Deregulation is much in style in Ronald Reagan's Washington. The virtues of the "free market" are sung daily. And government is usually pictured as the enemy of competition, rather than as its protector.
In that context, Stephen Fay's book about the "silver bubble" of 1980 holds more than passing interest. His intention was to tell a good story about how Texas billionaires Nelson and Bunker Hunt and their Saudi Arabian friends, including members of the House of Saud, almost cornered the world market for silver. Although marred by disconcerting errors (New Right Republican Sen. Steve Symms of Idaho is identified as a Democrat, for example), it is a well-written tale.
But the lesson of Fay's research is not just that even billionaires can get greedy. Clearly they can, and the Hunt brothers did. The real lesson is that regulation can protect the public, and we all pay the price when, as in this case, it does not.
The details of the Hunts' scheme are intricate, but the basics are straightforward. In the mid-1970s, Nelson and Bunker decided that silver prices were bound to rise faster than inflation and that, with the help of some Arab investors, they could buy enough silver bullion and futures contracts to drive the price even higher. In its most extensive form, the Hunts' effort could have led to a "corner" of the market, a set-up in which they could have demanded almost any price for their silver. Because most commodity speculators (unlike stock traders) can buy futures contracts for small fractions of their prices (low margins) and face no restrictions on the number of contracts they can control (position limits), the Hunts bought a dominant piece of the world silver business on credit.
As early as October 1979, federal regulators at the Commodity Futures Trading Commission (CFTC) knew the essence of what the Hunts were up to. CFTC Chairman James M. Stone, one of President Carter's "public interest" appointees, wanted the commission to threaten to declare a "market emergency." He hoped such a threat would convince the commodity exchanges where silver is traded to limit the number of silver contracts the Hunts could hold, and that would diffuse their pressure on the market.
According to Fay, Stone was "alive to the potential seriousness of the Hunts' raid on the silver market but was impotent to act until the new year because of the even split among the commissioners." Unfortunately, Carter had neglected to provide Stone with a working majority on the commission. Of the five CFTC slots, one seat was vacant, two members favored action and two opposed it.
Just as important, the commission's legal authority was murky. A united CFTC might have convinced the self-regulators at the exchanges to act, but Congress had denied the commission power to intervene directly in such situations. Only when the price of silver neared its $50-an-ounce peak three months later--more than triple the price when the commissioners had first shared their worries about the Hunts--did this rift on the commission start to bridge itself.
In the meantime, silver contributed to the hyperinflation that boosted the Producer Price Index up 2.8 percent from December to January. Six thousand workers in the jewelry, silverware and plateware industries lost their jobs between November and February. By January, speculators who had bet that prices would not rise so far were deeply in trouble. Unfortunately for the Hunts, these speculators dominated the governing boards of the major commodity exchanges. In January, the exchanges retroactively imposed limits on the number of contracts speculators could hold.
This and other actions forced the Hunts to sell, burst the bubble, and sent the silver price plummeting. By late March it had hit $16 an ounce.
Was this a demonstration that the market had corrected itself? Hardly. Focusing on one of the key exchanges, Fay notes, "Comex New York's Commodities Exchange acted only when the CFTC was finally able to bully the board into doing so." In October the CFTC might have used its limited power to persuade the exchanges to block the Hunts' scheme. By January, with the size of the Hunts' silver holdings growing, the commission's options were limited. When a majority finally decided to act, it leaned on the exchanges to do the job.
In the end, the Hunts failed. The market was protected. But because the CFTC's power was limited and too many commissioners were reluctant to use it, needless damage was inflicted on the economy. The damage did not end when the price stabilized. The mopping-up operation included a $1.1 billion loan to the Hunts at a time when farmers, small businesses and others were frozen out of the credit markets.
Fay's craft as reporter shows a bit too much in the first chapters, where he performs journeyman service, interspersing profiles of the players with what he calls the MEGO (My Eyes Glaze Over) affairs of explaining how futures markets work. That rather dry groundwork pays off in the second half of his narrative, where he glides swiftly through the rising tensions that surrounded Silver Thursday, the day the futures market almost collapsed.
Could it happen again? Of course it could. The Hunts came very close to cornering the market. Short of that, they made hundreds of millions of dollars as the price rose. They demonstrated that under current rules commodity prices can be manipulated--with costly results for innocent bystanders. Telling that story, Stephen Fay has reminded us that, even in the era of laissez-faire, there is a place for the visible hand of government protecting the market against those who would destroy it.