Plunge Protection Team

By Brett D. Fromson Washington Post Staff Writer Sunday, February 23, 1997; Page H01 The Washington Post It is 2 o !"o!# on a hy$otheti!a" %onday afternoon, and the &o' (ones industria" a)erage has $"u**eted ++, $oints, on to$ of a -,7.$oint s"ide the $re)ious 'ee#/ The !hair*an of the 0e' 1or# Sto!# 23!hange has !a""ed the White House !hief of staff and as#ed $er*ission to !"ose the 'or"d s *ost i*$ortant sto!# *ar#et/ 4y "a', on"y the $resident !an authori5e a shutdo'n of 6/S/ finan!ia" *ar#ets/ In the 7)a" 7ffi!e, the $resident !onfers 'ith the *e*bers of his Wor#ing 8rou$ on Finan!ia" %ar#ets .. the se!retary of the treasury and the !hair*en of the Federa" 9eser)e 4oard, the Se!urities and 23!hange :o**ission and the :o**odity Futures Trading :o**ission/ The offi!ia"s !on!"ude that a $residentia" order to !"ose the 01S2 'ou"d on"y add to the *ar#et s $ani!, so they de!ide to ride out the stor*/ The Wor#ing 8rou$ strugg"es to #ee$ finan!ia" *ar#ets o$en so that trading !an !ontinue/ 4y the !"osing be"", a *odest ra""y is under'ay/ This is one of the night*are s!enarios that Washington s to$ finan!ia" $o"i!y*a#ers ha)e re)ie'ed sin!e 7!t/ 19, 19-7, 'hen the &o' (ones industria" a)erage dro$$ed ;0- $oints, or 22/+ $er!ent, in the biggest one.day "oss in history/ <i#e defense $"anners in the :o"d War $eriod, !entra" ban#ers and finan!ia" regu"ators ha)e been thin#ing !arefu""y about ho' they 'ou"d res$ond to the unthin#ab"e/ =n out"ine of the go)ern*ent s $"ans e*erges in inter)ie's 'ith *ore than a do5en !urrent and for*er offi!ia"s 'ho ha)e $arti!i$ated in *eetings of the Wor#ing 8rou$/ The grou$, estab"ished after the 19-7 sto!# dro$, is the go)ern*ent s high."e)e" foru* for dis!ussion of finan!ia" $o"i!y/ (ust "ast Tuesday afternoon, for e3a*$"e, Wor#ing 8rou$ offi!ia"s gathered in a !onferen!e roo* at the Treasury 4ui"ding/ They dis!ussed, a*ong other to$i!s, the ris#s of a sto!# *ar#et de!"ine in the 'a#e of the &o' s sudden surge $ast 7000, a!!ording to sour!es fa*i"iar 'ith the *eeting/ The offi!ia"s $ondered 'hether $ri!es in the sto!# *ar#et ref"e!t a greater a$$etite for ris#.ta#ing by in)estors/ So*e e3$ressed !on!ern that the higher the sto!# *ar#et goes, the !"oser it !ou"d be to a !orre!tion, a!!ording to the sour!es/ These >uiet *eetings of the Wor#ing 8rou$ are the finan!ia" 'or"d s e>ui)a"ent of the 'ar roo*/ The offi!ia"s gather regu"ar"y to dis!uss o$tions and re)ie' !risis s!enarios be!ause they #no' that the go)ern*ent s rea!tion to a !ru*b"ing sto!# *ar#et 'ou"d ha)e a !riti!a" i*$a!t on in)estor !onfiden!e around the 'or"d/ ?The go)ern*ent has a rea" ro"e to $"ay to *a#e a 19-7.sty"e sudden *ar#et brea# "ess "i#e"y/ That is an issue 'e a"" s$ent a "ot of ti*e thin#ing about and $"anning for,? said a for*er go)ern*ent offi!ia" 'ho attended Wor#ing 8rou$ *eetings/ ?1ou go through "ots of fire dri""s and s!enarios/ 1ou *a#e sure you ha)e thought ahead of ti*e of 'hat #ind of infor*ation you 'i"" need and 'hat you ha)e the "ega" authority to do/? In the e)ent of a finan!ia" !risis, ea!h federa" agen!y 'ith a seat at the tab"e of the Wor#ing 8rou$ has a !onfidentia" $"an/ =t the S2:, for e3a*$"e, the $"an is !a""ed the ?red boo#? be!ause of the !o"or of its !o)er/ It is offi!ia""y #no'n as the 23e!uti)e &ire!tory for %ar#et
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:ontingen!ies/ The *a@or 6/S/ sto!# *ar#ets ha)e !o$ies of the !o**ission s $"an as 'e"" as the :FT: s/ Going to Plan A The red boo# is intended to *a#e sure that no *atter 'hat the ti*e of day, S2: offi!ia"s !an rea!h their o$$osite nu*bers at other agen!ies of the 6/S/ go)ern*ent, 'ith foreign go)ern*ents, at the )arious sto!#, bond and !o**odity futures and o$tions e3!hanges, as 'e"" as e3e!uti)es of the *any $ay*ent and sett"e*ent syste*s under"ying the finan!ia" *ar#ets/ ?We a"" ha)e e)erybody s ho*e and 'ee#end nu*bers,? said a for*er Wor#ing 8rou$ staff *e*ber/ The Wor#ing 8rou$ s *ain goa", offi!ia"s say, 'ou"d be to #ee$ the *ar#ets o$erating in the e)ent of a sudden, sto*a!h.!hurning $"unge in sto!# $ri!es .. and to $re)ent a $ani!#y run on ban#s, bro#erage fir*s and *utua" funds/ 7ffi!ia"s 'orry that if in)estors a"" tried to head for the e3it at the sa*e ti*e, there 'ou"dn t be enough roo* .. or in finan!ia" ter*s, "i>uidity .. for the* a"" to get through/ In that e)ent, the s*ooth"y running g"oba" finan!ia" *a!hine 'ou"d begin to "o!# u$/ This sort of "i>uidity !risis !ou"d i*$eri" e)en hea"thy finan!ia" institutions that are te*$orari"y short of !ash or tradab"e assets su!h as 6/S/ Treasury se!urities/ =nd 'orries about the finan!ia" strength of a *a@or trader !ou"d !as!ade and !ause other $"ayers to sto$ *a#ing $ay*ents to one another, in 'hi!h !ase the syste* 'ou"d sei5e u$ "i#e an engine 'ithout oi"/ 2)en a te*$orary "oss of "i>uidity 'ou"d intensify finan!ia" $ressure on a"ready stressed institutions/ In the 19-7 !rash, go)ern*ent offi!ia"s 'or#ed fe)erish"y .. and, u"ti*ate"y, su!!essfu""y .. to a)oid $re!ise"y that b"ea# s!enario/ 7ffi!ia"s say they are !onfident that the !onditions that "ed to the s"ide a de!ade ago are not $resent today/ They !ite "o' interest rates and a hea"thy e!ono*y as #ey differen!es bet'een no' and 19-7/ 7ffi!ia"s a"so $oint to S2:.a$$ro)ed ?!ir!uit brea#ers? that 'ere introdu!ed after 19-7 to gi)e in)estors ti*eouts to !a"* do'n/ 6nder the S2: s ru"es, a dro$ of 3;0 $oints in the &o' 'ou"d bring a 30.*inute ha"t in 01S2 trading/ If the &o' de!"ined another 200 $oints, trading 'ou"d !ease for one hour/ 0o additiona" !ir!uit brea#ers 'ou"d o$erate that day, but a ne' set 'ou"d a$$"y the ne3t trading day/ &es$ite these $re!autions, today s high sto!# *ar#et 'orries offi!ia"s su!h as Fed :hair*an ="an 8reens$an, 'ho in a s$ee!h in ear"y &e!e*ber raised >uestions about ?irrationa" e3uberan!e? in the *ar#ets/ 4e!ause the *ar#et de!"ined fo""o'ing 8reens$an s s$ee!h, go)ern*ent offi!ia"s ha)e be!o*e e)en *ore re"u!tant to !o**ent on these issues for fear of triggering the )ery e)ent they 'ish to foresta"", a!!ording to $o"i!y*a#ers/ A Brewing Concern 8reens$an had e3$ressed si*i"ar thoughts a year ago at a !onfidentia" *eeting of the Wor#ing 8rou$/ Treasury Se!retary 9obert 2/ 9ubin and S2: :hair*an =rthur <e)itt (r/ a"so are !on!erned about the sto!# *ar#et s )u"nerabi"ity, a!!ording to sour!es fa*i"iar 'ith their )ie's/ The four $rin!i$a"s of the grou$ .. 9ubin, 8reens$an, <e)itt and :FT: :hair'o*an 4roo#s"ey 4orn .. *eet e)ery fe' *onths, and senior staff get together *ore often to 'or# on s$e!ifi! agenda ite*s/
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In addition to the $er*anent *e*bers, the head of the President s 0ationa" 2!ono*i! :oun!i", the !hair*an of his :oun!i" of 2!ono*i! =d)isers, the !o*$tro""er of the !urren!y and the $resident of the 0e' 1or# Federa" 9eser)e 4an# fre>uent"y attend Wor#ing 8rou$ sessions/ The Wor#ing 8rou$ has studied a )ariety of $ossib"e threats to the finan!ia" syste* that !ou"d ensue if sto!# $ri!es go into free fa""/ They in!"udeA a $ani!#y f"ight by *utua" fund shareho"ders; !haos in the g"oba" $ay*ent, sett"e*ent and !"earan!e syste*s; and a brea#do'n in internationa" !oordination a*ong !entra" ban#s, finan!e *inistries and se!urities regu"ators, the sour!es said/ =s !hair*an of the Wor#ing 8rou$, 9ubin 'ou"d ha)e o)era"" res$onsibi"ity for the 6/S/ res$onse, but 8reens$an $robab"y 'ou"d be the go)ern*ent s *ost i*$ortant $"ayer/ ?In a !risis, a "ot of deferen!e is $aid to the Fed,? a for*er *e*ber of the Wor#ing 8rou$ said/ ?They are the on"y ones 'ith any *oney/? ?The first and *ost i*$ortant >uestion for the !entra" ban# is a"'ays, &o you ha)e !redit $rob"e*sB ? said 2/ 8era"d :orrigan, for*er $resident of the 0e' 1or# Federa" 9eser)e 4an# and no' an e3e!uti)e at 8o"d*an Sa!hs C :o/ ?The *inute so*e ban# or in)est*ent fir* says, Hey, *aybe I * not going to get $aid .. *aybe I ought to 'ait before I transfer these se!urities or *a#e that $ay*ent, then things get tri!#y/ The !entra" ban# has to sense that before it ha$$ens and ta#e ste$s to $re)ent it/? 1987: A Case Study The Fed s rea!tion to the 19-7 *ar#et s"ide, 'hi!h :orrigan he"$ed o)ersee, is a !ase study in ho' to do it right/ The Fed #e$t the *ar#ets going by f"ooding the ban#ing syste* 'ith reser)es and stating $ub"i!"y that it 'as ready to e3tend "oans to i*$ortant finan!ia" institutions, if needed/ The Fed s a!tions in 7!tober 19-7 read "i#e a finan!ia" 'ar story/ The *orning after the ;0-.$oint dro$ on 4"a!# %onday, the *ar#et began another si!#ening s"ide/ :orrigan and other Fed offi!ia"s strong"y dis!ouraged 0e' 1or# Sto!# 23!hange :hair*an (ohn Phe"an fro* re>uesting go)ern*ent $er*ission to !"ose the *ar#et/ Phe"an 'as !on!erned that if the *ar#et !ontinued to erode, the !a$ita" of the 01S2 *e*ber fir*s 'ou"d disa$$ear/ :orrigan feared a shutdo'n 'ou"d !ause *ore $ani!/ ?It 'as e3traordinari"y diffi!u"t around 11 o !"o!#,? :orrigan re!a""ed/ ?The *ar#et 'as at one $oint do'n another 2;0 $oints, and that s 'hen the debate 'ith Phe"an too# $"a!e/? Si*u"taneous"y, :orrigan and other !entra" ban# offi!ia"s s$o#e $ri)ate"y 'ith the big ban#s and urged the* not to !a"" "oans they had *ade to Wa"" Street houses, 'hi!h 'ere !o""atera"i5ed by se!urities that !ou"d no "onger be traded and 'hose )a"ue 'as in >uestion/ = fina" !riti!a" *o*ent !a*e that day 'hen the Fed de!ided not to shut do'n a subsidiary of the :ontinenta" I""inois 4an# that 'as the "argest "ender to the !o**odity futures and o$tions trading houses in :hi!ago/ The subsidiary had run out of !a$ita" to $ro)ide finan!ing to that *ar#et/ ?:"osing it 'ou"d ha)e drained a"" the "i>uidity out of the futures and o$tions *ar#ets,? said one for*er to$ Fed offi!ia" in)o")ed in the de!ision/ In)estors use sto!# futures and o$tions to hedge $ositions in the under"ying sto!# *ar#et/
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9e!ogni5ing the !ru!ia" ro"e of ban#s if another finan!ia" !risis shou"d stri#e, the 7ffi!e of the :o*$tro""er re!ent"y !ondu!ted an interna" study of 'hat da*age a *ar#et de!"ine 'ou"d inf"i!t on 6/S/ ban#s/ The 7:: de!"ined to dis!uss the study or its !on!"usions/ =t the S2:, one big 'orry is ho' to !o$e 'ith an internationa" finan!ia" !risis that begins abroad but >ui!#"y ro""s into 6/S/ *ar#ets/ ?We 'orry about a 6/S/ bro#erage fir* that is dea"ing 'ith a (a$anese insuran!e !o*$any, 'here 'e don t #no' ho' they are run or regu"ated,? a S2: sour!e said/ To i*$ro)e its abi"ity to rea!t in a !risis, the S2: and the Fed ha)e begun @oint ins$e!tions 'ith their 4ritish !ounter$arts of 6/S/ and 4ritish finan!ia" institutions 'ith g"oba" rea!h/ The *ost drasti! .. and $robab"y un"i#e"y .. *o)e the S2: !ou"d ta#e in a !risis 'ou"d be to $ro$ose a *ar#et shutdo'n to the $resident/ That 'ou"d re>uire a *a@ority )ote of the !o**ission/ If a >uoru* !ou"dn t be *ustered, the !hair*an !ou"d designate hi*se"f ?duty offi!er? and go to the $resident or his staff/ ?:"osing the *ar#et is, of !ourse, the "ast thing the !o**ission 'ants to do,? said a sour!e fa*i"iar 'ith the S2: s $"anning/ ?&uring a ti*e 'hen $eo$"e are e3tre*e"y 'orried about their in)est*ents, you are !utting the* off fro* ta#ing any a!tion/ / / / The $hi"oso$hy of the !o**ission is that *ar#ets shou"d stay o$en/? Just the acts 8athering a!!urate infor*ation 'ou"d be the first order of business for federa" regu"ators/ ?Inte""igen!e gathering is !riti!a",? :orrigan said/ ?It de$ends on the 'i""ingness of *a@or *ar#et $arti!i$ants to )o"unteer $rob"e*s 'hen they see the* and to res$ond honest"y to !entra" ban# >uestions/? The S2:, :FT: and Treasury ha)e *ar#et sur)ei""an!e units/ They *onitor not on"y the o)era"" *ar#ets, but a"so the !ash $ositions of a"" the *a@or sto!# and !o**odity bro#erages and "arge traders/ The regu"ators a"so are hoo#ed into the ?hoot.and.ho""er? syste* used to notify $arti!i$ants in a"" finan!ia" *ar#ets of trading ha"ts/ The hoot.and.ho""er syste* a"erts traders and regu"ators 'hen a ha"t is !o*ing/ !elying on "uic# Action In the e)ent of a shar$ *ar#et de!"ine, the S2: and :FT: 'ou"d be in !onstant !onta!t 'ith bro#erage and !o**odity fir*s to s$ot ear"y signs of finan!ia" fai"ure/ If they !on!"uded that a fir* 'as going do'n, they 'ou"d try to *o)e !usto*er $ositions fro* that fir* to so")ent institutions/ =t "east this tea* of !risis *anagers a"ready has been through the Wa"" Street 'ars/ 8reens$an 'as Fed !hair*an in 7!tober 19-7/ 9ubin has ser)ed as the !o.head of in)est*ent ban# 8o"d*an Sa!hs C :o/ <e)itt has been both a Wa"" Street e3e!uti)e and $resident of the =*eri!an Sto!# 23!hange/ ?I thin# the go)ern*ent is in good sha$e to hand"e a !risis,? said S!ott Pardee, senior ad)iser to 1a*ai!hi Internationa" D=*eri!aE In!/, a (a$anese bro#erage subsidiary, and for*er senior )i!e $resident at the 0e' 1or# Fed/ ?= "ot de$ends on $ersona" re"ationshi$s/ 1ou ha)e a nu*ber of
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seasoned $eo$"e 'ho ha)e gone through a nu*ber of !rises/ So if so*ething ha$$ens, things !an be hand"ed >ui!#"y on the $hone 'ithout ha)ing to introdu!e $eo$"e to ea!h other/? :onsider 'hat ha$$ened at 11A30 $/*/ &e!/ ;, 'hen 8reens$an *ade his !o**ents about irrationa" e3uberan!e/ ="ton Har)ey, head of the S2: s %ar#et Wat!h unit, 'as !a""ed at ho*e by offi!ia"s of 8"obe3, a futures trading syste* o'ned by the :hi!ago %er!anti"e 23!hange/ 6/S/ sto!# futures trading in =sia had fa""en to their 12.$oint "i*it, they said/ Har)ey i**ediate"y a"erted his dire!t su$erior as 'e"" as his o$$osite nu*ber at the :FT:/ %ore senior S2: and :FT: offi!ia"s 'ere infor*ed as 'e""/ 4ut there 'asn t *u!h to be done unti" the *orning/ So Har)ey 'ent ba!# to s"ee$/ 92=:TI08 T7 = P<6082 =fter the *ar#et !rashed on 7!t/ 29, 1929A F The Federa" 9eser)e $ro)ided "oans and !redit to finan!ia" syste*s/ F President Hoo)er *et 'ith business, "abor and far* organi5ations to en!ourage !a$ita" s$ending and dis!ourage "ayoffs; he a"so $ro*ised higher tariffs/ F Federa" in!o*e ta3es 'ere redu!ed by 1 $er!ent by the end of the year/ =fter the *ar#et dro$$ed 22/+ $er!ent on 7!t/ 19, 19-7, the Federa" 9eser)eA F 2n!ouraged the 0e' 1or# Sto!# 23!hange to stay o$en/ F 2n!ouraged big !o**er!ia" ban#s not to $u"" "oans to *a@or Wa"" Street houses/ F Ge$t o$en a subsidiary of :ontinenta" I""inois 4an# that 'as the "argest "ender to the !o**odity trading houses in :hi!ago/ F F"ooded the ban#ing syste* 'ith *oney to *eet finan!ia" ob"igations/ F =nnoun!ed it 'as ready to e3tend "oans to i*$ortant finan!ia" institutions/ What 'ou"d ha$$en today during a sto!# dro$ 'ou"d de$end on the $arti!u"ars/ Here are !urrent guide"inesA F If the &o' (ones industria" a)erage fa""s 3;0 $oints 'ithin a trading day, 01S2 trading 'ou"d be ha"ted for 30 *inutes/ F If the &(I= fa""s another 200 $oints that day, trading 'ou"d sto$ for one hour/ F If the *ar#et de!"ines *ore than ;;0 $oints in a day, no further restri!tions 'ou"d be a$$"ied/ S769:2A The 0e' 1or# Sto!# 23!hange, ?The :rash and the =fter*ath? by 4arrie =/ Wig*ore

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