-Caveat Lector- PART2 "Mr. Fisher, the No. 2 man at the Federal Reserve Bank of New York, was stunned by what he saw. The ailing Long-Term Capital, the huge, secretive, and unregulated investment partnership founded by John Meriwether, was `a lot bigger than anybody thought, ' he says, and far more intricately interwoven with major markets and major players. The fear of `this layer cake becoming unglued' and putting the world's financial system at risk, as Mr. Fisher puts it, led him and his boss, New York Fed President William McDonough, to round up the biggest names on Wall Street to inject $3.625 billion into Long-Term Capital a few days later. "The move thrust 42-year-old Mr. Fisher out of the shadows where Fed staffers usually reside and into the public spotlight. It also set off a barrage of criticism for Mr. Fisher, his boss. and the Fed. "W. Lee Hoskins, former head of the Cleveland Federal Reserve Bank, sums up critics' reasoning: `A perverse kind of incentive could be put in place that investors can continue to make these bets on the hopes that the government will limit the downside risk.' He adds: `As a general rule, one should err on the side of letting the market solve the problem.' "Before the Fed was created by Congress in 1913, there was no government entity charged with maintaining financial stability. When the collapse of the Knickerbocker Trust Co. threatened to unleash a panic in 1907, the task fell to J.P. Morgan, the legendary banker, to rally Wall Street to keep markets functioning. In a sense, Messrs. Fisher and McDunough are Mr. Morgan's successors. "Mr. McDonough, 64, a former commercial banker, gets the bigger office and the big title. Mr. Fisher's primary job is to run the Fed's trading operation. When Fed Chairman Alan Greenspan decides to cut interest rates, Mr. Fisher and his staff actually do it by buying and selling government securities to maintain the desired rate in the market. When Treasury Secretary Robert Rubin decides to help prop up the value of the Japanese Yen, Mr. Fisher sells the dollars and buys the yen. "In that capacity Mr. Fisher is the Fed's eyes and ears on the inner working of stock, bond, and currency markets and is given a wide degree of latitude about when certain events pose broader risks.... "In mid-September the New York Fed's traders were witnessing unsettling developments. After Russia's debt default and currency devaluation, investors were shunning risky assets; even in the United States trading volume was thin, and prices were volatile. "`These shocks were, in their own way, not unlike what the stock market suffered in October 1987,' Mr. Fisher says. "Amid the turmoil, Mr. Fisher heard frequent rumors about numerous firms in trouble, but one name was coming up with increasing frequency" Long-Term Capital Management in Greenwich, Conn. Thus it was that on Sept. 20 he left his parents' party in Cambridge and headed for Greenwich. "After looking at Long-Term Capital's books, he realized some of the recent bond market turmoil flowed directly from the hedge fund's dumping its investments to raise cash. It underscored how much worse the markets would be if the firm collapsed. `I had an epiphany,' he says. `I realized they would be in the eye of the hurricane.' "Based on that assessment, Messrs. Fisher and McDonough spent the next three days putting the rescue plan in place. On the night of Sept. 22, while Mr. McDonough was returning from London, where he had delivered a previously planned speech, Mr. Fisher summoned some of the biggest names on Wall Street to the nearby imposing stone headquarters of the New York Federal Reserve Bank. "He offered warm sodas and no food to his guests, who stayed past 10 p.m. He spoke for just a few minutes at the outset of the two-hour meeting, but what he said was potent. He didn't ask any firm outright to do anything. He didn't even hint at the possibility of using public money. He just observed that a collapse of the investment partnership could be chaotic for markets and that there was a `public interest in a collective industry option' to keep Long-Term Capital afloat, according to participants in the session. "The decision to give that nudge -- the crucial one -- appears to have been made largely by Mr. Fisher and Mr. McDonough. Mr. McDonough consulted with Mr. Robert Rubin and Mr. Greenspan by phone. But Mr. Greenspan told Congress that the decision was based on `the judgement of the officials at the Federal Reserve Bank of New York.' The Fed's board of governors was informed but not consulted. "Critics complain that by pulling together the Wall Street consortium, Messrs. Fisher and McDonough gave Long-Term Capital's Mr. Meriwether good reason to rebuff a buyout bid from billionaire Warren Buffet. That bid would have wiped out Mr. Merriwether and his partners, including a former Fed vice chairman, David Mullins. The Fed's move left them with their jobs and a 10 percent stake in the partnership. Messers. Fisher and McDonough say that it would have been inappropriate for Fed officials to help Messrs. Buffet and Meriwether negotiate terms of a buyout and that the rescue came together only after the Buffet bid evaporated. "`If you save a baby from getting hit by a truck, and the baby gets slightly bruised, you're going to get some criticisms for the bruises,' Mr. McDonough says. `The baby we were concerned about was the credit markets, not Long-Term Capital. And we think the risks were worth it.' "After Peter Fisher heard reports of distress at Long- Term Capital, he sprang into action. Sept. 20: Fisher leads a delegation of Fed and Treasury department officials to meeting at Long-Term Capital headquarters Sept. 22, 7:30 a.m.: Fisher gathers officials from Goldman Sachs, Merrill Lynch, and J. P. Morgan at New York Fed headquarters to discuss bailout. Sept. 22, 8:30 a.m.: At New York Fed, Fisher warns Wall Street's biggest firms of market turmoil if bailout fails. Sept 23: Agreement reached at New York Fed around 6 p.m." The question GATA would like the Banking Committee to investigate is whether the New York Fed is "bruising" another baby (the gold market) to help other financial markets and thereby harming millions of innocent parties. A 12-year-old Wall Street Journal article involving former Fed Governor Robert Heller is of particular interest here. "Have good intentions about intervening in markets gone astray? "Have Fed Support Stock Market Too "By Robert Heller, Oct. 27, 1989. "The stock market correction of Oct. 13, 1989, was a grim reminder of the Oct. 19, 1987, market collapse. Since, like earthquakes, stock market disturbances will always be with us, it is prudent to take all possible precautions against another such market collapse. In general, markets function well and adjust smoothly to changing economic and financial circumstances. But there are times when they seize up, and panicky sellers cannot find buyers. That's just what happened in the October 1987 crash. As the market tumbled, disorderly market conditions prevailed. The margins between buying bids and selling bids widened; trading in many stocks was suspended; orders took unduly long to be executed; and many specialists stopped trading altogether. "These failures in turn contributed to the fall in the market averages; uncertainty extracted an extra risk premium and margin calls triggered additional selling pressures. "The situation was like that of a skier who is thrown slightly off balance by an unexpected bump on the slope. His skis spread farther and farther apart -- just as buy-sell spreads widen during a financial panic -- and soon he is out of control. Unable to stop his accelerating descent, he crashes. "After the 1987 crash, and as a result of the recommendations of many studies, `circuit breakers' were devised to allow market participants to regroup and restore orderly market conditions. It's doubtful, though, whether circuit breakers do any real good. In the additional time they provide even more order imbalances might pile up, as would-be sellers finally get their broker on the phone. "Instead, an appropriate institution should be charged with the job of preventing chaos in the market: the Federal Reserve. The availability of timely assistance -- of a backstop -- can help markets retain their resilience. The Fed already buys and sells foreign exchange to prevent disorderly conditions in foreign- exchange markets. The Fed has assumed a similar responsibility in the market for government securities. The stock market is the only market without a market- maker of unchallenged liquidity of last resort. "This does not mean that the Federal Reserve does not already play an important indirect role in the stock market. In 1987 it pumped billions into the markets through open-market operations and the discount window. It lent money to banks and encouraged them to make funds available to brokerage houses. They, in turn, lent money to their customers -- who were supposed to recognize the opportunity to make a profit in the turmoil and buy shares. "The Fed also has the power to set margin requirements. But wouldn't it be more efficient and effective to supply such support to the stock market directly? Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying averages in the futures markets, thus stabilizing the market as a whole. "The stock market is certainly not too big for the Fed to handle. The foreign-exchange and government securities markets are vastly larger. Daily trading volume in the New York foreign exchange market is $130 billion. The daily volume for Treasury Securities is about $110 billion. "The combined value of daily trading on the New York Exchange, the American Stock Exchange and the NASDAQ over-the-counter market ranges between $7-$10 billion. The $13 billion the Fed injected into the money markets after the 1987 crash is more than enough to buy all the stocks traded on a typical day. More carefully targeted intervention might actually reduce the need for government action. And taking more direct action has the advantage of avoiding sharp increases in the money supply, such as happened in October 1987. "The Fed's stock market role ought not to be very ambitious. It should seek only to maintain the functioning of markets -- not to prop up the Dow Jones or New York Stock Exchange averages at a particular level. "The Fed should guard against systemic risk, but not against the risks inherent in individual stocks. It would be inappropriate for the government or the central bank to buy or sell IBM or General Motors shares. Instead the Fed could buy the broad market composites in the futures markets. The increased demand would normalize trading and stabilize prices. Stabilizing the derivative markets would tend to stabilize the primary market. The Fed would eliminate the cause of the potential panic rather than attempting to treat the symptom -- the liquidity of the banks. "Disorderly market conditions could be observed quite frequently in foreign exchange markets in the 1960s and 1970s. But since the member countries of the International Monetary Fund agreed in the `Guidelines to Floating' in 1974, such difficulties have been avoided. I cannot recall any disorder in currency markets since the 1974 guidelines were adopted. Thus, the mere existence of a market-stabilizing agency helps to avoid panic in emergencies. "The old saying advises: `If it ain't broke, don't fix it.' But this could be a case where we all might go broke if it isn't fixed." GATA believes it is reasonable to ask whether something is amok in the gold market. We are not making any wild accusations about the Federal Reserve. We are just searching for some answers to valid questions. Another compelling question concerns Fed Chairman Greenspan's comments on July 24, 1998, before a House Banking Committee and on July 30, 1998, before the Senate Agriculture Committee that "central banks stand ready to lease gold in increasing quantities should the price rise." GATA and many in the gold industry would like to know what Greenspan meant here. Was he signaling the bullion dealers that the U.S. government and other governments would not let the price of gold rise so that they could short-sell gold with impunity? The collapse of the price of gold is causing extreme hardships around the world, yet the Clinton administration has gone out of its way to support the IMF gold sales idea. Meanwhile the opposition in Congress to the IMF gold sale has created the most unusual of political alliances. Consider who is opposed to the IMF gold sale: 1) Rep. Jim Saxton, chairman of the Joint Economic Committee; 2) Sen. Jesse Helms, Senate Foreign Relations Committee chairman; 3) Sen. Tom Daschel, Senate minority leader; 4) Rep. Dick Armey; House majority leader 5) Tom DeLay, House majority whip; 6) Democratic senators such as Richard Bryan, Tim Johnson, and Harry Reid; and 7) the Congressional Black Caucus. While many of the leading figures in both political parties are against the proposed IMF gold sale, who is for it? Just the Clinton administration and its big- money supporters who are short gold. The reaction to the outrage of Africans and their request for support from the Labor Party in Britain is even stranger. Consider this recent story from the London Daily Telegraph: "Golden opportunity missed to show African solidarity." "Let them eat aid. New Labour's sympathy for the gold miners of South Africa is strictly limited. You would have thought that when the leader of their union turned up in London, he would be feted all the way from Islington to Millbank, which would be relabeled James Motlatsi House in his honour. Not a bit of it. "Sentiment counts for nothing when it conflicts with the Government's suddenly invented policy of selling off the gold reserves. In two months this prospect has lowered the price of gold by one-tenth, and 100,000 miners stand to lose their jobs. Mr. Motlatsi is here with Bobby Godsell from the Chamber of Mines to plead their industry's cause. In the House of Commons this week the prime minister could not find a single sympathetic word for them. We had sold, so he said, on the technical advice of the Bank of England, and got the best deal for the country -- this country, that is. Gold sales were just the Tories' latest obsession, and their party had supported apartheid, so who were they to talk? "His flinty response was misleadingly worded. It is a gold ingot to a china orange that this clearance sale was not proposed by the bank. The official reserves are not the bank's but the state's, and making policy for them is the responsibility, with the bank as its agent in the market. It has been left to make the best of a bad job. "New Labour's next good cause is to make the International Monetary Fund sell gold and use the proceeds to relieve poor countries of their debts. It does not seem to cross ministers' high minds that some of these countries have gold in the ground and make their living, or hope to, by digging it out. There would be no point in telling Zambia to dig for Special Drawing Rights or Mali to open an internet cafe. "Zambia and Mali (and, of course, South Africa) will be represented here next week, when their governments will try to make the industry's point for it. They are not asking for aid. Africa's best hope must be to work its way out of poverty -- if only the conceit and condescension of New Labour will let it." It is understandable that many people recoil when they hear the words "manipulation," "collusion," and "conspiracy." Yet many of the potential players in the gold market manipulation have been charged publicly with manipulations of some sort before, so why should it not follow that they may be involved manipulating the price of gold? After all, anyone who has borrowed gold the past several years at 1 percent interest and has sold it has had the opportunity to re-invest the funds and earn substantial returns and then return the principal at much lower prices and reap windfall gains there too. Let us examine some recent commentary about the behavior of current bullion dealers and associated parties: 1) Counterparty Risk Mangagement Group member Credit Suisse: "Tokyo, July 13 (Bloomberg) -- Credit Suisse Group, Europe's sixth-biggest bank, was humbled today when Japan indicated it may revoke the banking license of a financial subsidiary -- the most severe punishment of a financial firm since World War II." 2) The Commodities Futures Trading Commission fined LTCM bailout partner Merrill Lynch millions of dollars for helping Sumitomo manipulate the copper market 3) Goldman Sachs is being investigated for its underwriting fees. "Washington, April 30 (Bridge News) -- The U.S. Department of Justice served investment Bank Goldman Sachs & Co. with a civil investigative demand Thursday requesting information concerning an `alleged conspiracy among securities underwriters to fix underwriting fees,' according to a Securities and Exchange Commission filing from Goldman Sachs released today. "The request from the Justice Department marks an escalation of charges that were filed in a private class-action suit in November, a source familiar with the investigation told Bridge News." Consider this article from the July 1999 issue of London's Business Age magazine: "The recent dramatic fall in the gold price could have been triggered by the Bank of England irresponsibly signaling a massive unloading of bullion onto the market, amid suspicions that a global cartel has been attempting to manipulate values, writes David Guyett. "When the Treasury announced in early May that it was going to auction over half the nations 715 tonne gold reserves, it caused eyebrows to be raised in many parts of the world. It also triggered a steep decline in the market price of gold from just below $290 an ounce to $281.50. "In the blink of an eye over $90 million was wiped off the value of the gold the Treasury has earmarked for sale. Ordinarily, central bank gold sales are conducted in the utmost secrecy and are then routinely announced after the event. "This ensures a stable market price for the bank to sell into. Effectively talking down the gold price by announcing `future' sales is considered curious, especially for a nation possessing a long history of managing its gold reserves with skill and subtlety. "More recently, Gordon Brown's public comments in favour of the proposed sale of 10 million ounces of IMF gold have merely added to the confusion. "Unsurprisingly, the prospect of an additional large official disinvestment saw an even more dramatic plunge in the market price to under $260. The chancellor's comments, said to be aimed at raising funds to alleviate the horrendous debt burden of impoverished third world nations, wiped a further $300 million off the value of British gold reserves. "While many market analysts ponder just what the chancellor hopes to achieve by apparently cutting off his nose to spite his face, an independent American gold pressure group believe they know the answer. "Formed earlier this year, the Gold-Anti Trust Action Committee, known simply as GATA, claim the gold market is in the grip of a powerful cartel of leading Wall Street and European banks. These are said to have colluded to manipulate the price of gold to their commercial advantage. "According to Bill Murphy, a commentator on the gold market and GATA Chairman, up to 20 leading banks may be party to a cartel arrangement. Murphy says that many of these banks have leased gold from central and other gold banks at strike prices as low as $290. The lending banks, according to the insiders, charge little more than 1 percent per annum as a leasing fee. "This amounts to `a virtually interest-free loan,' Murphy says. By selling the leased gold, the banks receive a hefty cash `pool.' That is then invested in U.S. Treasury securities or placed in other overseas markets. With Treasury yields climbing above 6 percent, the net 5 percent `windfall' returns earned by the borrowing banks generate huge profits. Later covering their short positions at lower strike prices will generate additional income. "GATA believes that short sales of this type collectively total as much as 8,000-10,000 tonnes. Others believe it could be higher and amounts of 14,000 tonnes are mentioned. Meanwhile, one Wall Street bank is rumoured to be short 1,000 metric tonnes, worth about $9 billion. This is believed to be Goldman Sachs, America's largest investment bank. Goldman refused to comment but insiders at the bank deny the position is as large as claimed. "The risk of this short sale strategy is if the gold price shoots up beyond the $290 level. With annual gold mining production of 2,500 tonnes per year, it could prove impossible for those short banks to buy sufficient quantities of metal to repay back their loans. Locked into a trap of their own making, this could stampede the banks and cause the gold price to skyrocket, turning easy profit into crippling losses. Were just one of these banks to fail under the burden of such losses it could trigger a systemic collapse of the international economy. "This, Murphy believes, is the underlying reason why the Treasury took the unusual step of announcing a gold auction in advance, and why Gordon Brown is so strongly committed to an IMF sale. At the time the Treasury issued its announcement, the gold price was preparing to penetrate the $290 level. Forcing down the price enables the banks involved to extricate themselves from their now suspect trading positions. "Murphy admits that he cannot prove his case. However, he says the circumstantial evidence is overwhelming in support of his view. Not least he points to testimony given by Federal Reserve Chairman, Alan Greenspan, who told the House Banking Committee last summer that `central banks stand ready to lease gold in increasing quantities should the price rise.' "`What else could the Fed be up to?' Murphy asks, other than the wholesale manipulation of the gold price" "Whether Murphy's group is ever able to prove that the market is a rigged roulette wheel remains to be seen. Meanwhile GATA's efforts constitute the only truly independent attempt this century to penetrate the mysteries of one of the most secretive of all financial markets." Others are crying out for transparency, truthfulness, and accountability: "Basle, Switzerland, June 7 (Reuters) -- Nine months after the near bankruptcy of U.S. hedge fund LTCM shook the world, bank regulators still do not have the tools to judge accurately the risks that financial market speculators are running, the Bank for International Settlements said on Monday.... The inference of the rescue, the BIS commented, is that U.S. bank regulators and LTCM's principal creditors considered that a non- bank financial institution was `too complex to fail' .... `This might be thought a worrisome message sent out to much bigger banks and dealing firms with their own proprietary trading operations, ' the BIS said.... So intricate are the trading strategies used by sophisticated investors such as LTCM that existing statistics cannot readily measure how much market and credit risk they are exposed to." GATA believes that Congress easily can investigate this matter and get the answers that are necessary to protecting the international financial system against collapse. If all the bullion dealers and parties involved in the Long-Term Capital Management bailout are asked to disclose their gold trading books, you easily could determine if our suspicions are correct and if excessive gold loans pose an unacceptable threat to financial stability. My former associate, Frank Veneroso of Veneroso Associates, can assist your committee as he has compiled the most comprehensive study on the gold loans in the world. In his 1998 Gold Book Annual he determined that the gold loans were about 8,000 tonnes in total (7,000 to 7,500 tonnes of official swaps and deposits and 500 to 1,000 tonnes of private deposits). Since then he has received more information about the positions of 9 bullion dealers. Three were about as expected. Six were higher too substantially higher than expected. 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