Alarm Bells Sounded on Wall Street’s Derivatives

By Pam Martens and Russ Martens: February 20, 2018

Andy Green, Managing Director, Economic Policy , Center for American Progress

Andy Green, Managing Director,  Economic Policy Center for  American Progress

On February 14, the week after the Dow Jones Industrial Average experienced two separate days of more than 1,000-point losses, the House Financial Services’ Subcommittee on Capital Markets, Securities and Investment convened a hearing to discuss various legislative proposals to return to the wild west era of derivatives trading on Wall Street. (Many, including Wall Street On Parade, believe that we’ve never left that era – the risks have simply been hidden behind a dark curtain. See related articles below.)

One lonely voice for sanity on the witness panel, which was stacked with industry trade groups, was Andy Green, Managing Director at the Economic Policy Center for American Progress. Green’s written testimony stated that the legislative proposals “slice, dice, or otherwise poke holes – sometimes large holes – in the firewalls placed in the derivatives markets by post 2008 reforms….”

Green also reminded the Congressional members present that the “unregulated OTC derivatives market was at the heart of the 2007-2008 financial crisis, which cost 8.7 million Americans their jobs, 10 million families their homes, and eliminated 49 percent of the average middle-class family’s wealth compared with 2001 levels.”

Green provided a litany of the derivative horrors that led to panic and financial contagion during the financial crisis. The collapse of the giant insurer AIG from credit default swap derivatives and its role as counterparty to some of Wall Street’s largest banks. (In response to the AIG collapse, the U.S. government bailed out the company to the tune of $185 billion. Half of the bailout money effectively went in the front door of AIG and then out the backdoor to the big Wall Street banks and hedge funds that had used AIG as their counterparty to guarantee their bets on Credit Default Swaps.)

Also noted by Green was Lehman Brothers’ “disorderly failure” which “was exacerbated due to the company’s extensive OTC derivatives portfolio.” Green reminded attendees that Lehman “had around 930,000 OTC derivatives contracts at the time of its failure.”

Green then delved back a little further in time: there was the blow-up of the hedge fund Long Term Capital Management in 1998. The firm had $4 billion of net assets but had “used OTC derivatives to increase its total leverage exposure to $1 trillion.” That required the New York Fed to strong arm major Wall Street banks, who were counterparties to the derivatives, to bail it out.

Then, of course, there was Enron, which in 2001 filed the largest bankruptcy in U.S. history up to that time. Green says Enron’s “unregulated energy derivatives were at the center of Enron’s collapse” and it “used OTC derivatives to hide debt, to hide losses, and to speculate.”

What Green mentions only tangentially in his written testimony is that four years after Wall Street had exploded itself with wild derivative gambles, and two years after the Dodd-Frank financial reform legislation was passed in 2010, Wall Street’s largest bank was still unrepentant. In 2012 JPMorgan Chase was caught gambling in exotic derivatives in London in a scandal that became known as the “London Whale.” The bank eventually had to own up to using its bank depositors’ money for hundreds of billions of dollars in derivatives trades while losing a stunning $6.2 billion in the process.

In 2015, the U.S. Treasury’s Office of Financial Research released a report written by Jill Cetina, John McDonough, and Sriram Rajan, which revealed that JPMorgan’s London Whale trades were actually a capital relief trade – an effort to gin up its capital through derivatives. The report stated:

“JPMorgan Chase & Co.’s losses in the 2012 London Whale case were the result of CDS [Credit Default Swap] usage which was undertaken to obtain regulatory capital relief on positions in the trading book.”

Green sums up his pitch against further deregulation of derivatives as follows:

“Financial markets have a strong frequent tendency towards rent-seeking behavior which comes at the expense of the real economy. Regulatory standards are required to ensure transparency and competition that will benefit those in the real economy that would utilize those markets, irrespective of financial stability purposes. Small and mid-sized businesses, family farmers, and others in the real economy are far better served by a simple, robustly regulated market where prices are transparent and competition is meaningful.”

“Rent-seeking behavior” is a more polite phrasing of what Senator Bernie Sanders says is a Wall Street business model of fraud.

Related Articles:

Bailed Out Citigroup Is Going Full Throttle into Derivatives that Blew Up AIG

Citigroup Has More Derivatives than 4,701 U.S. Banks Combined; After Blowing Itself Up With Derivatives in 2008

Two of the Biggest Bailed Out Derivative Banks, Citi and Merrill, Get Fined for Breaking Derivatives Rules

Shhh! Don’t Tell this Bank Regulator We’ve Got a Derivatives Problem

The Contagion Deutsche Bank Is Spreading Is All About Derivatives

U.S. Government Is Now a Major Counterparty to Wall Street Derivatives

Who is Morgan Stanley and Why Its $31 Trillion in Derivatives Should Concern You

Financial System of U.S. Rests on Health of Just Five Mega Banks

Wall Street’s Regulators Move Deeper Into Darkness Under Trump

By Pam Martens and Russ Martens: February 16, 2018

Jay Clayton, Law Partner at Sullivan & Cromwell, Has Been Nominated to Chair the SEC by Trump

Jay Clayton, Chair of the SEC

In towns across America there are laws that prevent government officials from meeting secretly. Typically, the officials must first publish a notice to the public with the date and time of the meeting; circulate the notice in a widely read publication and post the notice on the official website in order to give the public advance notice and the ability to attend the meeting or hearing.

The ability of the U.S. public to attend government meetings; hear firsthand what is being done with taxpayers’ dollars; ask questions about any perceived conflicts that might exist; and file Sunshine law requests for documents is how citizens hold government officials accountable.

When we lose that, we lose the entire concept of America as a country of the people, by the people and for the people. Thus, any effort at all to whittle away at open government laws must be viewed as a dangerous encroachment on democracy.

Tragically, the mainstream media and much of America were so enamored with President Obama’s statesmanship and his status as the first black to sit in the highest office of the United States, that he was able to preach transparency while delivering darkness to a vast part of his government. Under President Donald Trump, the dark curtain has enveloped more and more parts of the Federal government with new details coming out just this week. We’ll get to those details in a moment, but first some necessary background to show that Wall Street Democrats have failed the American people as well as Republicans.

President Obama took office on January 21, 2009. On that very day, he issued an Open Government memo that promised the American people a new era of transparency. On March 19, 2009, under the President’s orders, the Attorney General’s office issued detailed guidelines on how Federal agencies were to respond going forward to Freedom of Information Act (FOIA) requests.  Federal agencies were instructed as follows:

“The key frame of reference for this new mind set is the purpose behind the FOIA. The statute is designed to open agency activity to the light of day. As the Supreme Court has declared: ‘FOIA is often explained as a means for citizens to know what their Government is up to.’ NARA v. Favish, 541 U.S. 157, 171 (2004) (quoting U.S. Department of Justice v. Reporters Comm. for Freedom of the Press, 489 U.S. 749, 773 (1989)…The President’s FOIA Memoranda directly links transparency with accountability which, in turn, is a requirement of a democracy. The President recognized the FOIA as ‘the most prominent expression of a profound national commitment to ensuring open Government.’  Agency personnel, therefore, should keep the purpose of the FOIA — ensuring an open Government — foremost in their mind.”

It was a grand exercise in illusion. For the next eight years, Wall Street On Parade and hundreds of other reporters and nonprofits were denied access to documents and materials that would have allowed us to hold our government accountable.

The most dramatic example of this was the fact that the Federal Reserve Board of Governors, designated an independent Federal agency and subject to FOIA laws, refused for years to respond to media requests for the details of loans it had made to Wall Street firms during the financial crisis. The Fed fought the media in court for years to keep this information secret. Only when it finally lost its court case and Senator Bernie Sanders attached an amendment to the Dodd-Frank financial reform legislation requiring a Government Accountability Office (GAO) Audit of the Fed, did the public learn that the Fed had become a secret government unto itself.

Without the knowledge or approval of Congress, the Federal Reserve had made $16.1 trillion cumulatively in almost zero interest rate loans from 2007 to mid 2010 to bail out the big Wall Street banks and their foreign counterparts. Almost half of that amount, $7.8 trillion, went to just four Wall Street mega banks: $2.5 trillion to Citigroup; $2 trillion to Morgan Stanley; $1.9 trillion to Merrill Lynch; and $1.3 trillion to Bank of America. (See the chart below from the 2011 GAO report for the full list of bailed out banks.)

Mark Pittman of Bloomberg News was one of the reporters who fought the Fed for this information. He died in the midst of this battle at age 52 on November 25, 2009. A year after Pittman’s death, his editor at Bloomberg News, Bob Ivry, wrote about the contemptuous treatment Pittman had received at the hands of the U.S. Treasury. Ivry wrote:

“More than 20 months later, after saying at least five times that a response was imminent, Treasury officials responded with 560 pages of printed-out e-mails — none of which Pittman requested. They were so heavily redacted that most of what’s left are everyday messages such as ‘Did you just try to call me?’ and ‘Monday will be a busy day!’

“Treasury also cited the trade-secrets exemption in responding to a separate, similar FOIA request by Bloomberg News for details about Citigroup’s segregated bad assets. In that response, 73 of 104 pages were completely blacked out except for headings. Only six pages — the cover, contents, a boilerplate list of legal disclosures and a paragraph titled ‘FOIA Request for Confidential Treatment’ — were free of redactions.”

The same year that the GAO released its Fed study on the trillions of dollars loaned to Wall Street, the Occupy Wall Street movement was born with the slogan: “Banks got bailed out, we got sold out.” Details would not come out for years attesting to just how accurate that characterization was. In January 2017 the public learned from another GAO study that the struggling citizens of America had received paltry billions in help during the financial crisis while the corrupt banks that had caused the crisis received trillions. The GAO study showed that as of October 31, 2016 only $22.6 billion had been disbursed to help distressed homeowners.

In 2016 the GAO released a report showing that during the Obama administration lawsuits by persons who were unable to obtain Federal records that they believed belonged in the public domain grew dramatically. In 2008, the last year of Bush’s presidency, 321 Freedom of Information Act (FOIA) lawsuits were filed. By 2014, that number had spiked to 434 lawsuits and registered 456 in 2015, an increase of 42 percent over 2008.

Wall Street On Parade made dozens of requests under FOIA while President Obama was President. We were stonewalled at every turn. We asked the Federal Reserve Bank of New York simply for a photograph of its trading floor. They refused to give us one. We had to spend endless days in order to find them elsewhere. In 2014 we asked the Securities and Exchange Commission (SEC) about how specific Dark Pools operate on Wall Street. They refused our request. In 2010 we asked the SEC to provide us with the names of two Wall Street firms who it had publicly admitted had played a pivotal role in the Flash Crash of May 6, 2010. It denied our request. In 2014 the Office of the Comptroller of the Currency (OCC), the Federal regulator of national banks, denied our FOIA appeal for documents related to JPMorgan Chase carrying life insurance on tens of thousands of its workers with the corporation named as the beneficiary. (See OCC Response to Appeal from Wall Street On Parade Re JPMorgan Banker Death Bets.)

Senator Elizabeth Warren, acting as a watchdog for the public, has consistently been denied access to Wall Street documents. On April 11, 2013, Senator Warren indicated at a Senate hearing that she had been stymied in her attempts to gather documents from the Federal Reserve and Office of the Comptroller of the Currency (OCC) to carry out the Senate’s oversight function. Warren stated:

“Over the last few months, Congressman Elijah Cummings and I have requested documents from your agencies regarding the basic data and the processes of the Independent Foreclosure Review. We made 14 specific requests to you in January, and despite multiple letters back and forth and multiple meetings, you have provided only one full response, three partial or minimal responses, and no response to nine of our requests. You have provided little specific information on what the review actually found, such as the number of improper foreclosures, the amount and number of inflated fees, or the extent of abusive practices by each of the mortgage servicers.”

All of the above occurred under the Obama administration. It’s getting worse under President Trump. Yesterday Bloomberg News reported that the SEC is now settling cases against banks and hedge funds without issuing press releases as it has historically done, ostensibly to save the firms embarrassment and deny the public the ability to see that wrongdoing continues unabated on Wall Street despite the huge fines following the financial crash. Last month, Susan Antilla and Gary Rivlin wrote an in-depth report for The Intercept showing how Trump’s SEC is allowing more secrecy in what Wall Street itself has to report to the public.

Now the U.S. Treasury, headed by the former foreclosure king, Steve Mnuchin, has announced it plans to hold a secret meeting of the Financial Stability Oversight Council (F-SOC) next Wednesday, February 21. F-SOC was created under the Dodd-Frank financial reform legislation of 2010 to make sure the financial collapse of 2008 would never happen again. That collapse was the worst economic event for the United States since the Great Depression of the 1930s. Given the financial devastation to citizens from that collapse, the public has every right to know about any new financial stability threats facing the nation.

Sitting in on that secret meeting will be representatives from the super secret Federal Reserve that took the elected members of Congress out of the loop as it spent years secretly funneling $16 trillion to Wall Street and foreign banks. Also present will be a representative from the increasingly secret SEC as well as other highly conflicted Federal regulators of Wall Street. The SEC will likely be represented by its Chair, Jay Clayton, who we previously reported had represented 8 of the 10 largest Wall Street banks in the three years prior to his assuming his SEC post last year.

The 24/7 cable news programs are consumed with investigating Russia. We’re not saying that’s not important but it’s happening while nothing is being reported about the growing dangers on Wall Street. The Republican-led Congress is consumed with funding wars against foreign terrorists. But it was neither Russia nor foreign terrorists that dealt America the two worst financial and economic crises in its history: the 1929-1932 and 2008-2010 Wall Street collapses and ensuing economic calamities. These occurred from well-documented illegal acts by Wall Street firms as their Federal regulators wore blindfolds.

The American public has only two choices today: allow the Trump administration to draw this dark curtain ever tighter around the actions of Wall Street and face another guaranteed financial system collapse; or march on Washington in mass protests until this era of robber baron secrecy ends.

GAO Data on Secret Emergency Lending Programs During  Financial Crisis

GAO Data on Secret Emergency Lending Programs During Financial Crisis

Have You Heard of Goldman Sachs’ Theory Called the “Balanced Bear”?

By Pam Martens and Russ Martens: February 15, 2018

Christian Mueller-Glissmann, Equity Strategist for Goldman Sachs

Christian Mueller-Glissmann, Equity Strategist for Goldman Sachs Speaking on CNBC

Last Friday, Christian Mueller-Glissmann, an equity strategist at Goldman Sachs, took to the airwaves at CNBC to discuss last week’s market selloff and entered a new phrase into the lexicon of investing. Mueller-Glissmann said: “The way this market has traded in this correction has been very much in line with our thesis from last year which was called the ‘Balanced Bear.’ You might remember this – this idea that equities and bonds can sell off together.”

In response to a question from his CNBC interviewer as to whether this means there is nowhere to “go and hide” in a market like this, Mueller-Glissmann responded: “Exactly. I think you’re dealing with a much higher portfolio risk, not only with equities being riskier but a much higher portfolio risk because there’s very little places to hide.”

If there’s nowhere to hide, we’d like to suggest that the new paradigm should be called the ‘Naked Bear’ rather than the ‘Balanced Bear.’

Historically, if the stock market is selling off sharply, money is moving into U.S. Treasury notes as a safe-haven play. That drives up the price of the notes which drives down their current yield. (The market expression for this is that yields move inversely to note and bond prices.) Likewise, if the stock market is rallying sharply, money should be moving out of Treasuries into stocks.

Now, obviously, retail investors are not making quick trades like this intraday in the stock and bond markets. We’re talking about hedge funds, institutional traders and the big trading desks on Wall Street that move at lightening speed from one asset class to another.

Lately, however, normal market behavior has been replaced by weird trading action, leading to a lot of speculation that the market is broken or rigged. Take yesterday for example. The Consumer Price Index (CPI) was released in the morning showing a higher than expected 0.5 percent increase. The 10-year Treasury price sold off, meaning its yield moved higher in anticipation that the Federal Reserve would interpret the higher inflation data as a sign it needed to move more quickly with rate hikes. In a normally functioning market, that should have been enough to send the stock market plunging which would, in turn, dampen the upward move in the 10-year Treasury yield as money moved into it as a safe haven play. But just the opposite happened. The Dow Jones Industrial Average closed with a gain of 253 points while simultaneously the yield on the 10-year Treasury spiked to trade intraday at 2.919 percent, hitting a four-year high.

One market that did behave as it should yesterday was gold. U.S. gold futures for April delivery rose 2.1 percent to $1,358. Gold is perceived as a hedge against inflation.

The aberrations in the markets are likely rooted in the aberrations of the Trump administration’s economic policies. And, let’s not forget that the immediate past President of Goldman Sachs, Gary Cohn, is Trump’s Director of the National Economic Council. At a time when the economy is in a growth mode, the Trump administration is planning on massive deficit spending rather than saving that maneuver for a period of recession when it’s critically needed. And at a time when the national debt is already an albatross around the nation’s economic neck at $20.6 trillion, Trump pushed through a tax cut that will add more than a trillion dollars to the debt load over a decade and increase the issuance of Treasuries at a time when the Federal Reserve is scaling back its purchases of Treasuries in order to normalize its balance sheet from the monster holdings it acquired to stem the financial crisis following the 2008 crash.

Gary Cohn’s former boss at Goldman, Lloyd Blankfein, who remains in the positions of Chairman and CEO at Goldman, voiced concerns about the situation in an appearance yesterday with Christine Romans of CNN. Blankfein said:

“I’m in the world of contingency planning for risks. And I would say that the odds of a bad outcome have gone up. I wouldn’t say that’s my case. That’s not my best case. But the idea that the Fed is behind – don’t forget, all these deficits have to be paid for, so there’s going to be more Treasuries that are going to be issued and they have a competitor, the central bank, which has to get rid of its inventory of Treasuries and they’re going to sell into the same kind of market to the same investors…”

Romans asked Blankfein what he’d say, not to bankers but to regular Americans who are watching the stock market. Blankfein responded:

“At this particular time I would say ‘don’t throw all in.’ People are saying, gosh, you should buy more at the lows. Yes, if you’re rich and you have a lot of excess capital. But I wouldn’t throw all in. I’d be planning for the contingency that this turns out to be a worse time than people are thinking. I wouldn’t be more audacious today with the Fed on a raising rates, with the withdrawal of QE, with the budget deficit widening out. I wouldn’t say this is the time I would max out on my risk as opposed to a year ago.”

We know from the financial crisis-era congressional hearings that occurred concerning Wall Street banks shorting subprime debt for their own accounts while selling it long to their own customers that when Goldman Sachs is worried it tells its own traders to “get closer to home,” code for paring back risk to protect Goldman Sachs while dumping it on the nearest dumb tourist-like investors. (See our 2010 article: Why A Criminal Case Against Goldman Sachs Matters and Why Charges Could Stick.)

Unfortunately, it’s likely we’ll have to wait for a new administration in Washington and the next round of crisis-era congressional hearings to find out just how close to home Goldman Sachs got this time around.

Volatility: Has Wall Street Found One More Index It Can Rig?

By Pam Martens and Russ Martens: February 14, 2018

Wall Street Street SignOn Monday, an anonymous whistleblower sent a letter via his lawyer to the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) charging that traders were manipulating the stock market volatility index known as the VIX. The whistleblower said that a flaw exists in the VIX that “allows trading firms with sophisticated algorithms to move the VIX up or down by simply posting quotes on S&P options and without needing to physically engage in any trading or deploying any capital.”

The Chicago Board Options Exchange (CBOE) where VIX options and futures trade, quickly denied the claims.

This whistleblower claims come at a time when billions of dollars are blowing up around the globe because traders placed wrong-way bets that the VIX would maintain the low volatility levels it has enjoyed over multiple years as a result of low volatility in the stock market. As the stock market plunged more than a thousand points on two days last week and saw big intraday reversals on other days, traders nursed big losses as the VIX spiked.

The CBOE explains the VIX as follows: “The VIX Index is based on real-time prices of options on the S&P 500 Index (SPX) and is designed to reflect investors’ consensus view of future (30-day) expected stock market volatility. The VIX Index is often referred to as the market’s ‘fear gauge’.”

For a detailed academic paper by the creators of this concept, Menachem Brenner and Dan Galai, see here.

The new whistleblower’s claims come in an era when Wall Street firms have been charged with rigging other major indices and markets in brazen collusion schemes.

In December 2012, UBS paid $1.5 billion to settle charges with U.S., U.K. and Swiss authorities for its role in participating in the rigging of the interest rate benchmark known as Libor. UBS received a non-prosecution agreement with the U.S. Department of Justice which covered all of its subsidiaries except UBS Securities Japan. That unit pleaded guilty to one count of wire fraud. Six months earlier, Barclays Bank PLC agreed to a $160 million settlement with the U.S. Department of Justice over illegal activities related to Libor and Euribor, another interest rate benchmark.

On December 4, 2013 a group of Wall Street trading firms were charged by the European Commission and paid a collective $2.32 billion for rigging interest rate indexes.  Wall Street titans JPMorgan and Citigroup admitted to participating in the Yen Libor financial derivatives cartel to the European Commission and paid fines of  €79.8m and €70m, respectively. Deutsche Bank and RBS admitted to taking part in both Libor and Euribor cartels and agreed to fines of €725m and €391m, respectively. Societe Generale agreed to pay €446m related to Euribor. RP Martin, a broker, paid €247,000.

At the times the charges and fines were levied, Joaquín Almunia, the European Commission Vice President in charge of competition policy, said this:

“What is shocking about the Libor and Euribor scandals is not only the manipulation of benchmarks, which is being tackled by financial regulators worldwide, but also the collusion between banks who are supposed to be competing with each other. Today’s decision sends a clear message that the Commission is determined to fight and sanction these cartels in the financial sector. Healthy competition and transparency are crucial for financial markets to work properly, at the service of the real economy rather than the interests of a few.”

The indexes the banks were attempting to rig were described by the European Commission as follows:

“Interest rate derivatives (e.g. forward rate agreements, swaps, futures, options) are financial products which are used by banks or companies for managing the risk of interest rate fluctuations. These products are traded worldwide and play a key role in the global economy. They derive their value from the level of a benchmark interest rate, such as the London interbank offered rate (Libor) — which is used for various currencies including the Japanese yen — or the Euro Interbank Offered Rate (Euribor), for the Euro. These benchmarks reflect an average of the quotes submitted daily by a number of banks who are members of a panel…They are meant to reflect the cost of interbank lending in a given currency and serve as a basis for various financial derivatives. Investment banks compete with each other in the trading of these derivatives. The levels of these benchmark rates may affect either the cash flows that a bank receives from a counterparty, or the cash flow it needs to pay to the counterparty under interest rate derivatives contracts.”

On May 20, 2015 we reported on criminal felony counts against five Wall Street banks:

“The U.S. Department of Justice held a press conference in Washington, D.C. this morning at 10 a.m. to announce that two of the largest banks in the United States, Citicorp, a unit of Citigroup, and JPMorgan Chase & Co., would plead guilty to felony charges in connection with the rigging of foreign currency trading. Two foreign banks, Barclays PLC and the Royal Bank of Scotland (RBS), also pleaded guilty to felony charges in the same matter. A fifth bank, UBS, pled guilty to rigging the interest rate benchmark known as Libor.

“Today’s felony charges fall just short of the 19th anniversary of the U.S. Justice Department charging almost every major firm on Wall Street, including JPMorgan, the predecessors of Citigroup, and UBS with fixing prices on the Nasdaq stock market. No criminal charges were brought. That now looks like a serious mistake…

“Barclays was found to have violated its June 2012 non-prosecution agreement involving Libor and required to pay an additional $60 million criminal penalty. UBS was also found to have violated its December 2012 non-prosecution agreement and was required to plead guilty to a one-count felony charge of wire fraud in that matter and required to pay a criminal penalty of $203 million.

“All five banks were put on a 3-year probation which will be overseen by a Federal Court and ordered to cease all criminal activity.

“Other regulators imposed additional fines, bringing the total today to $5.4 billion.”

Clearly, the rigging of indexes and markets by Wall Street banks is not being deterred by criminal charges, by big fines, or by reputational damage. As a Barclays trader was quoted in the foreign currency trading charges, the new Wall Street motto is: “if you aint cheating, you aint trying.”

It’s always been this way on Wall Street and it will always be this way. The only thing meaningful that Congress can do is to restore the Glass-Steagall Act that will separate the den of thieves from the FDIC-insured deposit-taking banks so that the wrongdoers can’t use depositors’ funds to facilitate their crimes. This will also put an end to their status of too-big-to-fail, which forces the taxpayer to bail them out of their insidious crimes.

Rumors Grow that the U.S. Fed is Propping Up the Stock Market

By Pam Martens and Russ Martens: February 13, 2018 

Traders at the New York Fed Have Speed Dials to Wall Street's Biggest Firms

Traders at the New York Fed Have Speed Dials to Wall Street’s Biggest Firms (Source: Federal Reserve Educational Video)

It’s not every day that three well-credentialed men are willing to put their names and reputations behind the allegation that the U.S. Federal Reserve is rigging the stock market. But that’s exactly what happened yesterday. Paul Craig Roberts, a former Associate Editor of the Wall Street Journal and Assistant Secretary of the U.S. Treasury under President Ronald Reagan joined with Economist Michael Hudson and Wall Street veteran Dave Kranzler to write that “it appears that in May 2010, August 2015, January/February 2016, and currently in February 2018 the Fed is rigging the stock market by purchasing S&P equity index futures in order to arrest stock market declines.”

This is not the first time the Fed has come under such suspicion. In 2013 Time Magazine’s Dan Kadlec wrote the following about the unprecedented number of central banks that were moving into stock purchases:

“The U.S. Federal Reserve does not appear to have joined in the stock-buying trend. The Fed is not permitted to make direct stock purchases. But there is nothing to prevent it from funding a Special Purpose Vehicle that buys a broad basket of stocks through indexes or Exchange Traded Funds. In the past year, Wall Streeters have speculated the Fed would buy stocks as part of its quantitative-easing programs to stimulate the economy.”

More suspicions were raised on May 23 of last year when long-tenured New York Post financial writer, John Crudele, suggested that the heavy purchases of stocks by the Swiss central bank could be “as an agent of US financial authorities who fear that a big decline in stock prices would be against America’s national interest?”

According to the latest official annual report of the Swiss central bank, it held $140 billion in stocks as of December 31, 2016, a 30 percent increase over 2015. We also reported on August 25 of last year that the Swiss central bank had a very large appetite for big U.S. tech stocks. We wrote:

“Since June 30 of last year, Switzerland’s central bank, the Swiss National Bank, has increased its stock holdings of five U.S. social media/tech stocks from $5.3 billion to $9.38 billion, an increase of 77 percent in 12 months. The stocks are Apple, Alphabet (parent to Google), Microsoft, Amazon and Facebook. The stock information comes from a 13F filing the Swiss National Bank made this month with the U.S. Securities and Exchange Commission (SEC), a quarterly form required of institutional investment managers who manage $100 million or more.”

Apple and Microsoft are two of the component stocks of the Dow Jones Industrial Average, a popular index used to gauge market strength. Apple, Alphabet, Microsoft, Amazon and Facebook are all components of the Nasdaq 100 index, another closely watched indicator of stock market strength.

But why single out the Swiss central bank? According to a research report released last week by BNY Mellon in collaboration with the University of Cambridge’s Judge Business School, 39 percent of central banks surveyed are now investing in stocks and 72 percent reported use of derivatives as part of their investment management activities.” It is likely that interest rate swaps are the more common derivatives being used by central banks. However, S&P 500 futures contracts are also derivatives and would be the most efficient means of propping up stock prices and/or leveraging a directional bet in stocks.

Another central bank closely aligned with the U.S. that is loading up on stocks is the Bank of Israel. Stanley Fischer, who recently served as Vice Chairman of the U.S. Federal Reserve under Janet Yellen, was governor of Israel’s central bank from 2005 to 2013. He holds dual citizenship.

In February 2016, Haaretz reported that the Israel central bank had increased its stock purchases to 10 percent of reserves or about $9 billion. That was up from 8 percent in 2014 and 3 percent when the central bank first began purchasing stocks in 2012. The largest representation in its global stock portfolio was U.S. stocks.

There are many fundamental reasons to distrust central banks meddling in what are supposed to be free markets. For one thing, U.S. securities laws and regulators are not set up to police central banks. But more importantly, with the power to create money out of thin air, what is to stop central banks from effectively becoming the stock market, killing off its very reason for existing: as a reliable pricing mechanism. Just as the central bank of Japan has boosted its stock market with a $50 billion a year stock purchase program and Switzerland and Israel keep ratcheting up the percentage of reserves they are committing to stocks, the central banks may have doomed themselves and the stock market by failing to address the most crucial part of this strategy: an exit plan.