August 3, 2009
At a time when states and municipalities are going broke, foreclosures are on the rise and bankruptcies are skyrocketing, it’s nice to know that the Federal Reserve keeps coming up with new and inventive ways to enrich the investment banks on Wall Street.
I’ve often discussed the involvement of the Federal Government in “propping up” (manipulating) the stock markets since the onset of the financial crisis, nearly one year ago. The so-called “Plunge Protection Team” or PPT was created during the Reagan administration to prevent stock market crashes after the October 19, 1987 event. Although the PPT has been called an “urban myth” by many skeptics, there is plenty of documentation as to its existence. Its formal name is the Working Group on Financial Markets. It was created by Executive Order 12631 on March 18, 1988, which appears at 53 FR 9421, 3 CFR 559, 1988 Comp. You can read the Executive Order here. Much has been written about the PPT over the years since 1988. Brett Fromson wrote an article about it for The Washington Post on February 23, 1997. Here is a paragraph from that informative piece:
In the event of a financial crisis, each federal agency with a seat at the table of the Working Group has a confidential plan. At the SEC, for example, the plan is called the “red book” because of the color of its cover. It is officially known as the Executive Directory for Market Contingencies. The major U.S.stock markets have copies of the commission’s plan as well as the CFTC’s.
In October of 2006, two years before the financial meltdown, Ambrose Evans-Pritchard wrote an interesting piece about the PPT for the Telegraph. Here’s some of what he had to say:
The PPT was once the stuff of dark legends, its existence long denied. But ex-White House strategist George Stephanopoulos admits openly that it was used to support the markets in the Russia/LTCM crisis under Bill Clinton, and almost certainly again after the 9/11 terrorist attacks.
“They have an informal agreement among major banks to come in and start to buy stock if there appears to be a problem,” he said.
“In 1998, there was the Long Term Capital crisis, a global currency crisis. At the guidance of the Fed, all of the banks got together and propped up the currency markets. And they have plans in place to consider that if the stock markets start to fall,” he said.
Back on September 13, 2005, The Prudent Investor website featured a comprehensive report on the PPT. It referenced a paper by John Embry and Andrew Hepburn. Here is an interesting passage from that essay:
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.
The conclusion reached in The Prudent Investor‘s article raises the issue of moral hazard, which continues to be a problem:
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.
That point brings us to the situation revealed in a recent article by Henny Sender for the Financial Times on August 2. Although, the PPT’s involvement in the equities markets has been quite low-profiled, the involvement one PPT component (the Federal Reserve) in the current market for mortgage-backed securities has been quite the opposite. In fact, the Fed has invoked “transparency” (I thought the Fed was allergic to that) as its reason for tipping off banks on its decisions to buy such securities. As Mr. Sender explained:
The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.
However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.
The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage. Barclay’s, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.
“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”
A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”
* * *
Larry Fink, chief executive of money manager BlackRock, has described Wall Street’s trading profits as “luxurious”, reflecting the banks’ ability to take advantage of diminished competition.
So let’s get this straight: When Republican Congressman Ron Paul introduced the Federal Reserve Transparency Act (HR 1207) which would give the Government Accountability Office authority to audit the Federal Reserve and its member components for a report to Congress, there was widespread opposition to the idea of transparency for the Fed. However, when Wall Street banks are tipped off about the Fed’s plans to buy particular securities and the public objects to the opportunistic inflation of the pricing of those securities by the tipped-off banks, the Fed emphasizes a need for transparency.
Perhaps Ron Paul might have a little more luck with his bill if he could demonstrate that its enactment would be lucrative for the Wall Street banks. HR 1207 would find its way to Barack Obama’s desk before the next issue of the President’s Daily Brief.
Doubts Concerning The Stock Market Rally
August 6, 2009
As of today (Wednesday night) the current “bear market rally” continues to surprise people with its longevity. On the other hand, many news outlets, including The Washington Times and CNBC are declaring a “New Bull Market”. There seems to be no shortage of commentators proclaiming that the market indices will continue to climb forever.
Back on planet earth, there is a good deal of commentary about the suspicious activity behind this rally. In my last posting, I discussed the “Plunge Protection Team” or PPT. Rather than repeat all that, for the benefit of those unfamiliar with the PPT, I will quote the handy definition at the Hamzei Analytics website:
Many of us have looked to the PPT as the driving force behind this rally. News sources have claimed that the rally is the result of money “coming into the markets from the sidelines” — implying that crisis-wary investors had finally thrown caution to the wind and jumped into the equities markets to partake in the orgy of newfound wealth. The cash accumulating in the investors’ money market accounts was supposedly being invested in stocks. This propaganda was quickly debunked by the folks at the Zero Hedge website, with the following revelation:
Similar skepticism was voiced by Karl Denninger of The Market Ticker website:
Many commentators, including Joseph Saluzzi of Themis Trading, have explained how the practice of computer-driven “High-Frequency Trading” has added approximately 70 percent of “volume” to the equities markets. This is accomplished because the exchanges pay a quarter-of-a-penny rebate to High-Frequency Trading firms for each order they place, waiving all transaction fees. As a result, the “big boy” firms, such as J.P. Morgan and Goldman Sachs, will make trades with their own money, buying and selling shares at the same price, simply for the rebates. Those pennies can add up to hundreds of millions of dollars.
I recently came across a very interesting paper (just over eight pages in length) entitled: A Grand Unified Theory of Market Manipulation, published by Precision Capital Management. The paper describes a tug of war between Treasury Secretary Ben Bernanke and the New York Fed, that is playing out in the equities and Treasury securities markets. The authors suggest that if Bernanke’s biggest threat is high long-term Treasury yields (interest rates), the easiest way to prevent or postpone a yield ramp would be to kill the stock market rally and create a “flight to safety in Treasuries” – situation that lowers long-term yields. The paper describes how the New York Fed facilitates “painting the tape” in the stock markets to keep the rally alive. For those of you who don’t know what that expression means, here’s a definition:
Instead of accusations that the PPT is the culprit doing the tape painting during the final minutes of the trading day, we again see a focus on the New York Fed as the facilitator of this practice. Here’s the explanation given in the paper by Precision Capital Management:
As for the all-important question of how the authors expect this to play out, they focus on what might happen at the market close on August 5:
What we saw on Wednesday afternoon was just that. At approximately 3 p.m. there was an effort to push the S&P 500 index into positive territory for the first time that day, which succeeded for just a few minutes. The index then dropped back down, closing .29 percent lower than the previous close. Does this mean that a market correction is underway? Time will tell. With the S&P 500 index at 1002 as I write this, many experts consider the market to be “overbought”. Fund manager Jeremy Grantham, who has been entrusted to invest over $89 billion of his customers’ hard-inherited money, is of the opinion that the current fair value for the S&P 500 should be just below 880. Thus, there is plenty of room for a correction. The answer to the question of whether that correction is now underway should be something we will learn rather quickly.