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Moral Hazard

By: Bill Murphy, Le Metropole Cafe, Inc.,

-- Posted Friday, 8 September 2006

September 8 - Gold $609.30 down $8.40 - Silver $12.13 down 43 cents

"Well, what I just want 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 most important, there's been--the Fed in 1989 created what is called a plunge protection team, which is the Federal Reserve, big major banks, representatives of the New York Stock Exchange and the other exchanges, and there--they have been meeting informally so far, and they have 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" ... former Clinton adviser George Stephanopoulos, September 17, 2001 on ABC Good Morning America


The entire US financial market system has become a total joke. While US interest rates dropped again, the dollar soared and gold and silver were trashed. Naturally, after two down days, the US stock market came in a fair amount higher and stayed that way.

The only solace on a day such as this is that if you are watching CNBC, or listening to other Planet Wall Street apologists, you have no clue as to what is really happening here. Fortunately, I received this email last evening re a web posting which says it all. It is so Planet GATA and detailed that I am making it the feature of this MIDAS commentary. It says it all about what is going on, what lies ahead, and supports EVERYTHING brought your way over the last 7 years by the GATA camp:

Hi Bill:
i just came across this fascinating posting by someone called JOE STOCKS at the following site

You may want to post it at the CAFE.

Cheers from Auckland, Ed Wener
To: mishedlo who wrote (69454) 9/7/2006 11:59:18 AM
From: Joe Stocks 5 Recommendations Read Replies (2) of 69470

Moral Hazard. For the last several months I have been doing a good bit of research trying to obtain some insight into the inter-relationship between the Federal Reserve, the government, and the large money center NYSE member banks. In my reading I kept coming upon the phrase 'moral hazard'- as in "we want to avoid a moral hazard". I tried to find the definition as they defined within the context of what I was reading - no luck. These guys seem to have their own code words.

Recently I started reading Robert Rubin's book, 'In an Uncertain World'. As Secretary of the Treasury during the Clinton Administration, I thought I would try to get in the mind of one of the principals of the group we call the Plunge Protection Team (PPT). In the book he writes about his service at the White House. The book starts off with the Mexican Bailout and discusses that bailout and those that followed from the perspective of Mr. Rubin. After the first few pages he uses the term and defines 'moral hazard'.

MORAL HAZARD - A problem whereas investors, after being insulated from the consequences of risk by intervention, might pay insufficient attention to similar risk the next time, or operate on the expectation of official intervention.

We traders know this government intervention more as the 'Greenspan Put'.

'Private Counterparty Surveillance' is another phrase that I read several times. This is basically the large NYSE member banks, a couple of well connected hedge funds, and that form the 'Counterparty Risk Management Policy Group'. The one financial member of this group that is not a bank or a hedge fund is General Motors Asset Management. I guess with $300 billion in outstanding paper they want to be sure GM has a seat at the table.

Now bailouts have been around for a long time. Going back a bit I remember the Chrysler bailout. Did you know that Alan Greenspan was against the government bailing them out. Wow! Did he change his tune in later years or what!

What we also know is that we had a series of bailouts in the mid to late 90's that started out with the Mexican bailout. Robert Rubin of Goldman Sachs was sworn in as Secretary of the Treasury on the evening of January 10th, 1995. That same evening an emergency meeting was held to finalize a plan to bail out Mexico. I guess this could not be done until the well connected Rubin was in office. The administration waited until Rubin was confirmed and sworn in to move ahead. Greenspan's "irrational exuberance" speech, Long Term Capital Management (LTCM) bailout, the "Asian Flu" economic crisis and Y2K followed. All contributed to what we all now know as a 'moral hazard'. In 1999 the 'Counterparty Risk Management Policy Group' (CRMPG) was formed to address the issues with LTCM and to develop policy that would protect the financial world from another threat to the financial markets such as the LTCM incident.

Now fast forward to 2002. In May of 2002 the SEC appears to have fears that a major bank - one of two that clear government paper - may become insolvent due to derivative issues. The possible problem bank is JP Morgan. By the end of the year CRMPG recommends the foundation of a new bank be put in place just in case. The new bank would be a coordinated effort of the members of the CRMPG. The Federal Reserve and the SEC approve.

Also in 2002 it just so happens that we see a big jump in the use of program trades. The major players are also members of the CRMPG. Those without large proprietary trading units such as Citigroup, start them. Citigroup is quoted as saying something along the lines that due to "new" innovations they see less risk in trading.

Remember JPM’s "problems". Suddenly they went away. A "stealth bailout" is put in place. About year later the Wall Street Journal reported concerns that JPM was making a lot of money in the "risky" business of trading their own capital. They said, "Profits have been increasing recently due to a small and low profile group of traders making big bets with the firm's money. Apparently, an eight man New York team has pulled in more than $100M of trading profit with the company suggesting it is a result of better market conditions and not greater risk." Program trading was running at about 25% of all shares traded on the NYSE in early 2002.

Today program trading is running near 60%.

Then, in September of 2002 Alan Greenspan gave this speech. The link:

Here is an excerpt;

Greenspan: "Owing to persistent advances in information and computing technologies, the structure of our financial institutions is continuously changing, I trust for the better. But that evolution in financial structure has also meant that supervision and regulation must be continually changing in order to respond adequately to these developments. In today's markets, for example, there is an increased reliance on private counterparty surveillance as the primary means of financial control. Governments supplement private surveillance when they judge that market imperfections could lead to sub-optimal economic performance.""

"I trust for the better." Sounds like he is not real sure.

"increased reliance on private counterparty surveillance as the primary means of financial control." Greenspan here acknowledges the CRMPG and endorses their actions to control the markets.

"Governments supplement private surveillance…" Governments – as in more than one? If you look at the members of the CRMPG you will find some foreign banks included. We are not looking at a group that deals solely with the US markets. Any market that could be contagious to the greater good is subject to control by the CRMPG.

In 2004 Greenspan acknowledged concerns about derivative growth. All markets had seen strong growth in the previous five years. In the OTC market, the notional outstanding of equity-linked derivatives was $4.5 trillion in June 2004, having tripled in size over the previously five years (source: BIS). The listed options market has also shown strong growth. For example, in 2004 the combined open interest of equity index options contracts on was around $3 trillion notional, double that of 1999. Turnover, at $200 billion notional per day in 2004, was triple that of 1999 (source: BIS). Data for the retail structured product markets is less comprehensive. Estimated issuance in Europe was around €100 billion in 2004. Around half of the issuance was in Italy, Spain and the UK (the other major European markets are France, Germany and Switzerland). On this basis, the market has doubled in size from 2000 to 2004. Greenspan called on the major players to meet with the Fed and discuss their exposure. Out of this meeting came the request for the CRMPG to report what actions it felt necessary for the markets to remain stable.

The CRMPG filed their report in July of 2005. Here are some selected excerpts with my comments. The report can be found here.

CRMPG: "The primary purpose of CRMPG II — building on the 1999 report of CRMPG I — is to examine what additional steps should be taken by the private sector to promote the efficiency, effectiveness and stability of the global financial system. As practitioners, the members of CRMPG II recognize that periodic financial disruptions and shocks are inevitable. However, the Policy Group also believes that it is possible to take steps that would be capable of reducing the frequency of such shocks and, especially, to reduce the risk that such shocks would take on the contagion features that can produce systemic damage to the financial system and the real economy."

Again it appears the CRMPG mandate is to control the markets. How else are they to reduce the frequency of periodic financial disruptions.

CRMPG: "since we know that financial disturbances and even financial shocks will occur in the future, and we know that no approaches to risk management or official supervision are fail-safe, we also know that we must preserve and strengthen the institutional arrangements whereby, at the point of crisis, industry groups and industry leaders, as well as supervisors, are prepared to work together in order to serve the larger and shared goal of financial stability."

If you read through this whole document it is all about working together for the greater good. On the surface, that sounds all well and good. However, free markets do not work this way. Their collusion at their highest ranks to secure the financial stability of the largest financial institutions could be at odds with the investments of smaller institutions and may be at odds with the small investor’s long term investments and goals. When LTCM failed many of us could have not cared less if you were not a shareholder of one on the banks that bailed them out. The bailout was simply put in place to save their own skins and the investors they serve.

CRMPG: "It is acceptable market practice for a financial intermediary’s sales and trading personnel to provide their sophisticated counterparties with general market levels or "indications," including inputs and variables that may be used by the counterparty to calculate a value for a complex transaction. Additionally, if a counterparty requests a price or level for purposes of unwinding a specific complex transaction, and the financial intermediary is willing to provide such price or level, it is appropriate for the financial intermediary’s sales and trading personnel to furnish this information."

Sounds like a formula for collusion and manipulation to me. How would you like to be the other side of the trade with these guys in one of the pre-arranged trades.

CRMPG: "Following execution of a complex transaction, the financial intermediary will often maintain communication with the counterparty in the interest of maintaining good client relations. As part of this communication, the financial intermediary, although under no legal obligation to do so, may wish to alert its counterparty to any observed market change that it determines may challenge the underlying assumptions or principal drivers that motivated the counterparty to establish the original position."

No, I did not make this up. We know from above that the big banks are being encouraged to share information. We know there are two sides to each trade. Again, how would you like to be the less connected investor. Let’s read Greenspan’s thoughts excerpted from the same speech as referenced earlier;

Greenspan: "There should not be much dispute that markets function best when the participants are fully informed. Yet, paradoxically, the full disclosure of what some participants know can undermine incentives to take risk, a precondition to economic growth.

No one can deny that fully informed market participants will generate the most efficient pricing of resources and the most efficient allocation of capital. Moreover, it could be argued that, if all information held by individual buyers or sellers became available to all participants, the pricing structure would more closely reflect the underlying balance of supply and demand. Thus full information would appear to be the unambiguous objective. But should it be?"

But should it be? Who is he trying to kid! As a small investor I would like to have as much of an equal footing through the knowledge available as the next guy, no matter how connected they are. We require public corporations to provide open and full disclosure with the public, why should the CRMPG be allowed to collude to rig the market against free market principles?

In closing – the CRMPG has to be in the market daily. Current derivative exposure of the major NYSE banks makes it necessary. The CRMPG report gives them the outline to execute their strategy in collusion at the expense of ultimately the small investor that gives them the fuel to increase that trading returns. Moral hazard has led to moral decay at the highest ranks of our financial institutions. Move over PPT – the CRMPG is at the wheel now.

A link for the most current CRMPG report is here.

Notice how the report is addressed to the chairman of Goldman Sachs. Notice that Goldman Sachs had much input into the report and the CRMPG is Chaired by a Goldman Sachs guy. Also make note that the current Secretary of the Treasury just came over from GS as well as a new appointee.


Amen. In essence that is what MIDAS has been bringing The Café way since its inception.

From Ed Wener as a recap:

Hi Bill:
Did you see this quote from that earlier email I sent you about JOE STOCKS? this explains a lot, including Ted Butler's repeated amazement that the FUNDS are always taken to the cleaners in the silver market. All this gives new meaning to the word FIDUCIARY!
Cheers, Ed

"I think one must ask themselves how, across the board, the top mega banks can show such substantial growth trading their own funds while the funds they manage for others show less stellar returns. The only way it can be done is through an orchestrated effort involving the Federal Reserve and the ‘PCS’ team. Remember, these are the same banks that the Federal Reserve uses to put more money into the system. Through collusion these member banks can gain substantial profits for their proprietary accounts at the expense of not only the small investor, but anyone that is not a member of this group."


Most everything else to report today is meaningless compared to the above, except to say that one day all this market manipulation will blow up and there will be hell to pay. The little guy, average investor will lose a third or half of his or her net worth in a brief period of time and they won’t know what hit them. This is a developing American tragedy of epic proportions.

Which leads to the most horse manure comment of the day:

Paulson Says Strong Dollar Is in U.S. Interest

By Alison Fitzgerald

Sept. 8 (Bloomberg) -- A strong currency is in the interest of the U.S., the nation's Treasury Secretary Henry Paulson said today in Vietnam.

``I'm very much in favor of a strong dollar because that's in our nation's interests,'' Paulson said in answering questions from students after a speech at a university in Vietnam's capital of Hanoi, where he attended an Asia-Pacific Economic Cooperation forum meeting. ``The value of the dollar should be set in open and competitive markets.''

Paulson's comments reiterate the long-held U.S. ``strong dollar'' policy, first stated by former Treasury Secretary Robert Rubin, while at the same time assuring markets that the U.S. has no intention to intervene in the market to boost the value of the dollar…


What a crock! All he and Rubin have done is to intervene as brilliantly discussed by "Joe Stocks" above.

The so-called smart money were the buyers on the Comex, while the funds dumped like crazy once gold broke.

The gold open interest only fell 1287 contracts to 321,092, which means there are a good deal of new shorts on the books. The silver open interest dropped more sharply, down 2746 to 106,206.

One positive note. Gold’s fall was stopped dead in its tracks at the same key support level again and it also failed to fill its breakaway gap left months ago right above $600:

October gold

The downdraft low on spot gold was $605.90.

Silver took out $12 on this drubbing, falling to $11.93, but wouldn’t stay below the key $12 level for the umpteenth time, which is constructive in a big picture sense.

More gold goodies

Indian ex-duty premiums: AM $8.12, PM $8.46, with world gold at $$618.20 and $613.55. Ample for legal imports. The rupee tried to strengthen but was held down by State bank selling. The stock market rose 0.55%.

TOCOM was locked down the 60 yen limit all day. However, in the curious way it has, the equivalent of 7,072 Comex lots did trade, with open interest rising 6.4 tonnes (2,064 Comex lot equivalent). Mitsubishi’s data implies the public added 5 tonnes to their long. World gold actually spent almost all the Japanese session $1-$2 above the NY close, but was knocked down $1 below in the final few minutes as Europe opened and began selling.

Yesterday’s $16.90 loss in NY involved volume of 64,520 contracts (22% above estimate). Open interest fell 1,287 lots (4 tonnes). Consolidated CBOT volume was equal to 62,442 Comex contracts, with open interest rising the equivalent of 1,928 lots, so that net US open interest picked up 2 tonnes.

So for all the talk of fund stop losses and liquidation (some of which must have occurred) the predominant feature of yesterday in America was short selling on the futures exchanges.

Today essentially saw the same pattern, but starting earlier in Europe. NY gold lost $7.60 on estimated volume of 43,000.

All who think gold prices are endogenously determined by the NY speculative community are now very distressed by the technical situation. The reality is the market has now been placed in the hands of the physical buying community, particularly the Indians (reported to be very active). Unless the seller at $630 and $640 has decided to come down, the issue, as so many times 2002-5, is how long it takes for them to squeeze out the shorts.


The above "Joe Stocks" posting is so important, I am changing the MIDAS format somewhat in that I am bringing as little else to your attention as possible, for little else matters on a day like this. I suggest a reread of his commentary again.

The DOW gained 61 to 11,392, while the DOG rose 10 to 2166. What a suprise to see the orchestrated DOW gradually and continually move away from the key 11,000 mark.

For the past two days the yields on the pivotal 10-YR T note have come down as the dollar has gone straight up and gold has been trashed. Its yield fell to 4.76%. It makes no sense unless you realize the Exchange Stabilization Fund (ESF) and CPRMG are at work…

10-YR T note

The dollar rose .48 to 85.96

The comments from the CNBC pundit crowd about why the dollar is going up while US interest rates are going down ia almost hilarious. They almost stutter.

Crude oil was battered again, losing another 95 cents to $66.37. Copper fell 6 cents.

15:00 Jul Consumer Credit reported $5.5B vs. consensus $6.8B
Prior reading $10.3B was revised to $14.1B.
* * * * *

Ladies and Gentlemen:
During the September 7th TOCOM sessions the seven large gold shorts increased their net short position by another 4,559 contracts to a total of 166,469 contracts. Mitsui Bussan Futures reduced their net short position by 775 contracts to 8,583 contracts. The drop in net short position by Mitsui Bussan was more than made up by Mitsui & Co. Ltd who increased their net short position by 4,177 contracts to 50,054 contracts.

In silver, the same seven dealers cut their net short position by 215 contracts to a total of 2,910 contracts.


In the September 7 session of the TOCOM, Goldman Sachs INCREASED their net short position by 452 contracts to 40,605 contracts. They have obviously been called to arms to help the battle against gold and support an ailing dollar. In my opinion the CB’s will not fill their WAG2 quota but by the Cartel selling short paper gold some weak hands and technical traders can be made to believe that perhaps 160 tons of real gold will be offloaded by the CB’s. I believe this is a brief killer move down before a strong move up. Those who are ill-informed will be fooled into running for the exits.

Could not agree more with Adrian.

There are a number of commentators who reasonably point to the action of the shares as a prelude to what gold is going to do. I was one of them after the breakout of the HUI above 350. As "Joe Stocks" knows, that meant nothing in these managed markets. All the CPRMG and PPT did was sucker in some longs and have blown them out, once again stealing money from the little guy investor.

Peter sees it this way:

My impression is that the last couple of days of metals takedowns were more a reaction by the manipulators to an unwelcome surge in gold's price rather than a well-planned assault. I base this opinion on the failure of the gold shares to anticipate the drop, as well as how well many companies have held up under the onslaught. The classic Cartel attack involves the insider-trading shorts sharpening their knives and taking their positions before the metal itself is whacked. I didn't see that this time and my guess is that this episode will pass swiftly because the elements weren't all in place. Let's see...
Best wishes,
Peter R.

The HUI continued to set back, falling 9.74 to 338.18 and the XAU sank 4.05 to 140.90.

The best way to view the past couple of days is liken them to a thunderstorm. We have seen so many since 2001 and they all have passed. This one will too. The gold fundamentals, both in a natural supply/demand sense and a macro sense, could not be better.



A chat room posting today that nails it:

The week appeared to start quite positive for PM’s but changed quickly for no strongly supportive reasons, other than cartel intervention. It can be speculated that perhaps Tuesday was simply a trial balloon for the cartel as they allowed PM’s to move freely for a change as they simply observed the activity from the sidelines. Such inactivity would allow them to gauge the true momentum entering the PM sector with the return of the hedge funds after the Labour Day weekend. With their observations well at hand, the cartel, both yesterday and today, applied the calculated selling pressure to not only offset the buying momentum but to dissuade other hedge funds and large investors from entering the PM markets in the near term. Today can be considered even worse than yesterday because the DOW rallied as the HUI was forcefully moved down. The PPT moves the DOW up while the cartel simultaneously moves PM’s down. There is no doubt that cartel activity over the past 48 hours has been blatant and severe. It can almost be compared to a warning beacon from New York to the rest of the world that the cartel is still in fine form and well in control of PM’s.


Perhaps you could paste this image on your update. This is something that goes back much further. What has effectively happened is this: the world in one massive trading program. There is nowhere to hide. Virtually everything is moving together. If you were tooverlay India on to this chart it would lokk the same. Same for $gold and $oil. If you do not believe in manipulation, you are not paying attention.

History proves that the correlation betwen commodities and stocks is negative.Not perfectly negative but certainly negative at a high level. Since this re-flation trade started in earnest, everything moves together. No individual movements among various financial products is allowed anymore.

-- Posted Friday, 8 September 2006


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