage - outfitting the ship and crew in return for a percentage of the proceeds if the voyage was successful. These early limited liability companies often lasted for only a single voyage. They were then dissolved, and a new one was created for the next voyage. Investors spread their risk by investing in several different ventures at the same time, thereby playing the odds against all of them ending in disaster. (For more on how this practice plays out today, see: The Importance Of Diversification.)

When the East India companies formed, they changed the way business was done. These companies had stocks that would pay dividends on all the proceeds from all the voyages the companies undertook, rather than going voyage by voyage. These were the first modern joint stock companies. This allowed the companies to demand more for their shares and build larger fleets. The size of the companies, combined with royal charters forbidding competition, meant huge profits for investors.

A Little Stock With Your Coffee?

Because the shares in the various East India companies were issued on paper, investors could sell the papers to other investors. Unfortunately, there was no stock exchange in existence, so the investor would have to track down a broker to carry out a trade. In England, most brokers and investors did their business in the various coffee shops around London. Debt issues and shares for sale were written up and posted on the shops' doors or mailed as a newsletter.

The South Seas Bubble Bursts

The British East India Company had one of the biggest competitive advantages in financial history—a government-backed monopoly. When the investors began to receive huge dividends and sell their shares for fortunes, other investors were hungry for a piece of the action. The budding financial boom in England came so quickly that were no rules or regulations for the issuing of shares. The South Seas Company (SSC) emerged with a similar charter from the king and its shares, and the numerous re-issues, sold as soon as they were listed. Before the first ship ever left the harbor, the SSC had used its newfound investor fortune to open posh offices in the best parts of London.

Encouraged by the success of the SSC—and realizing that the company hadn't done a thing except for issue shares—other "businessmen" rushed in to offer new shares in their own ventures. Some of these were as ludicrous as reclaiming the sunshine from vegetables or, better yet, a company promising investors shares in an undertaking of such vast importance that they couldn't be revealed. They all sold. Before we pat ourselves on the back for how far we've come, remember that these blind pools still exist today.

Inevitably, the bubble burst when the SSC failed to pay any dividends on its meager profits, highlighting the difference between these new share issues and the British East India Company. The subsequent crash caused the government to outlaw the issuing of shares—the ban held until 1825. (To learn more, see Crashes: The South Sea Bubble.)

The New York Stock Exchange

The first stock exchange in London was officially formed in 1773, a scant 19 years before the New York Stock Exchange. Whereas the London Stock Exchange (LSE) was handcuffed by the law restricting shares, the New York Stock Exchange has dealt in the trading of stocks, for better or worse, since its inception. The NYSE wasn't the first stock exchange in the U.S. however. That honor goes to the Philadelphia Stock Exchange, but it quickly became the most powerful.

Formed by brokers under the spreading boughs of a buttonwood tree, the New York Stock Exchange made its home on Wall Street. The exchange's location, more than anything else, led to the dominance that the NYSE quickly attained. It was in the heart of all the business and trade coming to and going from the United States, as well as the domestic base for most banks and large corporations. By setting listing requirements and demanding fees, the New York Stock Exchange became a very wealthy institution.

The NYSE faced very little serious domestic competition for the next two centuries. Its international prestige rose in tandem with the burgeoning American economy, and it was soon the most important stock exchange in the world. The NYSE had its share of ups and downs during the same period, too. Everything from the Great Depression to the Wall Street bombing of 1920 left scars on the exchange - the 1920 bombing left 38 dead and also left literal scars on many of Wall Street's prominent buildings. The less literal scars on the exchange came in the form of stricter listing and reporting requirements.

On the international scene, London emerged as the major exchange for Europe, but many companies that were able to list internationally still listed in New York. Many other countries including Germany, France, the Netherlands, Switzerland, South Africa, Hong Kong, Japan, Australia and Canada developed their own stock exchanges, but these were largely seen as proving grounds for domestic companies to inhabit until they were ready to make the leap to the LSE and from there to the big leagues of the NYSE. Some of these international exchanges are still seen as dangerous territory because of weak listing rules and less rigid government regulation. (For related reading, check out Broadening The Borders Of Your Portfolio and Why Country Funds Are So Risky.)

Despite the existence of stock exchanges in Chicago, Los Angeles, Philadelphia and other major centers, the NYSE was the most powerful stock exchange domestically and internationally. In 1971, however, an upstart emerged to challenge the NYSE hegemony.

The New Kid on the Block

The Nasdaq was the brainchild of the National Association of Securities Dealers (NASD) — now called the Financial Industry Regulatory Authority (FINRA). From its inception, it has been a different type of stock exchange. It does not inhabit a physical space, as with 11 Wall Street. Instead, it is a network of computers that execute trades electronically.

The Future: World Parity?

The NYSE is still the largest and, arguably, most powerful stock exchange in the world. The Nasdaq has more companies listed, but the NYSE has a market capitalization that is larger than Tokyo, London and the Nasdaq combined — and the merger with Euronext will make it larger still. The NYSE, once closely tied to the fortunes of failures of the American economy, is now global. Although the other stock exchanges in the world have grown stronger through mergers and the development of their domestic economies, it is difficult to see how any of them will dislodge the 800-pound gorilla that is the New York Stock Exchange.

For more interesting facts about the past 100 years of investing, check out The Stock Market: A Look Back.

Gcl, one of the India's leading diversified Financial Services Group, is promoted by a family having decades of experience in financial market. Start trading online in Indian Share Market with Gcl.