Remembering the magical recovery of the Dow Jones Industrial Average (DJIA) on April 20, when it touched the 10,000-point mark for a few seconds before magically bouncing off and opening about one percent higher the next day, I still cannot suppress the feeling that other than only market forces were at work to prevent a fall below the psychologically extremely important five-figure mark in the current period of exploding deficits, accelerating inflation, stagnant private sector employment and slowing GDP growth projections.
John Embry and Andrew Hepburn from Toronto-based, well-reputed Sprott Asset Management have recently come up with a disturbing piece of research "Move Over, Adam Smith: The Visible Hand of Uncle Sam" (pdf) that fuels lingering skepticism whether US capital markets are driven by expectations of private investors and their asset managers only.
Executive Order No. 12,631 gave birth to the PPT
While the authors would not have needed to get the existence of the PPT confirmed by former Clinton adviser George Stephanopoulos as it was officially born as the "Working Group on Financial Markets" by Ronald Reagan's presidential executive order no. 12,631 in 1988, they raise well-founded concerns that the PPT has been intervening on Wall Street multiple times. The Treasury website hosts pictures of PPT members Treasury secretary John Snow and Fed chairman Alan Greenspan, the other two heads of the group being the acting chairmen of the Securities Exchange Commission (SEC) and of the Commodity Futures Trading Commission (CFTC).
Excuse me for omitting the links but I am currently blogging via modem connection. But a search of the Treasury's site for the "Working Group on Financial Markets" reveals several dozen documents, none of them very informative though.
The press has been rather silent about the PPT too, all the while this group has been meeting on a regular basis. The Washington Post published the most extensive article on the PPT in 1997, followed by a report in the British Guardian on September 16, 2001 and one in the Financial Times on February 21, 2002. Embry and Hepburn also refer to John Crudele's writings in the tabloid New York Post and "The Texas Hedge Report" from December 2004.
In their introduction they write
"Most people probably assume that the U.S. stock market is free of government interference. It is acknowledged that the bond and currency markets are influenced by policy-makers, but equities are considered different territory altogether. Current mythology holds that share prices rise and fall on the basis of market forces alone.They admit that
Such sentiments appear to be seriously mistaken. A thorough examination of published information strongly suggests that since the October 1987 crash, the U.S. government has periodically intervened to prevent another destabilizing stock market fall. And as official rhetoric continues to toe the free market line, manipulation has become increasingly apparent.Almost every floor trader on the NYSE, NYMEX, CBOT and CME will admit to having seen the PPT in action in one form or another over the years."
much of the information is evidence of intent to intervene, rather than proof of manipulative activities themselves. This amounts to a distinction without a significant difference. That the government has given such serious consideration to supporting the stock market demonstrates its willingness to cross an important line, violating the traditional American belief in unfettered markets. It underscores the notion that the health and stability of the market represents an integral part of national security, thereby justifying government action when financial peril looms.Provocative Conclusion: The Market Is Rigged
In their foreword the authors come to the following provocative conclusion:
We believe we can establish that the government has intervened in the stock market. What we cannot outline with any degree of certainty are many of the details, nuances, twists and turns of such activities. This is due to the utter lack of official disclosure of market interventions.The Drop Of '89
Embry and Hepburn open their case with the drop of October13, 1989, when the Dow plunged 130 points or 6.9 percent in the wake of the collapse of United Airlines management takeover bid.
Treasury Secretary Nicholas Brady acknowledges that an unprecedented 48-hour whirlwind of meetings and phone calls took place that weekend, involving major stock, option and futures exchanges, brokerages, big institutional investors, the Federal Reserve, foreign central banks, the Securities and Exchange Commission and the Commodity Futures Trading Commission.
The following monday a futures-induced rally helped prevent a further plunge, the research paper claims.
It backs its doubts about a free stock market with quotes from former Fed governor Robert Heller who suggested in a Wall Street Journal article,
the Fed's stock market role ought not to be very ambitious. It should seek only to maintain the functioning of markets, not to prop up the Dow Jones or New York Stock Exchange averages at a particular level. The Fed should guard against systemic risk, but not against the risks inherent in individual stocks. It would be inappropriate for the government or the central bank to buy or sell IBM or General Motors shares. Instead, the Fed could buy the broad market composites in the futures market. The increased demand would normalize trading and stabilize prices. Stabilizing the derivative markets would tend to stabilize the primary market. The Fed would eliminate the cause of the potential panic rather than attempting to treat the symptom, the liquidity of the banks.Strong stuff, indeed.
The doubting couple at Sprott produce further ammunition from NY Post stories done by Crudele.
In a 1992 article, John Crudele quoted someone who maintained strong connections in the Republican Party as stating that the government intervened to support the stock market in 1987, 1989 and 1992: Norman Bailey, who was a top economist with the government's National Security Council during the first Reagan Administration, says he has confirmed that Washington has given the stock market a helping hand at least once this year.A Treasury-Fed Split?
People who know about it think it is a very intelligent way to keep the market from a meltdown," Bailey says. Bailey says he has not only confirmed that the government assisted the market earlier this year, but also in 1987 and 1989.
Now a Washington-based consultant, Bailey says the Wall Street firms may not even know for whom they are buying the futures contracts. He says the explanation given to the brokerage firms is that the buying is for foreign clients, perhaps the central banks of other countries.
The authors go on to highlight that Fed chairman Greenspan always denied any direct intervention in the stock market by the Fed itself.
But Greenspan had hinted that the Treasury could be following a different agenda, responding to questions about market interventions during the Mexico debt crisis of former St. Louis Fed president Tom Melzer with this cryptic answer,
"I seriously doubt that, Tom. I am really sensitive to the political system in this society. The dangers politically at this stage and for the foreseeable future are not to the Federal Reserve but to the Treasury. The Treasury, for political reasons, is caught up in a lot of different things."At the March 28, 1995, FOMC meeting Greenspan is quoted about the relationship of the Fed towards the Treasury and the stock market,
"We have to be careful as to precisely how we get ourselves intertwined with the Treasury; that is a very crucial issue. In recent years I think we have widened the gap or increased the wedge between us and the Treasury.... In other words, we have gone to a market relationship and basically to an arms-length approach where feasible in an effort to make certain that we don't inadvertently get caught up in some of the Treasury initiatives that they want us to get involved in. Most of the time we say 'no'."The Sprott team interpretes these words with the perspective that
"these passages obviously suggest that by 1995 the Treasury was engaging in activities that Greenspan deemed politically dangerous and, accordingly, with which he was very reluctant to be associated. It is only logical that these actions had not been disclosed publicly by the time he made these two statements. Had they been public, the Treasury would have already suffered the consequences of the political dangers of which Greenspan spoke.<>Greenspan Hated To Be On The Record
Greenspan revealed what looks to have been a major split between the central bank and the executive branch of government. He spoke of having "widened the gap" between the Fed and Treasury, taking their relationship to a market-based one. This "arm's-length approach" was likely the Fed's attempt to preserve its credibility if the Treasury's initiatives resulted in a political storm. Whatever Treasury was up to sounds rather questionable, judging by Greenspan's explicit statements about political dangers and also his implied worry that the central bank could "inadvertently get caught up in some of the Treasury initiatives that they want us to get involved in."
He seems to have fretted that even the appearance of the Fed's participation in these activities could be politically toxic for a central bank that prides itself on independence. Precaution thus appears to have been the Fed's approach when dealing with the Treasury. Of course, according to Greenspan, the Fed only said no to the Treasury most of the time, indirectly admitting that in at least some instances the central bank participated in the unspecified initiatives.
We do not know what these initiatives were and, indeed, Greenspan's frustrating ambiguity suggests he was cognizant of the fact that his words were being recorded. So we are left to speculate. It's a reasonable assumption that whatever the Treasury was doing was market-related. This likelihood is indicated by the Treasury's apparent attempts to include the Fed in the initiatives. The central bank is not responsible for fiscal policy, so logically its only use to the Treasury would be to execute or participate in some market-related transactions. This is further corroborated by Greenspan's comment that the Fed had moved to a "market relationship" where feasible with the Treasury. That statement suggests that the Fed had to conduct at least some of the initiatives on behalf of the Treasury.
At this point we return to the Exchange Stabilization Fund (ESF), which is controlled by the Treasury Secretary. According to the New York Fed's website, "ESF operations are conducted through the Federal Reserve Bank of New York in its capacity as fiscal agent for the Treasury." As a result, it is easy to see how the Fed could become entangled in questionable Treasury initiatives.
Speaking of such endeavours, at the January 31, 1995, meeting the Federal Reserve's general counsel revealed that the ESF conducted previously undisclosed gold swaps, and, while not spelling out the crucial details, a close reading of the transcript suggests they were recent transactions. Six years later, in an apparent cover-up, that same lawyer would claim not to know of any such dealings. But gold was probably not the only area in which the ESF dealt covertly. According to Greenspan, as of 1995 the Treasury was caught up in not one or a few, but "a lot of different things." While only speculation, it is certainly possible that the Treasury used the ESF for stock market interventions that the central bank deemed unnecessary. If so, the Fed would logically have been concerned that its participation could draw criticism if such a scheme were revealed.
Responsibility To Prevent Major Market Disruptions
At this point I recommend to my readers to download the whole 41-page research paper (link at the beginning of this post which lists countless other goodies like this excerpt from a Greenspan-speech from November 1996, repeated in January 1997.
He declared that
"governments, including central banks, have been given certain responsibilities related to their banking and financial systems that must be balanced. We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstances, through direct intervention in market events. But we also have the responsibility to ensure that private sector institutions have the capacity to take prudent and appropriate risks, even though such risks will sometimes result in unanticipated bank losses or even bank failures."
I hope to have whetted your appetite for this highly interesting paper that tells of financial war games, dives into the response to 9/11and claims that the whole concept of the PPT is a brainchild of Fed governor Heller.
From The LTCM Crisis To The Iraq War
The Sprott paper also covers the dealings following the crash of Long Term Capital Management (LTCM) and secret agreements between the USA and Japan before the invasion of oil-rich Iraq.
The View From Now
And here come the last four pages of conclusions from this report that should make everybody think twice whether the stock market is really a free market or a matter of national interest to the nation with the highest debt on record in mankind's history.
The road to Baghdad in March 2003 may represent the last planned stock market intervention that we can identify, but our suspicions linger on to the present day. Displaying markedly low volatility, the Dow hovers comfortably above the 10,000 mark. Yet with severe trade and budget deficits, rising interest rates and stubbornly high oil prices, the reasons to be bearish on U.S. equities are numerous. Strangely, the market has an uncanny ability to maintain its footing when serious declines threaten. Given the historical backdrop of U.S. government activity in the market, this curious trading activity is suspicious to say the least. Indeed, it is our belief that market intervention continues and has actually increased in intensity.Worrisome Implications
For a possible explanation of why this may be happening, we turn to a rather extraordinary article that appeared in the Financial Times in March 2002. After noting the public revelation that the Federal Open Market Committee considered unconventional policy measures at its January 2002 meeting to cope with a possible deflation, the story revealed that a senior Fed official who attended the meeting said the reference to "unconventional means" was "commonly understood by academics."
The official, who asked not to be named, would not elaborate but mentioned "buying U.S. equities" as an example of such possible measures, and later said the Fed "could theoretically buy anything to pump money into the system" including "state and local debt, real estate and gold mines, any asset."
The Fed's aggressive easing of monetary policy after the tech bubble burst no doubt helped stave off a potential lapse into deflation. But the threat remains. As Myles Zyblock, Chief Institutional Strategist of RBC Capital Markets, recently commented:
Global policymakers are facing one of the most challenging backdrops in decades. The combination of excessive credit creation and extremely low inflation creates a potentially lethal mixture that, if left unchecked, could undermine the financial system and the economy. We need only to remind ourselves of the huge run-up in debt and the impact of its subsequent collapse on the economies of the U.S. in the 1930s and Japan in the 1990s to recognize the risks inherent in the present situation.
The U.S. lies at the heart of this new danger.... [T]otal debt (i.e., foreign, private and government) has risen 70 percentage points since the mid-1990s to about 307% of GDP - an all-time high! At the same time, inflation is hovering near a multi-decade low. A debilitating debt-deflation in this overleveraged economy is a possibility. The authorities have learned from the mistakes made by their predecessors and have embarked upon one of the most aggressive reflationary campaigns in post-war history in the hopes of producing strong tailwinds in order to thwart the risks.
Many people have noted that the Federal Reserve Act does not explicitly permit the central bank to purchase equities. Nevertheless, the significance of the statement in the Financial Times article by the anonymous Fed official should not be downplayed. For an organization not prone to unauthorized leaking, it is reasonable to assume that, much like the 1997 Washington Post story about the Working Group on Financial Markets, this remark about "buying U.S. equities" was not made without regard to the consequences of such a disclosure. In other words, as David Tice of the Prudent Bear Fund observed in 2003: "It would be naive in the extreme to assume that a central bank notorious for its supine treatment of markets would be insensitive to the effect the news of these (FOMC) deliberations would have on the equity market." He continued by arguing that any support lent to the market would likely remain covert providing that a sufficiently large critical mass of fund managers understood that there were support mechanisms at work in the market. The references to "unconventional measures" in the FT article help to create this "understanding."
Such an implicit understanding on the part of these managers would facilitate their ability to trade on the back of periodic covert interventions, thereby supporting government objectives. In these circumstances, policy makers would likely do nothing to disavow such a belief (and might in fact quietly encourage it), since the herding dynamics of these portfolio managers would enhance the authorities, objective of supporting the market. Only after this option has proved wanting would the authorities move to explicit intervention.
Why explicit? The public does not react to inferences and hidden coded messages by America's leading policy makers in the way in which a professional fund manager well attuned to the vagaries of the market would.
Tice concluded by noting a worrisome implication of the Financial Times article:
The FT disclosure is particularly ironic given that just last week the Fed chairman again professed his belief in market forces as the best means of curtailing weaknesses in the corporate governance exposed by the collapse of Enron. An incredible statement coming from a man who has become synonymous with the perversion of the very free market forces he regularly extols. Has any other central banker ever had a put named after him? But Mr. Greenspan and his colleagues seem dead keen to establish moral hazard precedents as far as the eye can see, leaving the rest of us to deal with its exceptionally messy consequences when these "extraordinary measures" stop working.Conclusion
The authors conclude - and I feel tempted to completely agree with them:
Given the available information, we do not believe there can be any doubt that the U.S. government has intervened to support the stock market. Too much credible information exists to deny this. Yet virtually no one ever mentions government intervention publicly, preferring instead to pretend as if such activities have never taken place and never would. It is time that market participants, the media and, most of all, the government, acknowledge what should be blatantly obvious to anyone who reviews the public record on the matter: These markets have been interfered with on numerous occasions. Our primary concern is that what apparently started as a stopgap measure may have morphed into a serious moral hazard situation, with market manipulation an endemic feature of the U.S. stock market.No Level Playing Field
We have not taken a position on the wisdom of intervention in this paper, largely because exceptional circumstances could argue for it. In many respects, for instance, the apparent rescue after the 1987 crash and the planned intervention in the wake of September 11 were very defensible. Administered in extremely small doses and with the mostsafeguards and transparency, market stabilization could be justified.
But a policy enacted in secret and knowingly withheld from the body politic has created a huge disconnect between those knowledgeable about such activities and the majority of the public who have no clue whatsoever. There can be no doubt that the firms responsible for implementing government interventions enjoy an enviable position unavailable to other investors. Whether they have been indemnified against potential losses or simply made privy to non-public government policy, the major Wall Street firms evidently responsible for preventing plunges no longer must compete on anywhere near a level playing field. It is most unfair that the immensely powerful have been further ensconced in their perched positions and thus effectively insulated from the competitive market forces ostensibly present in our society.
In addition to creating a privileged class, the manipulation also has little democratic legitimacy in the sense that the citizenry has not given its consent. This has tangible ramifications. By not informing the public, successive U.S. administrations have employed a dangerous policy response that is subject to the worst possible abuse. In this regard, the line between national necessity and political expediency has no doubt been perilously blurred.
We can only urge people to see what the evidence indicates and debate what is and ought to be a very contentious matter. The time for such a public discussion is long overdue.