Has Executive Order 12631 Effectively Ended the Era of Free Markets?

May 11, 2008

There has been a lot of speculation for many years now that during extreme financial crises, the U.S. Federal Reserve and other entities intervene in free markets from behind the scenes and do not allow free market forces to operate. There are usually two schools of thought that dominate this hotly contested issue. One group of people asserts that free market interference is entirely acceptable because the alternative of allowing free market conditions to create a market crash is not an option. Another group of people asserts that interference in free markets is undemocratic and self-destructive as intervention in free markets do not solve problems but only cover-them up and delay them, thereby only allowing the elite money who truly understand such actions to exit stock markets at the heights of these artificially manufactured rallies while laying waste to the wealth of the common investor when things inevitably fall apart in the near future.

Those that argue that free markets are dead state that free markets ended when U.S. President Ronald Reagan signed Executive Order 12631 into law on March 18, 1988, establishing the Working Group on Financial Markets, known as the Plunge Protection Team (PPT) in more conspiratorial circles. The Working Group’s members consist of the most powerful men in global finance – the U.S. Secretary of the Treasury, the chairman of the Board of Governors of the Federal Reserve, the chairman of the SEC and the chairman of the Commodity Futures Trading Commission. Reagan’s decision to form the Working Group was inspired by Black Monday, a day when U.S. Dow Jones index shed an incredible 508 points, or 22.6% of the index’s value at the time, in a single day.

The Working Group was assigned the mission of ensuring that such an event would never happen again. Instead of addressing the root causes of Black Monday such as money supply growth that encourages the formation of speculative stock market and real estate market bubbles that lead to inevitable crashes, many have contended that the Working Group instead operates by intervening in the free markets to prop up stock markets and real estate markets when bubbles form and threaten to burst, thereby compounding the problems that give rise to these bubbles instead of attacking the root of these problems. Despite a mountain of circumstantial evidence that seems to point to the existence of “propping up” measures, circumstantial evidence is called circumstantial because of the lack of a “smoking gun”.

Still, the circumstantial evidence is overwhelming, as in the case of O.J. Simpson and the bloody gloves. Just as there are still legions of people today that claim that O.J. is innocent despite the mountains of circumstantial evidence primarily because the murder weapon was never found, there will always be legions of people that insist that since free market interference is so un-American and un-democratic that there is no possible way it could happen. In the end, only members of the Working Group themselves will ever know exactly to what extent and how frequently they intervene in free markets. But do I think O.J. murdered his wife and that various financial entities interfere in free markets? The answer and reasoning for my answer to both questions is the same. Yes – because the circumstantial evidence is overwhelming.

In recent years, members of the Working Group themselves and high-level government officials have directly fueled the rampant accusations that free markets no longer exist. In 1989, former Board Member of the U.S. Federal Reserve Robert Heller stated: “instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying market averages in the futures market, thus stabilizing the market as a whole.” On January 14, 1997, former U.S. Federal Reserve chairman Alan Greenspan, during a speech delivered in Leuven, Belgium, stated the following: “We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstance, through direct intervention in market events.”

Later that same year, in February of 1997, Washington Post journalist Brett Fromson stoked the fires of these supposed manipulative free-market intervention schemes by reporting that a government official who attended Working Group meetings told him that: “The government has a real role to play to make a 1987-style sudden market break less likely. That is an issue we all spent a lot of time thinking about and planning for. You go through lots of fire drills and scenarios. You make sure you have thought ahead of time of what kind of information you will need and what you have the legal authority to do.” Fromson reported that other unnamed Working Group officials told him that their mission “would be to keep the markets operating in the event of a sudden, stomach-churning plunge in stock prices — and to prevent a panicky run on banks, brokerage firms and mutual funds.”

Fromson also reported that of the four bodies that constitute the Working Group, that all pay deference to the U.S. Federal Reserve’s wishes because the Feds are the only entity that can create money. Given the very secretive nature of the Working Group’s meetings, of which minutes of their meetings are never made available for public scrutiny, the admission of various Working Group members and their high level associates that they would directly interfere in free markets if necessary is quite curious when you consider that they unilaterally deny ever executing such interventions whenever questioned about specifics.

So why would they publicly admit to considering intervening in free markets when “necessary” but always deny that they actually participate in such interventions when pressured to disclose their specific actions?   Here is what I think is going on. In financial markets, mere words alone are sufficient to move markets quite significantly as former Chairman of the Federal Reserve, Alan Greenspan, aptly demonstrated numerous times during and even after the end of his reign. I believe that the Working Group’s goal is to boost investor confidence in flailing stock markets by leaking hints that any time the markets are on the brink of failure, they will intervene to prop up stock markets. Just the belief that there is a fail safe net waiting to catch them is often sufficient to propel the thundering sheep herd of investors to irrationally bid the stock market higher and cause markets to rally in the face of horrendous underlying fundamentals as we have witnessed in the past couple of months. So the first preference of the Working Group would be to not intervene at all and simply use rhetoric to move stock markets in their preferred direction, and thus, the reason for the numerous apparent “slips of the tongue” by its various members over the years. Then, if well-timed planted stories prove insufficient to prop up stock markets, only then will they perhaps consider implementing a series of actions, both out in the open and from behind-the-scenes, to prop up stock markets, as was evidenced by their recent bailout of Bear Stearns.

On September 17, 2000, George Stephanopoulos, a senior political advisor of former U.S. President Bill Clinton, granted the final addition to the growing mound of circumstantial evidence that suggests that the U.S. Federal Reserve routinely interferes in free markets during crises. During an interview on an American TV morning talk show, Mr. Stephanopoulos stated: “Well, what I wanted to talk about for a few minutes is the various efforts that are going on in public and behind the scenes by the Fed and other government officials to guard against a free-fall in the markets….perhaps the most important the Fed in 1989 created what is called the Plunge Protection Team, which is the Federal Reserve, big major banks, representatives of the New York Stock Exchange and the other exchanges and they have been meeting informally so far, and they have a kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem. They have in the past acted more formally. I don’t know if you remember but in 1998, there was a crisis called the Long term Capital Crisis. It was a major currency trader and there was a global currency crisis. And they, with the guidance of the Fed, all of the banks got together when it started to collapse and propped up the currency markets. And, they have plans in place to consider that if the markets start to fall.”

Although some of Stephanopoulos’s comments were not exactly on point as the Working Group was formed in 1988 and not 1989, and the Long Term Capital Management fund dealt with highly leveraged fixed-income arbitrage positions and not currency trading, this admission was still shocking as he revealed that the Working Group’s mandate was indeed to interfere in free markets and to prop up stock markets and currency markets as needed. In the past, I’ve written many articles on my blog, theUndergroundInvestor.com, explaining how easy it would be to manipulate stock markets through the purchase of futures during times when short interest positions are particularly high. During times when short interest positions are high, relatively small amounts of capital could be deployed to create a domino effect whereby short interests would be forced to cover their positions and cause markets to surge much higher on days when they would fall were free-market forces allowed to predominate. Again is this proof that this indeed happens? Of course not. But does it provide an avenue in which to easily manipulate markets from behind-the-scenes? Yes.

I’ve also written about how incredulously easy it would be to interfere in free market behavior in commodity markets and manufacture corrections as necessary to prop up stock markets. Since commodity markets in gold and silver are controlled primarily by day traders that religiously follow technical resistance and support lines, if the U.S. Federal Reserve or a representative of the Commodity Futures Trading Commission were also buying or selling large blocks of futures in these markets to force prices above or below technical support or resistance lines, then these markets would be incredibly easy to manipulate in the short-term as well.

So if the Working Group meddles in free markets, an undoubtedly anti-Capitalism and anti-democratic notion, they could, in theory, by studying the level of short interest positions, very easily pick the best days to intervene to produce a domino effect in which the instigated short interest covering action would artificially manufacture a significant boost to markets. On the surface level, the goals of the Working Group as outlined in Executive Order 12631sound entirely reasonable. Who in their right mind wouldn’t want measures to be implemented to prevent stock market crashes? However, the question that needs answering is how the Working Group achieves this stated mission. If they achieve this through free-market intervention, then questions of legality, ethics and morality would no doubt arise. Again, as I stated at the beginning of this article, no one but the Working Group members themselves will ever know the answer to the questions I have posed in this article. In Part II of this article, I will discuss the anomalies and irregularities in stock market behavior that have occurred just within the past several months that critics of the Working Group point to as “proof” they interfere in free markets. Read part II of this article here.

[tags]the Working Group on Financial Markets, market manipulation, free market interference, the Plunge Protection Team[/tags]

One thought on “Has Executive Order 12631 Effectively Ended the Era of Free Markets?

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top