Chapter 3

The Berkeley Years

The thing the sixties did was to show us the possibilities and the responsibility that we all had. It wasn't the answer. It just gave us a glimpse of the possibility.

—John Lennon

The failure of Project CCARP only increased my determination to learn more about futures markets. I continued to write academically about industrial inventive activity as a means to procure tenure, but my heart wasn't fully in it. Coincidentally, some of my research would serve as a natural segue into understanding and practicing financial innovation. I had always wanted to invent, and the futures industry was changing. It had become ripe for new ideas, and the seeds of inventive activity were beginning to flower.

A New Direction

As I sought to expand my understanding of the industry and how new futures contracts were developed, it occurred to me to teach a course on futures markets. Two fortuitous opportunities led me to propose this to the dean at Berkeley.

Although Project CCARP was dead, the network and reputation I had built during its life had some unintended consequences. Gerry Taylor, a publisher at the humor magazine National Lampoon, had been organizing annual conferences run by Institutional Investor for equity investors. He was convinced that he could create a comparable event for futures traders. Gerry sought to include academics in his event alongside senators, industry leaders, and CEOs, and was given my name by some traders in Chicago. He was intrigued by my work in computerized trading models and on Project CCARP.

Gerry came to my office at Barrows Hall one day to discuss his plans to put together his conference for the futures industry. He was a tall man, was nattily dressed, and had a terrific sense of humor. Gerry was married to Mary Travers of the folk band Peter, Paul, and Mary. A willowy woman with sleek blond hair, his wife reflected the activist liberal mood of Greenwich Village in the '50s and '60s. I reveled at Gerry's stories about working at National Lampoon, and we shared many stories about our New York origins. He invited me to speak at the conference he was organizing. I accepted, even though it wasn't clear that he could pull it off.

I was buoyed by my personal life that summer. Ellen was pregnant and we were expecting at the end of September. This time, it was me prodding Ellen to start classes in natural childbirth. My second daughter, Penya Lauren Sandor, a fair-haired baby, was born on September 24, 1970. Ellen was in labor for only two hours before Penya came into the world. The lightning speed at which she was delivered was a metaphor for her life. Penya was and is adventurous, resourceful, and perceptive. By the time she was 18 months old, Penya was watching Sesame Street with her sister, reading numbers, deciphering words, and counting in English and Spanish. Like her sister, she was always quick to defend those who were attacked due to their disadvantages. When Penya was in grade school, she witnessed a teacher yelling at a fellow student who had difficulty reading. She audibly told the student that the teacher was stupid and insensitive—the exact words she used were less pleasant. Ellen received a call to meet the school principal to discuss Penya's behavior. After she learned what our daughter had said, Ellen proclaimed that Penya's description was accurate, and challenged the group to differ. No one did, and that was the end of that. Penya's perceptiveness and creativity with words revealed that she would become a published poet.

Gerry's idea about a commodities conference became a reality. I went to New York to attend the 1970 International Commodities Conference just after Penya was born.¹ I had never seen anything like it. From the exquisitely plated hors d'oeuvres to the gleaming ballroom in which the event was held, Gerry spared no expense.

Unfortunately, the event wasn't a financial success. There were almost as many speakers as attendees. Nevertheless, the conference was an opportunity for me to further my knowledge of the industry and to meet its leaders. Speaking on a panel titled, “Will Computers Take Over Futures Markets?” I now knew there was life after Project CCARP after all. My ideas on using computers to forecast prices were better received than my views on electronic exchanges. Although some in the audience encouraged me to pursue the latter, others argued that the vested interests in the industry were opposed to being replaced by computers. I realized that without support from industry or a large grant, it was futile to continue my research. In 1970, the concept of a fully automated futures exchange was dead on arrival. It was simply ahead of its time, and the only way it could happen was if a new exchange was interested in starting from scratch, which was unlikely.

Soon, I received an invitation to speak at another conference, organized by the New York Coffee and Sugar Exchange (NYCSE). “The Changing Complexion of Commodity Trading”² attracted about 50 faculty and student attendees from 40 different colleges and universities. The NYCSE president delivered welcoming remarks. Unlike the International Commodities Conference, it was held in a more humble room at the exchange itself.

The conference program had two themes: university course curriculums on commodity trading, and new directions in futures trading. I described what was going on in futures trading at the Berkeley Graduate School of Business Administration.³ For the most part, the study of futures trading was confined to departments of agricultural economics. A small number of graduate courses in MBA programs featured brief discussions on futures markets, including a course on agribusiness taught at Harvard Business School. At Berkeley, I encouraged my students to conduct individually supervised research on futures markets in satisfaction of their MBA degrees. Examples included studies on futures trading in frozen concentrated orange juice, cattle, and broilers, as well as our previous feasibility study and bylaws for the Pacific Commodities Exchange.⁴

After the conference, I became convinced that business schools should offer courses on futures markets.

The other part of my presentation was devoted to the use of computers in price forecasting. Instead of sticking with arcane charting, I focused on mathematical forecasting models based on fundamental analysis, as well as computerized forecasting models based on price and volume statistics. The infancy of computers was matched by the nascency of forecasting models. I suggested that widely used academic tools, such as econometrics and simulation, could be applied to price forecasting and I stated that these models would not only be applicable to speculators, but also be used by agribusiness companies for hedging purposes.

I left New York knowing that I was about to make the unalterable decision to enter the world of futures trading. It promised to be a life-changing experience. It was a little frightening to leave behind everything—my research on patent life and R&D, as well as articles I had written on these subjects—to focus on the study of futures.

At the beginning of 1971, I developed an outline and readings list for a proposed course on futures exchanges and trading. The preparation was exhilarating. I read histories of exchanges,⁵ futures pricing theories, and everything available regarding the invention of new contracts.⁶ The course was approved and was the first of its kind in a school of business administration. The course included not only history and theory, but also an impressive list of guest speakers, including practitioners like the head of agricultural lending at the Bank of America, the administrator of the Commodity Exchange Authority (CEA), and Warren Lebeck, executive vice president and secretary of the CBOT.

After one particular class, Warren and I walked through Sproul Plaza together. Warren was a former Navy officer who dressed immaculately at all times—a distinct contrast with the student body and faculty on campus. He was made somewhat uncomfortable by the hippies and dogs that roamed Berkeley's campus. He said, “I like stories about rebels. The movie Love Story is one of my favorites, but that's a lot different from these guys.”

The experience with CCARP had taught me the power of the press. I had been quoted in The Financial Times and The Journal of Commerce, and this public visibility gave me both exposure and access to industry leaders. I persuaded a reporter from The San Francisco Chronicle to write an article on the course. I clipped the article and sent copies of it to the guest speakers along with a thank-you note. Ultimately, it was a combination of the futures course, Project CCARP, research on financial innovation, press coverage, speaking engagements, and finally, a casual conversation with one of the other guest speakers, that opened up a life-changing opportunity for me in Chicago.

Plywood Futures—Learning How Others Create a Good Derivative

Between 1960 and 1970, the volume on U.S. exchanges had more than tripled. One-third of that growth came from new commodities. In 1969, the CBOT had launched a futures contract in plywood, and by 1970, the exchange had traded more than 47,000 contracts. This had created a new arena for futures markets, namely, that of fully processed industrial commodities. I suspected that a case study on the evolution of commodities would be exciting and might even be worthy of publication.

I called Warren to ask if the CBOT would cooperate with a case study of the research and development of the plywood futures contract. Warren's response was both positive and enthusiastic. Desperate to be published, I made a cold call to Ronald Coase, editor of The Journal of Law and Economics, to see if the journal was interested in an article on financial innovation. I remember sitting in my office in Barrows Hall and hearing a crisp English accent saying, “This is Ronald Coase returning your call.” I explained the case study I was planning and asked if he was interested in seeing it when it was completed, but was careful not to ask about publication. He was especially intrigued because the plywood futures study was a practical example of theoretical economics.

Studying the research and development activities conducted on exchanges helped me transition from inventive activity in the industrial sector to inventive activity in finance. I learned that the CBOT's New Products Committee had considered launching a futures market in plywood back in 1961. The idea lay dormant for some time due to the lack of price volatility. In 1967, plywood cash prices had risen from under $70 at the beginning of the year to about $95 during the summer months, retreating to a little over $70 toward the end of the year—representing an unusual amount of price volatility. By mid-1968, prices had rebounded to approximately $100.

The volatility in plywood prices had set the stage for a futures contract, and the exchange hired a forestry graduate to conduct some economic research. His first assignment was to conduct a feasibility study on a lumber or plywood futures contract. The study was quite extensive, describing the lumber and plywood industries while hypothesizing a futures contract for both. It was clear that both could be standardized. Using figures on concentration of product, size of wholesalers, and institutional relationships in the industry, the study concluded that the industry was competitive. Production of both commodities was also sizable.

Furthermore, as a result of supply and demand, prices continued to be volatile throughout 1967 and 1968. The study's description of the industry implied that a high-volume, liquid spot market existed, although the forestry graduate did not seem to have looked for this specifically.

The study went on to specify the salient features of a futures contract in plywood, which included grade, delivery points, and pricing. Other salient features, such as the location of delivery, changed as a result of feedback from both producers and users of plywood. They also changed as a result of market makers and speculators.

The final contract was not designed in a vacuum, but benefited from the continuous input of potential buyers and sellers throughout the inventive process.

The inventive process of the plywood futures contract, from its inception to the initiation of trading, took approximately 17 months. Almost seven years had gone by since the New Products Committee had first begun its investigation into plywood futures. The biggest challenge was determining the right location for delivery, one of the most important features of a commodity futures contract. Grain futures contracts at the time specified delivery at grain elevators in Chicago. Since the city had historically been a center for the buying and selling of grain, both buyers and sellers would be able to make or take delivery at a convenient location. Furthermore, the local market was representative of grain prices nationally. The first draft of the futures contract called for delivery in Chicago. This proved to be a mistake.

The original contract in plywood called for mills to deliver a shipping certificate, a promise by the issuer to deliver to the buyer the quantity and quality of plywood specified in the contract. The contract price would be settled using the freight-on-board mill convention (dubbed FOB mill), through which plywood was loaded on to a carrier at the mill without incurring any additional cost to the buyer. There were a limited number of mills that were eligible to make delivery. As a result of the small number of mills, prices on the futures market were artificially high relative to the national market. Hedges were therefore ineffective, calling for a modification of the original contract. The new contract provided for unrestricted mill delivery and also permitted warehouses in certain newly designated areas to qualify as delivery points. The changes resulted in the elimination of artificial scarcity. The solution was so simple that it was amazing that no one had thought of it before. The contract subsequently became more representative of national prices.

The case study gave me an understanding of how a new futures contract was developed. First, the market had to be large enough to warrant a futures market. Second, there had to be a sufficient number of buyers and sellers for the standardized product. Third and finally, there had to be volatility of prices and a concomitant need and desire by industry to hedge. If all these characteristics were satisfied, the staff of the exchange proceeded to draft an initial contract. The staff then took in comments and input from plywood manufacturers and distributors, as well as the member committee charged with developing the new product. Once there was consensus by the industry and member committee, the contract was launched. If necessary, the contract was redesigned based on market experience.

The entire activity was characterized by interactions among professional exchange staff, exchange members, and advisory groups who were commercial users of the market. My research for the article on plywood futures gave me insight into how to design a futures contract. I was ready for what was about to happen.

Grain Markets and Mortgages

In the 1960s, I shared a bullpen with Albert H. “Hank” Schaaf and other Berkeley faculty. Hank was an expert in real estate economics and we often discussed the changes in the world around us. At the time, the rise in interest rates in 1966 and 1969 was having a particularly strong effect on the California real estate market. The state was in a high-growth stage of development, and capital was needed to finance the growing demand for housing. I kept on bouncing between trading futures and discussing mortgage finance. Combining my interest in the housing markets with hands-on experience trading futures led me to an interesting solution to the California housing problem—mortgage interest rate futures. The prospects of solving the problem of the interest rate risk in California was exciting. I had to let this go, however, in order to work on Project CCARP. I was only speculating about an idea and didn't have any interest in pursuing it at the time.

The idea later took on a life of its own. While teaching a course on futures markets at the Berkeley Graduate School of Business Administration, I was struck by the similarity between the business flows in the grain and mortgage markets. Farmers grew wheat and sold it to grain merchants that operated storage facilities known as elevators.⁷ Local merchants took temporary ownership of the commodity, and then sold it to larger elevators in major markets known as terminal electors. Eventually, the grain was sold to food processors.

In many ways, the mortgage market functioned in the same manner as the grain market: the borrower was the farmer, the mortgage banker was the local grain elevator (even the terminology was the same—elevators “originated” grain just like mortgage bankers “originated” mortgages), the investment banks were the terminal grain elevators, and savings and loans associations (S&Ls) and pension funds were the food processing companies. The convergence of a number of factors—the increase of interest rates, the long tradition of futures contracts in the grain market, the state of real estate finance, and the surge in mortgage rates—made the potential for a mortgage interest rate futures contract obvious. The origins of the idea of a futures market in interest rates lay in the work of W. R. Hicks. Although he did not explicitly state the need for such a market, it could be easily inferred from his pioneering work.⁸

The conception of mortgage interest rate futures faced three challenges. First, a standardized mortgage instrument needed to be created. Second, there had to be a real or perceived interest rate risk to generate demand from hedgers. In other words, interest rates had to be volatile. Third, the legal and regulatory environment needed to be conducive to allowing an exchange to launch a futures contract based on that instrument.

Major structural economic changes typically precede the development of new markets. The invention of any new product is ultimately a response to latent demand or overt demand. Accordingly, the latent demand for new markets in the financial sector typically follows a period of major structural economic change. To the dispassionate observer, the period from 1960 to 1975 represented one such period. The stage was set by Kennedy-Johnson deficit spending, an unpopular, socially disruptive war in Vietnam, President Nixon going off the gold standard, and the OPEC oil embargo. All of these led to an increase in inflation and interest rates.

California and the rest of the nation suffered from a spike in interest rates in 1966 and another in 1969, as federal deficits had begun to take their toll. In addition, there was a special set of problems for faster-growing western states: a rapidly rising population was sparking a burst in housing starts, which was the number of residential building construction projects that began each month. Local S&Ls, however, had insufficient capital to satisfy the growing demand for mortgages. To fill the funding gap, rates on deposits had to be higher than in the savings banks in the Northeast. Of course, the higher costs of procuring funds forced banks to raise mortgage rates. Deposit rates could even go higher in order to attract capital. A better solution was to create a transparent and liquid secondary market in which S&Ls in the high-growth areas of the West could sell to translate what they created, the proceeds from which could then be used to relend to new borrowers. To make this possible, a hedging mechanism was desirable to reduce the risk of owning mortgages while they were being originated for resale, thereby transferring risk from hedger to speculator. All of my studying, research, and teaching made me more confident about the value proposition.

Structural economic changes that result in the need for capital and risk-shifting mechanisms typically drive the standardization of products, regardless of whether the products are tangible commodities or financial assets. Here again, the grains market provides a useful paradigm. In the mid-nineteenth century, the American westward expansion and the growing demand in Europe for imports from the United States led to the development of standards for measuring and grading grains set by the CBOT. The standards allowed market participants around the world to buy and sell grain futures with confidence because everyone agreed on the exact nature of the underlying commodity should they wish to take or give delivery. In short, standardization is a necessary condition for financial innovation in the development of new markets—a major theme that will occur throughout this story.

Mortgage Interest Rate Futures—Creating Good Derivatives

As the 1960s drew to a close, three men from the savings and loan industry would change the capital markets in the United States: an academic-turned-regulator and central banker, a real estate developer-turned-CEO of a government-sponsored enterprise, and the CEO of a financial institution. Over the next decade, Preston Martin, Thomas Bomar, and Anthony Frank played unique roles in the invention of financial futures. Preston, Tom, and Tony significantly modified existing financial institutions and created new ones.

Preston Martin was a professor at the University of Southern California. He was subsequently appointed the regulator of California's savings and loan industry, and in 1969 was appointed the chairman of the Federal Home Loan Bank Board (FHLBB) by President Nixon. It was at the FHLBB that he strongly advocated for the development of a futures market in mortgages.⁹

Thomas “Tom” Bomar was the first CEO of the Federal Home Loan Mortgage Corporation. His objective was to create a secondary market and for the Federal Home Loan Mortgage Corporation (FHLMC), nicknamed Freddie Mac, to be a temporary holder of mortgages. He also promoted the idea of interest rate risk management for depository institutions through the use of variable rate mortgages and interest rate futures. Tom went on to become chairman of the Federal Home Loan Bank and took a leadership role in providing the regulatory authority for savings and loan institutions (S&Ls) to hedge against adverse interest rate movements. Tom was a creative businessman who used his practical skills as a public servant. In retrospect, if Tom's philosophy had been adhered to, I believe the failure of government-sponsored enterprises such as the Federal National Mortgage Association (FNMA), nicknamed Fannie Mae, might never have occurred. Tom embraced change and innovation, but valued careful regulatory oversight.

I learned about the interest rate risk facing Freddie Mac from Preston Martin in the spring of 1971. He helped arrange a meeting with Thomas Bomar to discuss how a futures market in interest rates could be designed to manage Freddie Mac's interest rate risk. Tom had a laser-like focus and a propensity to laugh. Having reviewed all recent literature on the subject and fortified by my own research on plywood contracts, I was confident that interest rate volatility was going to become a permanent part of the U.S. economic landscape. The big challenge lay in translating heterogeneous mortgages into a homogeneous pool. Simply put, mortgages had to be standardized before a futures contract could be written.

If grain standards could be developed with features such as protein and infestation requirements as early as the 1850s, then the same could certainly be done with mortgages. If we could standardize mortgages with features like percentage down payment and the ratio of household income relative to mortgage payments, a market could be created. I summed up the need for standardization by saying, “If you could grade it, you could trade it.” Tom laughed and I knew that this was the beginning of a long friendship. What I needed was a large portfolio of mortgages that could be statistically analyzed. Tom advised me to call Anthony Frank and give him a heads up. The vistas seemed unending as I drove my Austin Healy across the San Francisco–Oakland Bay Bridge for my first meeting at Tony's headquarters at Citizens Federal on Market Street in San Francisco. It was the summer of 1971 and I was looking forward to doing research during my break from teaching. This was a unique opportunity to combine my interest in futures and the need to get published in academic journals.

Citizens Federal was an industry leader that greatly affected its fellow thrift institutions. As its CEO, Anthony “Tony” Frank had led the first transformation of an S&L mutual organization to a stock-owned company. Tony was unafraid of taking positions that were unpopular in the industry and led the thrift industry efforts to embrace new financial innovations that would mitigate its risk. Tony did not fit the mold of a traditional banker. He went on to become postmaster general of the United States in 1998, and even put Elvis Presley on a postage stamp.

As I walked into Tony's office, a tall, athletic man with a big smile extended his hand and welcomed me. Conversation flowed easily and I knew almost immediately that he would help. Tony asked one of his associates to help me access a portfolio of 18,000 conventional loans to find a representative sample. I returned to Berkeley and immediately contacted Hank Schaaf, the head of the Center for Real Estate and Urban Economics, to see if the center would give me a grant to support the study. I knew Hank was always interested in finding new ways to make the center nationally preeminent while advancing real estate finance at the same time.

From an academic point of view, we needed to gain some understanding of mortgage risk premiums based on the size of loans as well as borrower characteristics before mortgages could be standardized. Although there had been prior research conducted on the subject, this was the first study to analyze the risk premiums of a particular institution. Aggregated data might not have yielded the same results, and I could perhaps shed some light on this important subject. I had to craft the proposal in a way that would fit into the literature and therefore be promising for publication in an academic journal. Admittedly, my real motive was to see if mortgages could be standardized enough to create a futures market. Nevertheless, this idea was too novel at the time and, in order to secure the funding, I had no choice but to frame my objectives in this manner. I did, however, share this long-term goal with Hank.

Massaging the data was a serious challenge, especially because not all paperwork associated with new mortgages had yet been computerized at that time. A sample of 556 loans were drawn from the 4,907 originated loans, but only loans that had all the required data were included in the sample. Statistically speaking, these loans were representative of the entire portfolio. We broke down mortgage characteristics according to the effective mortgage rate, loan-to-appraisal ratio, loan amount, and term in months. The loans were distinguished by neighborhood ratings and property condition ratings, both with five ratings from poor to excellent. We included four borrower characteristics: net worth, housing-to-income ratio, loan amount to net worth ratio, and secondary financing.¹⁰ The study took quite some time to complete and publish, but yielded some interesting and statistically significant results because it expanded on previous research on mortgage standardization by including borrower, property, and neighborhood characteristics.¹¹ While the study proved academically interesting, it turned out to be a blow to my long-term goal of mortgage grading. Conventional mortgages could not be standardized because every house and every borrower were different.

As Louis Pasteur once said, “Chance favors the prepared mind.”¹² I was sitting in my office in 666 Barrows Hall (the office number was the butt of a lot of jokes related to my work on futures), reading The Wall Street Journal in late 1971, when I saw an ad by First Boston advertising its role in the new Ginnie Mae (GNMA) market. I had been following the creation of the security but until then dismissed it as a solution to standardization because the market was too small and was of less interest to the S&L industry. If a leading investment bank was advertising, however, it must have meant that the market was growing and that there was perhaps enough supply to warrant a futures market. I called the number in the ad to ask for a brochure. I was connected to a helpful GNMA salesman who not only got me a brochure but personally delivered it to my office two weeks later. We spent about an hour together and then went to lunch on Telegraph Avenue. It seemed that he, like most Americans, had the images of hippies and antiwar protests burned into his mind from the media. He soon supplied me with GNMA data and introduced me to a GNMA trader at the desk. There began the story of the introduction of the first financial futures, all done on notes taken in a Chinese restaurant on Telegraph Avenue.

Chicago Calls

I received some surprising news in the fall of 1971. The Chicago Board of Trade had hired an executive search firm to head up a new planning department. The existing planning department had been working on establishing what would become the Chicago Board Options Exchange (CBOE), and the entire department were leaving the CBOT in order to manage the CBOE. There was a need to develop a new department from scratch, and my name had surfaced during the executive search.

I had no idea about this when the phone rang. “This is Warren Lebeck,” the caller said. “Remember when we spoke after I lectured at your class in Berkeley? I asked you if you'd ever leave the academic world, and you said, ‘Only if the chief economist post at a major financial institution opened up.’ Well, it's opened up now.” He proceeded to ask me if I was interested in becoming the head of the new Department of Economic Research and Planning at the CBOT. I told him that this was the opportunity of a lifetime and it was a great honor to be considered for the position. I was ecstatic.

Unbeknownst to me, I gained another endorsement from the CBOT management team. The director of education had flown to Berkeley to ask me to write a booklet on speculation, the purpose of which was to create well-versed speculators and educate traders on the supply and demand dynamics in the grain markets.¹³ The director had done his due diligence on my credentials and gave a ringing endorsement to Warren.

Warren wanted me to come to Chicago as soon as possible, hoping that I could get an early lead in the search. Ellen and I flew to Chicago in early 1972. I met with Henry Hall Wilson first, a charming Southerner. Henry had served President Kennedy in the White House as liaison to the House of Representatives, and exemplified the President's New Frontier team. He was convinced that a research and development department was needed to modernize the exchange and professionalize its staff.

I explained to Henry the vision of the agricultural exchange and continuing his push for new futures products. Henry had been a large supporter of CBOE, and mortgage interest rates and reinsurance futures fascinated him. Phil Johnson, an attorney with Kirkland and Ellis, also sat in on the meeting to provide legal counsel to the CBOT. Phil served as more of a consigliere for Henry and the small management team. Henry relied on him for much more than legal insight, valuing his opinion on almost all matters. Next, I spoke to Henry about Walter Heller, a professor at the University of Minnesota. Walter was the chairman of the Council of Economic Advisors under President Kennedy and, like Henry, was also part of the New Frontier. This proved to be an icebreaker.

It was a grueling day, though the numerous meetings with other members from the board of directors appeared to go well. But then, of course, I had also mistakenly thought that the presentation for the CCARP report had gone well.

In between meetings, Henry, Phil, and I met Ellen for lunch at the Union League Club. A small problem arose when Henry told me that Ellen would have to go through the woman's entrance on the side door in order to meet us in the lobby. This spelled trouble. Ellen had been the founding member of the Berkeley chapter of the National Organization for Women in the 1960s. In the end, she entered the lobby through the front entrance and in doing so, became one of the first women to walk into the club's entrance unaccompanied by a man.

Shortly after, we flew back to Berkeley where I waited to hear from the exchange. As advised by some colleagues, I had planned a sabbatical year. A prestigious position such as chief economist at the Chicago Board of Trade would surely favor the case for my tenure. My desire was to return to the academic world once I had established the new department at the CBOT—a dilemma that I would have explain to Warren. Although my heart was set on moving to Chicago, I had alternatives if the offer was not made.

I received an offer letter two weeks later outlining my responsibilities at the exchange and reflecting the vision I had for the department. It included developing new products, revising existing contracts and long-term strategic plans, serving as chief economist, and being a spokesperson on these matters for the exchange.

Now came the tough part. I explained to Warren and Henry that I wanted to have the option to return to Berkeley at the end of the first year. It could kill the deal, but I wanted to give it a try. In return, I promised to build a fully functional research and planning department within a year, and swore that I would not leave until this was accomplished. Berkeley too was prepared to move forward with the understanding that I would be taking a sabbatical.

I told my colleagues about the offer, and went home to celebrate. Ellen and I took the kids to our favorite Chinese restaurant. The kids had their usual guō tiē, which Julie chewed and Penny gummed. I had never felt more relaxed than during that day and the several months thereafter. It was like being between jobs. I had mentally left behind my position on the faculty and had no full-time responsibilities yet at the exchange.

I signed my employment contract in May 1972 without the advice of an attorney, as I couldn't really afford one. The contract specifically said that any new products I developed would be the property of the exchange. Furthermore, I was forbidden to write about my work until years after it was done. This was consistent with what I knew about professional inventors and scientists at industrial companies, and I was unfazed. We agreed that I would begin consulting immediately and start full time as vice president and chief economist on July 1, 1972. This was the high point of my life to date and I was brimming with excitement.