The Visible Hand

 Is the stock market on the level? There are many investors who, comparing their own paltry returns with overall market performance, get a little paranoid about this, and convince themselves that somebody has to be manipulating the thing.

However, according to a recent report, they may be onto something, if not quite in the ways that they think. Dishonest brokers, greedy, deceitful CFOs, and their henchmen in crooked accounting agencies have gotten plenty of publicity. But the role that government may play in the stock market is seldom even acknowledged, much less openly discussed.

A year ago Sprott Asset Management, a Toronto-based financial services firm, published an exposé of central bank manipulation of gold prices. This August, they followed that up with a paper entitled Move Over, Adam Smith: The Visible Hand of Uncle Sam.

The report, written by the firm's president, John P. Embry, and his assistant, Andrew Hepburn, concludes that the U.S. government has intervened to support the stock market often enough 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."

This is distressing news because, while American investors understand that the government is involved in the bond and currency markets, most like to believe that the value of stocks is driven by market forces alone. Using only publicly available sources, the Sprott team makes its case that this is probably not true. It concludes that the government almost certainly intervened in the stock market on four notable occasions--in 1987, 1989, 1992 and 1998--and may have done so at other times as well. The first was, of course, to stop the bleeding from Black Monday, the following two to prevent a repeat of same, and the last to temper the effects of the LTCM hedge fund crisis. All instances of stabilization probably involved the surreptitious buying of stock index futures, where a little money can go a long way toward reversing price trends in the broader market.

Much of the post-'87 activity was apparently due to the efforts of the so-called "Plunge Protection Team"--a joint executive branch/private sector working group created in the aftermath of the crash and composed of representatives from government, banking, brokerage houses and the exchanges--whose function is to prevent unacceptably large market declines. This shadowy partnership is not officially admitted to by the government, but its existence has been confirmed by former presidential aide George Stephanopoulos and by a former National Security Council economist quoted in the New York Post.

A 1997 Washington Post story described the team this way: "These quiet meetings of the Working Group are the financial world's equivalent of the war room." The Post article, however, stuck to the subject of planning for crises, and avoided the question of whether the team had conducted any real-world interventions. But Stephanopoulos was more direct, saying in a 2001 interview that the team has "kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem."

Chairman Greenspan himself, while denying that the Fed has ever been involved, has addressed the subject on several occasions, using words such as these from late 1996: "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 [italics mine]."

In actuality, though, we probably should be surprised if there wasn't such a group as the Plunge Protection Team, and if it hadn't acted--since the stability of the American stock markets is considered by the government to be a matter of national security, and keeping them in good health is paramount to the country's continued preeminence, if not the financial stability of the entire world.

The Sprott report acknowledges that it cannot state its conclusions with absolute certainty, due to the shroud of government secrecy surrounding the subject (indeed, there is evidence that even the Federal Reserve may not entirely know what the Treasury Department is doing). But that very secrecy is a primary target of the authors' criticisms. Their opinion is that there may in fact be times when government intervention is warranted "in extremely small doses and with the most stringent safeguards and transparency." As examples that were "very defensible," they cite "the apparent rescue after the 1987 crash and the planned intervention in the wake of September 11."

However, they point out, if the government has in the past acted decisively to prevent a terrible financial catastrophe, then why not admit it and even promise to do the same again, should circumstances warrant? We would not like for the answer to be this: The secrecy means that the government is actively involved in tweaking the market on a regular basis, to keep it running by someone's definition of "orderly." Or, worse, for someone's profit.

As the Sprott report concludes, "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 . . . [and] no longer must compete on anywhere near a level playing field.

". . . 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."

The report is highly provocative and we strongly encourage interested readers to check it out in its entirety at http://www.gata.org/SprottReportTheVisibleHand.pdf.

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Posted 11-01-2005 12:09 AM by Doug Casey