By Pam Martens and Russ Martens: September 22, 2021 ~
Michael Derby of the Wall Street Journal broke the story on September 7 that Dallas Fed President Robert Kaplan was trading in and out of millions of dollars of individual stock positions in 2020. Last year was a year of unprecedented crisis when Kaplan was a voting member of the Federal Open Market Committee (FOMC) and had access throughout the year to non-public, market-moving information.
On September 18, Wall Street On Parade reported that Kaplan was not just trading individual stocks but was, astonishingly, also trading S&P 500 futures contracts in transactions of more than $1 million in 2020. The most popular and liquid S&P 500 futures contract is the E-mini, which can provide a trader with as much as 95 percent leverage. The stock exchanges are only open in the U.S. from 9:30 a.m. to 4 p.m. (EDT) weekdays, but the E-mini trades continuously from 6 p.m. Sunday night through 5 p.m. on Friday evening (EDT), allowing someone who might wish to trade on inside information far greater opportunities to do so.
Adding to alarm bells around Kaplan’s trading, the Dallas Fed’s communications team declined to provide a yes or no answer to our question as to whether Kaplan shorted the market in 2020. (Shorting means to place a trade that grows in value if the market or security declines in price.)
If a member of the central bank of the United States shorted the market in 2020, in the midst of an economic and health crisis, it would be interpreted by millions of Americans as betting against the country. There is not a good explanation we can think of for why the Dallas Fed’s communications team would not want to get that question quickly disposed of.
Kaplan is a highly sophisticated trader, having worked at Goldman Sachs for 22 years and rising to the ranks of Vice Chairman and a member of its Management Committee. He has written multiple books on what it means to be an effective leader. If anyone should understand the tenets of avoiding conflicts of interest it is Kaplan.
The only public response from Federal Reserve Chairman Jerome Powell thus far to the trading scandal was to ask his “staff” to review the Fed’s current rules. Asking subordinates to review what powerful people are doing at the Fed is equivalent to doing nothing at all.
The nonprofit watchdog, Better Markets, has called for an investigation by the Department of Justice, the Securities and Exchange Commission and the Fed’s Inspector General. In a letter to Powell yesterday, Dennis Kelleher, the President and CEO of Better Markets, called for Kaplan to either resign or be fired. (Kelleher urged the same for Boston Fed President Eric Rosengren, who was trading in and out of Real Estate Investment Trusts in 2020 while the Fed was buying up assets that impacted REIT values.)
As far as we know at this point, both Kaplan and Rosengren are still in their positions and have been listening to non-public information coming out of the FOMC meetings yesterday and today. (For how the public thinks about this kind of arrogance from the Fed, check out the Northman Trader’s Twitter page where his followers are suggesting names for a Reddit group for Fed officials trading their own accounts.)
The reason that Powell may have been quick to ask for a staff review of the Federal Reserve rules that allowed this trading scandal to occur, is that the Fed’s trading rules are a joke. They consist of 284 words that appear on page 14 (Attachment 4) of a Fed document called the Program for Security of FOMC Information. There is not one word in this document that deals with prohibitions on shorting, trading in the futures market, using leverage, using derivatives, and so forth. A retail broker on Wall Street, on the other hand, is typically given an entire three-ring binder filled with prohibitions on certain trading activities.
Even less confidence inducing is the fact that these rules state that they were “reaffirmed effective January 26, 2021.” If the Fed staff didn’t see any problem with this joke of a set of trading rules just eight months ago, why should the American people trust the staff to conduct a new review now.
The trading restrictions are effectively limited to just a so-called blackout period around the FOMC meetings that are conducted eight times a year, typically six weeks apart. The blackout amounts to 10 days before the FOMC meeting until midnight on the last day of the meeting.
But the Fed has been making stunning, market-moving announcements outside of its FOMC meetings since September 17, 2019. That’s the date that the Fed announced it was ramping up its repo loans to Wall Street firms, lending hundreds of billions of dollars weekly. By March 14, 2020, just three days after the World Health Organization declared COVID-19 to be a global pandemic, the Fed had already pumped out more than $9 trillion in cumulative repo loans to Wall Street, according to its own data.
Take the blackout period around the Fed’s FOMC meeting of March 2-3, 2020. The Fed released its statement on March 3, 2020 that it was cutting interest rates by one-half point. The blackout period for trading, according to its rules, ended on March 3, 2020 at midnight.
But here’s what happened next during the non-blackout period, in many cases requiring an FOMC vote, on which Kaplan was a voting member:
On March 12, 2020, the Fed announced it would be providing $1.5 trillion in repo loans over a two-day period. CNBC ran this headline: “Fed to pump in more than $1 trillion in dramatic ramping up of market intervention amid coronavirus meltdown.”
On Sunday evening, March 15, at 5 p.m., just one hour before S&P 500 futures began to trade, the Fed announced it was slashing interest rates to zero; launching a $700 billion Quantitative Easing (QE) program; and cutting its Discount Window rate (the interest rate at which banks can borrow anonymously from the Fed) from 1.25 percent to one-quarter of one percent. As any savvy Goldman Sachs trader would expect, the market interpreted this as full-blown panic on the part of the Fed and S&P 500 futures tanked shortly after the announcement.
On Tuesday, March 17, at 10:45 a.m. in the morning, the Fed announced it was creating a bailout facility for commercial paper. At 6:00 p.m. the same day, the Fed announced another bailout facility for its primary dealers (the trading houses on Wall Street).
The next day, Wednesday, March 18, the Fed announced a bailout facility for money market mutual funds. That announcement came late at night, at 11:30 p.m. when U.S. stock exchanges were closed but S&P 500 futures were trading.
And so it went throughout the crisis year of 2020 when many of the Fed’s biggest market-moving announcements came outside of its trading blackout periods.
For the Fed to restore any semblance of credibility to its role as central bank of the United States, it needs to move quickly to require Kaplan to release the dates and times of his trades since September 17, 2019.
And, equally important, the Justice Department needs to subpoena Kaplan’s trading records from the brokerage firm that was conducting the trades and investigate if the broker and/or the brokerage firm initiated their own duplicative trades based on the belief that Kaplan had inside information.