Where to begin?
Let’s start with the Donner is a lunatic -- must be wearing TV rabbit-ears-wrapped-in aluminum-foil inter-galactic communications gear to guide the Martian spacecraft to a rendezvous with the black helicopters to plot the takeover of the NYSE-- crowd.
I take it from the general tone of hilarity, incredulity and truly cutting edge wit expressed by certain members of the Board that there is a fairly large majority of opinion here that the idea that your U.S. Government would organize a secret public/private team within the Treasury Department to intervene in the equity markets at times of crisis perceived to be a threat to national security is an absolutely ludicrous, absurd, impossible, and , frankly, preposterous proposition. Couldn’t happen, never happened and isn’t happening right now. Only a real fruit cake waiting for the spaceships to land would even contemplate the possibility. Is that about right?
Hhmmmm.
Let’s, for a moment, accept your contention that such an operation does not, in fact, exist.
The Administration at this very moment is being excoriated for a perceived lack of preparation, leadership, and slow-footed response to a natural disaster. Imagine the outcry (from your crowd) in the event of a man-made disaster in the financial markets. I watched a PBS special on the anniversary of 9/11 last night. One of the haunting lines was, “It took 10 years to build the towers and 10 seconds to bring them down.” Apply that to the nation’s savings (what’s left of them) built into the edifice of the equities markets. A whole lifetime of working and saving to build them up, only to be destroyed in ten minutes or ten hours by a panic or financial attack by an adversary. There goes your precious FIRE and your LBYM retirement. Back to ****! You same bunch of witty guys would be in a blood frenzy howling for scalps.
If, as you so jocularly advance, there is no Plunge Protection Team, it seems to me there certainly ought to be one. Dereliction of duty not to have one. The problem is, the devil is in the details.
Now let’s, for a moment, concede the possibility, not to say the certainty, that such an operation exists somewhere inside the Government, as the Canadians contend. I agree it remains to be confirmed, or denied, by the Fed and the Treasury. But let’s – just for a moment -- say it exists. What are the implications, both beneficial and problematic, associated with such an operation?
The benefits are pretty straightforward. Protect and defend. Security. Save the savings. Maintain continuity of markets. Foil the enemy – Al Quaeda, the Chinese, the French? Fill in the blank. Boy Scout motto: Be Prepared. Sounds nice.
What are some of the problematic issues?
Well, there a number of philosophical issues, which I thought this bunch would leap at, concerning the relationship, duties and responsibilities of the State toward the People and the People toward the State. Does the State have the duty and responsibility to secretly intervene in the private, legal, commercial affairs of individuals and organizations in the name of national security? I believe Vladimir Putin would certainly endorse that concept in Russia. Do we endorse it here? Private property. Property rights. Liberty. Freedom. The freedom to go broke. Does the Government have a duty and responsibility to act tyrannically in private financial affairs in order to preserve Liberty and Freedom and, in the process, save us from ourselves? Do the People bear a duty and responsibility to sacrifice their taxes, savings, and a lifetime of sweat and wealth-building in the defense of Liberty and Freedom as embodied, at least in some perceived critical part, in the maintenance of a continuously functioning stock market? Does it matter whether the People are aware that such sacrifice, large or small as the case may be, is being or may be imposed on them by an informal, secretive public/private Plunge Protection Team? To what degree is our property “private” and to what degree is it an essential component, in aggregate, of “national security”? Who gets to decide?
Let’s consider for a moment this idea of “national security.” Does a 50% plunge in the Dow Jones Industrial Average constitute a threat to national security? Good question.
If the answer is yes, then how about a 40% plunge, a 20% plunge, or a 5% plunge? Who draws the line, and where? What triggers the “protective” secret market intervention manipulation activities of a PPT? Is it a question of “we will know it when we see it”? The Canadians allege that this capacity developed as an ad hoc, thrown together at the last minute, crisis response to the 1987 stock market bust. According to the Canadians, the activity has “morphed” (their word) into an endemic and pervasive aspect of the market. So how often and in what way and to what extent does the PPT intervene? Does a threat to the political stability of an Administration (any Administration) qualify as threat to national security? It might, if you were leading up to an election. Ask the Spaniards.
To what extent does the PPT intervene? Is it just little, mid-course corrections with series of strategically-placed, small, little trades to convey the image of market strength where there really isn’t any at all? Confidence maintenance operations. What was it that Mick Jagger called those little greenies in that song? --“mother’s little helper.” Is that what the markets are getting? A series of mother’s-little-helpers just to keep things pleasantly mellowed out? Isn’t just a little-bitty secret market intervention here and there now and then okay in the name of national security? Like, after a terrible hurricane, or in the wake of speculative oil spikes? Wouldn’t we want to be “proactive” at the first sign of “market weakness” in order to prevent market “sentiment” from getting out of control? Kind of like evacuating NOLA in advance of a Level 5? A little prudent, precautionary intervention in advance of real trouble? Cost effective, that. Requires a continuous presence, but prudent and cost effective. So what’s your problem?
If the Canadians’ description of how the operation works is fairly accurate, then we have additional messy, little administrative questions to consider. Like: who’s getting rich off this? Who’s getting the commissions? Who’s enjoying trading portfolio gains on the basis of insider information? Don’t you think we ought to follow the money here? If the preferred approach, as described, is to avoid direct intervention and employ surrogate private partners to execute Government-inspired intervention strategies, then how do we choose who gets the inside info? Who gets invited to the 5 am conference calls? Are these guys indemnified for losses, or what? Are they simply good patriots putting their own, and their clients’, portfolios on the line for the greater good? Do they have a Martha Stewart exemption? “National Security!” “National Security!” Poor Martha.
One aspect of this that is particularly troublesome to me is that a successful secret market intervention strategy focused on the index futures markets necessarily pits one group of Americans against another. There are winners and losers. For every seller there is a buyer. Short sellers are a particular group that would be in the crosshairs of the PPT.
The strategy in 1987 as described by the Canadians was to foment a massive short squeeze by bidding up the depressed futures contracts to a premium relative to the underlying shares. The shorts were ambushed by the Feds. The idea is kinda like shooting the last cow in the herd in the rear end to start a stampede. A small expenditure of lead resulting in a very big reaction indeed. Arbitrageurs swooped into the market scrambling to buy the underlying shares at a discount to the futures price and selling the futures to that willing buyer, the U.S. taxpayer. Printing money. Shooting fish in a barrel. And it apparently worked very well. Somebody on the other end of those Fed trades got very rich indeed. The underlying shares stopped plunging, turned on a dime, and stampeded higher on a “sudden change in market sentiment.” Right. So, some folks got hurt badly by doing what comes natural in a free market environment. Sacrifices have to be made. Collateral damage, so to speak. National Security. Ugly.
Somebody on the Board asked the question, what about my MSFT and the Tech bust in 2000-2003? Where was your PPT then, Donner, huh? Good question. Let’s go back to the Volker days for a moment. Volker perceived a “threat to national security” ( though I doubt that he ever expressed it that way) from stagflation. In Texas there is purported to be an acceptable murder defense plea that runs along the lines, “I killed him ‘cuz he needed killin’!” Volker put the country through a wringer, shrinking the money supply, choking off the fuel of inflation, and drafting into the service of that cause what McCulley calls the “army of the unemployed” in the process. Collateral damage. A necessary sacrifice. Unwilling draftees every one, including yours truly. Worst time of my life. Roll the tape forward to late 1990’s. Greenspan perceives a “threat to national security” (though I doubt he ever expressed it that way) from the Tech bubble. Irrational exuberance, he called it. He stood by and watched it pop. Why? Well, it may have something to do with the notion “it needed killin’!” Casualties? You bet. Including many of you reading these lines. Collateral damage. Necessary sacrifice. Roll the tape forward to today. Greenspan perceives a “threat to national security” (though I know he hasn’t expressed it that way) from a Real Estate Bubble and out-of-whack market valuations. Does it need killin’!? You bet. Will there be casualties? Count on it. Collateral damage. Necessary sacrifice. Along comes Katrina and an oil shock and a President under assault and a trip by Mr. Greenspan to the White House. Change in plan, Maestro. National security. Crank up that PPT, and crank it up now!
Why should any of this be of any concern to anybody on this Board? What’s in it for ER’s and R’s and wannabes? If we have a national policy of propping up the stock market by whatever expedient means in the interest of national security, or political security for any particular Administration, or for any other reason, it alters the calculus
of market valuation. For one thing, you can toss the FIRECALC and 4% SWR thing into the trash can and start all over. We will have to start viewing the environment in terms of Pre-1987 performance and Post-1987 performance -- two different worlds operating under different rules. If there is a floor below which the Market will not be allowed to fall in the name of national security, then I think we can expect a pretty flat trajectory for stock market performance long term going forward – no sharp valleys but no sharp peaks either. Kind of like a line drive to center field. Good, but not great. With rewards for undertaking market risk muted, if not eliminated, price appreciation will refocus on the fundamental values and not on “confidence” or “animal spirit.” No risk, no reward -- that is the essential market calculus. That gas comes out of the balloon. Risk-free becomes more attractive vs. equities. Equity valuations will morph into something that will more closely resemble risk-free, or “near” risk-free, instruments. And “near” risk-free volatility will more closely resemble risk-free volatility. A new trade-off enters the calculation: investors trade performance away for increased security. National security has its cost. Broad market index values will tend to rise in close correlation with whatever the economic growth rate is, and not much more. Individual issues may outperform the economy as a whole, or competitors in its sector. “Business Risk” will come to be a more dominant concern than “Market Risk.” Business Risk is about the only risk Mr. Market is going to pay you to take. Stock picking comes back into vogue. Bogle, Vanguard and Index investing is out. You are going to be paying Bogle not much for not much reward. Discontent will ensue. Warren Buffet and active portfolio management, focused on asset values and earning potential and reasonable Dividend Discount Model expectations, is in. Back to the days of Graham, Dodd and Cottle. You are going to have to pay the stock pickers again to get the performance you think is acceptable. ER heresy.
BUT! And this is a very big BUT! This won’t happen until we have a very significant re-calibration of the relationship between debt and equity markets. And here is where market calculus kicks in. I have been beating the drum here on the ER Board that risk premiums are too low in the market today. Even Greenspan jumped on that as quoted in the OP. In other threads I have elucidated that a high risk premium leads to lower market valuations while low risk premiums lead to higher market valuations. If the markets are not going to be permitted to fall for reasons of national security, then the existing risk premiums are…what? Too high, that’s what! If the Greenspan Put is a reality, then risk premiums likely have got to fall even further and market values will rise -- perhaps in a massive blow-off top -- Alan Greenspan’s worst nightmare. Where will the juice come from to power the market to this blow-off top? Why, from the risk-free sector, that’s where. Why would you settle for 4% risk-free, when you can get 7% “near risk-free”? You will move out of bonds and into equities, moving the risk free rate up while erasing the gap between risk-free and “near risk-free” valuations. Bond portfolios tank, pushing risk-free returns higher while equity values rise, pushing “near risk-free” risk premiums lower, until a new equilibrium, a new calibration, between risk-free bond markets and “near risk-free” equity markets is attained by Mr. Market. Kind of like how thunder is made – bonds and equities rushing toward each other in a mighty thunderous clap of market noise. The Greenspan Put is the lightning that triggers it off. Could be this is the fundamental reason why Richard Russell has turned short run bullish and is advising his clients that they may want to speculate on the S&P 500 in the short run. My comments to Wab in an earlier thread get turned on their head. I told Wab that he had an appetite for risk and he was willing to accept a lot of it to get his hands on future income and dividend streams. And given Wab’s personal inputs, his very low personal discount rate reflecting low risk premiums the market was way undervalued. My risk-averse inputs with a high-risk premium requirement baked in to my personal capitaliztion rate led me to the conclusion that the markets are overvalued. In a PPT world, with a national determination to not let the markets sink, Wab’s inputs are a lot better reflection of sustainable risk premiums than mine. Greenspan’s Fed working to prop up the markets, working for a PPT, may unleash forces they can’t control on the upside. Another equity bubble. In curing one problem, a PPT may create a worse one. Very powerful stuff here.
See, I’m not such a perma bear as many of you think.
What about that 4% SWR? Does that still make sense in a PPT re-calibrated world? Depends. How fast is the economy going to grow in an expensive Post-Peak Oil energy environment? What kind of inflation are we going to experience? How long are you going to live? Be realistic now. If inflation stays “well contained” at, say, a 3% rate and you don’t live too long, and the economy grows at a rapid 4% plus real clip (7 % plus nominal) then your 4% SWR ought to work just fine. In my view, the risk-free world and the “near risk-free” world converge at somewhere around 7%. That would result in a rising line drive to center – base hit. No peaks, but no valleys either, courtesy of your friendly PPT, backed by the taxpayers. Your “near risk-free” diversified asset allocation founded on no-load index funds makes it home with something to spare. Turn the portfolio over to the kids at your demise. If inflation creeps higher, and the economy slows below 4%, and you live a little longer, you might be in a little trouble. A sinking line drive to center stock market performance just might not cut it for you. You might die broke and be a burden to your kids. Nothing wrong with that. I believe that is the exit strategy for some people on the Board anyway. You are going to have to choose between a 6.5% risk-free alternative and a 7% “near risk-free” alternative. Some choice. Is that premium enough to induce you into “near risk-free” equity investments over the long run? You want to stretch a little for that 1/2%? Think rising inflation is going to boost that 7% “near risk-free return? Ask Paul Volker about that. This is what I thought the Board might be concerned about – not wrapping rabbit ears in tin foil.
Is there or isn’t there a Plunge Protection Team operation? Personally, I think there is one. If there isn’t, there ought to be. Defending the integrity of our financial markets is a fundamentally important concern. But I think we are playing with fire if we are doing it secretly with covert market manipulation techniques as the Canadians allege.. I agree with the Canadians that the rules need to be open, above board and transparent. The rules of engagement and the limits need to be clearly spelled out so that all market participants are playing with the same set of assumptions. If defending the Dow Jones Industrial Average is a matter of National Security then let’s defend it. Get authorizing legislation, get the needed appropriations enacted, staff it up with the best and brightest, make sure there is adequate Congressional oversight and let any adversary know we will give as good as we get. Pitting one group of American investors against another, inflicting “necessary sacrifice” on some but not all and enriching a few select insiders along the way is no way to go about the task. Do it through direct action through the front door not through indirection, subterfuge and telling lies to the American people. And make no mistake, there are direct methods that would work to quell panic and defeat an organized attack. The American way.
If a few of us have to tape a pair of rabbit ears to an old football helmet and wrap ‘em in tin foil to alert more people to the dangers of an unaccountable Plunge Protection Team on the loose with good intentions to save us from ourselves then, as for me, please pass the Reynolds Wrap.
Donner
