The Plunge Protection Team: An Adventure of Acronyms

The Plunge Protection Team (PPT) refers to widespread beliefs that the US President’s Working Group on Financial Markets role is to prevent undue plunges in value of US stocks. The PPT was brought into being after Black Monday of 1987 and its overt role is to coordinate policy in times of financial market stress and to advise the President.

Speculation has it that the Working Group, and by extension the government, has resorted to illegally physically intervening in the markets to prop them up. We cannot be privy to the internal workings of this group, but when one of them makes a press announcement we do catch a glimpse of them in action: the Secretary of the Treasury, currently Hank “Bazooka” Paulson, the Governor of the Federal Reserve Ben Bernanke, the chairmen of the SEC, Christopher Cox, and CFTC, Walter Lukken.

So far there are a number of operations conducted by the Fed to guarantee liquidity in the monetary system by lending to banks and widening the variety of collateral accepted; this has created the TAF, TSLF and PDCF, the latter two run under the aegis of the New York Fed as they sit closest to the financial markets and are therefore responsible . The Fed has opened swap lines with other central banks to provide USD liquidity globally to help ease the funding situation. Back in March they also took on $29 billion in liabilities from Bear Sterns to facilitate their takeover by J.P. Morgan. They have taken control of and provided a loan facility of up to $80 billion for AIG to ensure the continued solvency of this crucial insurance entity.

Given the performance thus far, why was Lehman allowed to fail you may ask? Firstly, unlike in March, the contagion had spread to other banks, so the fear was that any take over of Lehman would include the bad assets that created their problems in the first place, these bad assets seemed to swell from $30billion to $80 billion on the fateful weekend they were trying to sell themselves to BofA or Barcap, and would therefore contaminate any bank that purchased them. Secondly, the PPT had to show the banks it meant business, arguably this would have been achieved had they let Bear Stern’s go down in the first place.

Hank Paulson has fired his bazooka on Fannie and Freddie and is now taking the TARP (Troubled Asset Relief Program) off his bomber, but now that he has to ask congress for the ammunition of taxpayers money the solution is not such a sure thing. The TARP has been put in place to backstop the vicious circle of writedowns and asset price drops amongst housing and mortgage related products initially (Mortgage Backed Securities, MBS), but ultimately any sensitive, illiquid and systematically risky asset pool (CDOs, ABS). At the same time the SEC has stepped in and banned the shorting of financial stocks in an attempt to stop the self-fulfilling rot in the markets, with a number of countries around the world joining the party. Cue the burning of banker effigies and general outcry against anyone who works in finance. Of course, it is rarely mentioned that it was the SEC which allowed the independent investment banks to lever up in the 90s by expanding what was definable as assets that could be held in the first place.

What conclusions can we come to whilst all this plays out? The most obvious but least acknowledged point is that crises occur with almost cyclical regularity and these should and can to some extent be anticipated and prepared for. The ordinary investor should have or be in the process of rotating their portfolio to more defensive instruments such as government bonds, precious metals, liquid defensive stocks (large, diversified corporations) and cash; as well as minimising debt and spending.

As I’ve touched on previously, one of the biggest worries is that the problems of Wall Street fall out to Main Street. The immediate effect of decreased banker pay will be felt in the wider economy, but it is the monetary transmission mechanism and bank lending that are absolutely crucial. The Eurozone is officially in recession and the UK and US are likely to follow, growth around the world is slowing and some economists have mooted that there could be a global recession. China is likely to slow from >10% GDP growth p.a. to only 8%, so if you’re brave enough there’s plenty of opportunity out there. Perhaps, minds numbed from all the acronyms and wallets thinned from the slowdown, we will start to see a reverse brain drain to the developing markets? Keep your tin hats close whatever you do.