A Modern Morality Play

January 16, 2002

Let's suppose that there were a group of free-wheeling, wealthy Texans that saw a way to make an easy billion. They were already dealing with commodities, such as oil, so they understood the volatile nature of this business. They had a corporate framework, a bright workforce, a tradition of placing and brokering large futures contracts. They had offices and equipment, and a sharp IT department with lots of contacts in the booming Texas computer industry.

While having dinner one evening with some European friends in some posh New York restaurant, they began to formulate an idea to make easy money - almost guaranteed - from a small, opaque market that could be easily manipulated, like the precious metals market. A German fellow was present that related to them that he had already designed a system for metals trade that was reaping huge profits on a daily basis. Because of the minimal investment, combined with the insiders knowledge of the commodity, there was almost no risk to this venture.

The "sponsoring" firm would initiate an electronic trading system that would allow people anywhere in the world to sit at terminals and trade the commodity electronically. The operation would be based in Texas, where regulation was less likely than a meteor strike. The SEC and market participants would be kept in the dark as much as possible. Opacity would be insured by forming a sham operation with a New York address where trading was supposedly taking place, while all operations would be conducted in Texas where everything is cheaper and where the big boys could keep everything super-secret. The New York address would also give an air of legitimacy and internationalism to the entire venture. The best part of all would be that they wouldn't actually have to have any of the commodities. People would be buying and selling digital blips that represented the commodities.

Some at the dinner table may have been concerned that no one would actually pay for such a service, but the brighter ones carried the thought a little further. What if the company maintained extraordinary secrecy about its operations, calling it proprietary. They could even place trades themselves through another division of the company, or through shadow corporations owned by the executives themselves, using inside knowledge to book steady profits. They could also float huge amounts of stock to the public and ride the tech boom (didn't the operation use lots of computers and elegant equations?). The company could even make money by leasing the commodity on the open market and selling into rallies, all the time placing trades in the opposite direction and reaping huge profits from the prior knowledge of the commodity dumping.

They chose to move forward on their little venture. Why not? It required very few physical assets, so if anything went wrong, or if the whole thing blew up, they could walk away and let the banks seize some used computers. As the operation began to prosper, they began to learn just how political gold and silver were! They had to be on constant alert that some regulatory official would step and look too closely at what they were doing. But luck was on their side, because Washington was in the mood to listen to them. Deregulation was all the rage. Alan Greenspan was a believer in market fundamentalism. Robert Rubin was hearing good things about the venture from his old firm, Goldman Sachs. The Treasury department and the Fed saw the "virtue" of a controlled gold market. In fact, they were assured by the management of the company that every effort would be made to suppress sudden movements in the commodity, since the most money could be made by keeping price movement as small as possible, thereby allowing the computerized trading programs to make predictable profits on the arbitrage. Most individual traders would be making "out of the money" bets that would expire worthless.

As the business developed, the company became wildly successful. Its stock price rose consistently as profits continually met or exceeded expectations. The company officials were very savvy and personable. They contributed generously to both political parties, but they rewarded the party of anti-regulation by lavishing huge sums on their campaigns and offering the fleet of company jets for campaign appearances. The Fed and treasury were astonished at the good that this brought to the markets. Hard assets were declared dead and paper assets flourished. The budget deficit disappeared as if by magic as the economy surprised everyone. Who needed manufacturing when the service economy was so strong? Gold and silver could hardly catch a bid and those who traded them were punished daily by the inexorable downward movement of the barbaric metal. Inflation was declared dead. President Bill Clinton pointed to the flat-lined metals market and proclaimed the business cycle dead. The Fed economists worked night and day to find new metrics to justify what appeared to be happening in the economy.

The discredited Bears kept pointing to the astronomical and parabolic increase in credit creation, but Alan Greenspan easily dismissed their concerns by pointing to behavior of the gold market. If money were being created as they suggested, wouldn't the gold market be signaling inflationary pressures? Obviously, there was no cause for concern. A few government officials began to have deep concerns about the potential outcome of this economic experiment. What if the new metric of hedonic deflators and the new tools of risk-pooling were merely phantom creations being used to justify a bubble economy? The nervous officials, such as Arthur Levitt, quietly left the scene as they sensed trouble ahead, being careful to give cautionary speeches that might be used later to exonerate themselves from a debacle.

Then along came 2000. The Fed had flooded the market with liquidity just in case the computer doomsayers were right. Companies had purchased extraordinary amounts of new equipment to ensure that they would not experience Y2K problems, which, in turn, promoted extraordinary levels of capitol investment in chip making plants. Computers (and, indeed, all of Information Technology), which had driven the new era, were now in a serious overcapacity situation. As the Fed began to pull in the reins to prevent inflation, business investment began to collapse. Everyone had all the equipment they would need for years. As capital became more expensive, advance orders began to dry up and inventory started to pile up.

By now, our trading company had grown to be one of the largest companies in America, as measured by revenues. Pension funds, average citizens, widows, and orphans owned this giant company's stock and debt. You were an idiot if you didn't have some money invested in this company. The Fed and Treasury needed this operation badly to keep gold prices as level as possible, thereby preventing any spike that might alert the general public of the massive imbalances in the economy. Perhaps the ESF assisted the company by providing massive amounts of gold for lease so that it could be sold into the market to suppress prices. Perhaps they helped by using the IMF to encourage and coerce smaller countries to divest themselves of their tiny gold reserves. And replace them with Federal Reserve Notes. Perhaps the Administration was offered compelling reasons to allies, such as England, to keep gold under control by regularly offering highly publicized "public" auctions where secret bids could be placed and prices could be "set" below the current spot price and released to the public as evidence of further weakness in the market.

Regardless of the circumstances, the government became entangled with the manipulations of this giant, and the fate of the country became entwined with the success of the companies strategy. But some unexpected things began to happen that would bring disaster to the company. A change in Administrations led to some confusion in the Treasury department, and perhaps the company didn't fully appreciate the full effects of this transition. The hubris of the executives of the trading company led them to believe that the liberal amounts of cash they had given to candidates of both parties would steer them clear of harm, but instead, it led them on the path to catastrophe.

Larry Summers, who had been left in charge of the game when Rubin left, was now being shown the door. With him, left many of the people that knew how this game was supposed to work. The incoming Administration inherited a nightmare scenario. Would they be honest with the public and expose the facts? Would they tell the American public that the people's gold had been leased out, sold into the market, never to be returned. Did they dredge up one more scandal to heap on a scandal weary public? Or did they want to pick up the pieces, ignore the illegalities of manipulation, and learn how the game was supposed to work, trying and keep it going - at least into the mid-term elections? Perhaps they did nothing, or at least did what it could very poorly. As things began to go bad, and the full extent of the impending debacle began to dawn on them, they called in the Master of the Universe. In secret meetings, they quizzed him on the structure of this scheme. The smartest man in any room, Dick Cheney, instantly realized that Alan didn't really understand what was going on, or he was unable or unwilling to share the secrets. Finally, they picked up the phone and called the clever Robert Rubin. Rubin, who by now knew very well where this was headed, reluctantly agreed to meet with the Administration and explain to them how they had arrived at this point.

The head-rush that Dick Cheney must have experienced as he began to fully understand this sorry scheme must have been nearly enough to shake the earth. He knew full well the largess this trading firm had graced upon the Bush campaign. He knew of the legendary friendship of his boss and the boss of the trading company. He knew this would end very, very badly for everyone.

Then came September 11th, and the whole world changed. The Administration had bigger fish to fry. Moral certitude and righteousness invaded Washington. The threat to American lives posed by misguided zealots made the markets a mere sideshow. The trading company was on its own now. All the influence it had bought was now worthless. Worst of all, the markets had turned decidedly ugly. No amount of physical gold seemed to quell the sudden urge the public had to own it. Massive losses were getting harder to hide. Most damning of all, the company executives were in danger of being exposed for selling massive amounts of their own stock to investors, just as they tied the hands of their own employees by locking their 401(k) plans just as the company's woes became public. The executives now knew that if light were shined into the practices of this company, many people could go to jail.

A few well placed telephone calls to the accountants would help get incriminating documents destroyed. Email servers could be cleaned out and backup tapes erased. Perhaps, the public could be distracted long enough for most of the executives to flee. It was panic time. The Bush Administration had decided early on that these practices were probably illegal and that their friends and chief contributors were best kept at a distance, so it was easy for Administration officials to ignore pleas for help. Alan Greenspan was beginning to realize that he had made a colossal mistake by delaying his retirement.

So here we are today. Both political parties can sense an impending scandal that will find a place in many future history books. They know full well that they are almost all guilty of negligence, and they fear that some of their members may have been in collusion. The ignorant and lazy press is faced with a story that is beyond their comprehension. Everyone is looking for a scapegoat. But the problem is that there are so many potential scapegoats that they may not be able to find the spotless investigative lamb to sort the mess out.

All the while, the American people are going to want to know why they are being beggared. They will want answers about how things could have gone from so good to so bad in so little time. They will want justice for crimes against employees and misdeeds by public officials. If they do not get clear answers, then they will make up some plausible legend to explain the misery that is being brought upon them. They need to be told the truth, but will they instead get what they deserve for supporting corruption and neglecting they responsibility to research their own investments?

The next chapter could be very horrific. Only time will tell. One thing is certain: Capitalism will be wrongly called into question. Americans were able to anesthetize themselves to the corruption that pervaded our lives during prosperous times. It will be interesting to see if they are so forgiving in times of unimaginable sacrifice.

With gold stolen by Conquistador Francisco Pizarro from the Inca Empire in 1532, Spain financed its conquest of Europe.