SILVER THURSDAY

He was a towering six foot seven, his round, balding head perpetually wreathed in cigar smoke. Paul A. Volcker, the chairman of the Federal Reserve System, was formidable even when he was cheerful. On Wednesday afternoon, March 26, 1980, he was furious.

Volcker, in office for barely seven months, had been pulled out of a meeting by a frantic message from Harry Jacobs, the chairman of Bache Halsey Stuart Shields, the second-largest brokerage firm on Wall Street. The Fed had almost no authority over brokerage firms, but Jacobs said he thought “it was in the national interest” that he alert Volcker to a crisis in the silver market—a market over which the Fed also had virtually no authority.

Jacobs’s news was alarming. Silver prices were plummeting, and two of the firm’s biggest customers, a pair of billionaire brothers in Texas named William Herbert and Nelson Bunker Hunt, had told him the previous evening that they could not cover a $100 million debit in their Bache accounts, which they had used to amass millions of ounces of actual silver and paper claims on millions more. If silver prices fell further and the Hunts did indeed default on their debt to the firm, the silver they had pledged as collateral was no longer worth enough to cover their obligations. Bache was confronting a ruinous loss, possibly a threat to its financial survival. Jacobs suspected the Hunts also owed money to other major banks and Wall Street firms and may well have pledged more of their silver hoard as collateral.

Volcker immediately wanted to know which banks had made loans to the Hunts. He didn’t regulate Wall Street brokers or silver speculators, but he emphatically did regulate much of the nation’s banking system. There, at least, his authority to act was clear.

Indeed, Volcker had been responding to fire alarms in the banking system for weeks, as banks and savings and loans struggled with rising interest rates—themselves a consequence of Volcker’s attack on the raging inflation that had sapped the economy for nearly a decade. Confidence in America’s banks was as fragile as blown glass, and the last thing Volcker needed was a “bolt from the blue” like this. Yet, here was the head of Wall Street’s number-two firm warning him that some big banks were financing what sounded like wildly speculative silver trading by a couple of Texas plutocrats.

Within minutes, Volcker had reached out to Harold Williams, the urbane and seasoned chairman of the Securities and Exchange Commission, the primary U.S. government regulator of Bache and its fellow brokerage firms. Williams was at a conference in Colonial Williamsburg; he ducked into a side room, spoke with Volcker about Bache, and then phoned to tell his staffers to check immediately on the rest of Wall Street’s exposure to the silver speculators. Williams then hurried back to Washington. A senior Treasury Department official and the comptroller of the currency (another bank regulator) were also alerted to the potential crisis. Both headed for the Fed’s headquarters on Constitution Avenue. Together, perhaps they could cover all the financial corners of this unfamiliar crisis.

To do that, the group needed a regulator with some authority over the silver markets. Volcker called the office of James M. Stone, who had been tapped less than a year earlier by President Jimmy Carter to be the chairman of the Commodity Futures Trading Commission, a young federal agency that regulated the market where most of this silver speculation had gone on.

At age thirty-two, Jim Stone—a cousin of the notable filmmaker Oliver Stone—had already studied at the London School of Economics and earned a doctorate in economics from Harvard. His doctoral thesis had been published as a prescient book predicting how computers would revolutionize Wall Street trading, first by doing the paperwork but ultimately by sweeping away the traditional stock exchanges entirely. Stone was a slight, brilliant, and determined young man, but his view that regulation played a positive role in the markets made him deeply unpopular in the industry he regulated and put him at odds with his more laissez-faire CFTC colleagues. One grumpy board member at a leading Chicago commodity exchange privately dismissed him as a “little twerp.” Almost everyone in political circles (except Volcker, apparently) knew that young Dr. Stone had become so isolated at the CFTC that he could barely get support for approving the minutes of the last meeting.

When Volcker got Stone on the phone, his question was similar to the one he had asked Harold Williams at the SEC: how big a stake did the Hunt brothers have in his market?

“I can’t tell you that. It’s confidential,” Stone said.

The politely delivered answer stopped Volcker cold; he was momentarily speechless. Then he let loose.

Volcker conceded later that he “did not react very well” to Stone’s refusal to share the vital information, even after the CFTC chairman explained that a law passed in 1978 barred his agency from revealing customer trading positions, even to other regulators. Stone simply did not have the authority to comply with the Fed chairman’s request.

Stone, like Volcker, instantly saw that the silver crisis was a danger to the financial system because of the hidden web of loans that linked the banks and the brokerage firms to the Hunts and to one another. He promptly headed for Volcker’s office. Sometime later, the SEC’s Harold Williams arrived. Aides shuttled in and out, working the telephones, checking silver prices, and pressing bankers and brokerage finance officers for straight answers.

By 6 p.m., as twilight filled the deep, high windows of Volcker’s office, the ad hoc group had finally established that at least a half-dozen major Wall Street firms, including Merrill Lynch and Paine Webber, had set up trading accounts for the Hunts and that a number of major banks had been lending money to those firms, or directly to the Hunts, since at least the previous summer, transactions secured by a growing pile of rapidly depreciating silver.

Eight months earlier, on August 1, 1979, silver was trading below $10 an ounce. Prices rose through Labor Day, past Thanksgiving, and into the Christmas holidays. At $20 an ounce, silver had broken out of its traditional ratio to gold. At $30 an ounce, the sky-high price prompted newlyweds to sell their sterling flatware before burglars could steal it. Printers and film manufacturers, which used silver as a raw material, started laying off workers and feared bankruptcy. Through it all, the Hunts kept buying, largely with borrowed money.

Then, on January 17, 1980, silver prices paused at $50 an ounce and started to slide. At that point, the Hunts’ hoard was worth $6.6 billion. After that date, prices dropped sharply; they had fallen to $10.80 on Tuesday, March 25, the day before Harry Jacobs at Bache called Volcker. At that price, the Hunts owed far more than their silver would fetch in the cash market, and their lenders were pressing for more collateral of some kind.

It was on that Tuesday evening that the brothers told Jacobs they were unable to pay anything more. The next day, they shared the same unwelcome news with their other brokers. Crisis had arrived, and panic might quickly follow if a big bank or brokerage firm failed as a result of the Hunts’ default.

That’s where Paul Volcker stepped into the story. After their Wednesday war room conference, held together more by personality and mutual respect than by any clear lines of authority, Volcker and his fellow regulators sweated out Thursday’s trading day. Stone, in defiance of the CFTC’s legislative restrictions, had finally given his fellow regulators an estimate of how much money the Hunts owed in his market: $800 million. That figure, which turned out to be an understatement, was so staggering it prompted the shocked bank regulators immediately to order examiners to visit various vaults to be sure that the Hunt brothers hadn’t pledged the same silver to multiple lenders.

By Thursday, the rest of Wall Street had gotten wind of the silver crisis, and the stock market had a wild day. The Dow Jones Industrial Average fell by as much 3.5 percent before stabilizing, as traders reacted to rumors that the Hunts and some of their creditors were dumping stocks to raise desperately needed cash.

Of course, it is true that every share of stock that is sold is also bought—by someone, at some price. When far more people want to sell than to buy, prices have to drop sharply before buyers will bid for even a few shares. The term heavy selling, then, means that shares can be sold only at increasingly lower prices—not that everyone is selling and no one is buying.

With that caveat, “heavy selling” is what happened as the stock market reacted to fears of a default by the Hunt brothers. One Wall Street veteran said that Thursday’s trading reminded him of the frenzied response to President John F. Kennedy’s assassination in 1963. A Treasury official called the leadership at the New York Stock Exchange several times that day to assess how it was faring in the storm. The fear in Washington and on Wall Street was that the Hunts’ failure to pay their creditors would mean that those creditors would default on their own debts, spreading the contagion.

Infusions of cash by the owners of the most vulnerable silver trading houses prevented an immediate disaster, but the reality was that no one really knew where all the fault lines ran, or how much time they had before the next aftershock. The silver crisis made headlines across the country, and “Silver Thursday” entered Wall Street’s diary of very bad days.

By Friday, March 28, the price of silver had crept up a little, and the crisis seemed to have eased, but the Hunts still owed a lot of people a lot of money. By Sunday afternoon, March 30, it was clear they wouldn’t be able to pay it unless someone lent them the money to do so. It was a crazy dilemma, but one where Volcker’s authority was clear. The Fed chairman looked at the widening cracks in the nation’s financial foundation. He considered the pressure that another year or two of high interest rates would put on the banking industry, and how a bank failure would impair the Fed’s fight against inflation. He held his nose and stood watchfully on the sidelines as a team of bankers, all conveniently attending an industry convention in Boca Raton, Florida, negotiated through Sunday night over the terms of a new $1.1 billion loan for the Hunt brothers, secured largely by the family oil company. The loan would allow them to pay their staggering debts on Wall Street.

On Monday morning, with the bankers still working on the fine print, Jim Stone of the CFTC took a seat at a huge, microphone-studded conference table in a House of Representatives hearing room on Capitol Hill. Also summoned to the hearing were Harold Williams of the SEC and a senior Treasury official involved in the crisis.

The subcommittee chairman was a veteran New York Democrat named Benjamin Rosenthal, and he was as angry as Volcker had been five days earlier. “We are deeply concerned that the activities of a handful of commodity speculators could have such a profound effect on our nation’s financial markets,” he said in his opening remarks.

What was especially new and scary was that the crisis involved commodities markets, banks, brokerage houses, the stock market, and even the oil business, the source of the Hunt brothers’ wealth. Rosenthal demanded to know if there had been sufficient coordination among the CFTC, the SEC, the Treasury, the Office of the Comptroller of the Currency, and the Federal Reserve.

The worrisome response: Maybe not. But the improvised effort (and the lucky rebound in silver prices) had prevented a series of domino defaults, and the regulators promised to do better if they ever faced a similarly messy crisis again.

Early in the hearing, Stone was asked for details about the Hunts’ silver holdings.

“I cannot discuss position information,” Stone replied, in a frustrated echo of his answer to Volcker. “That is forbidden by Congress.”

More knowledgeable about the ban than Volcker had been, Rosenthal snapped back, “You are forbidden to make it public. It is not forbidden to give it to Congress.”

“It is not forbidden to give it to Congress,” Stone conceded, a bit awkwardly. “Our commission has voted—with myself in the minority, I might add—to do that only upon subpoena.”

Rosenthal held tense, hurried consultations with staff aides. The CFTC was not under the control of Rosenthal’s subcommittee; the commission was supervised by the House and Senate agriculture committees, because of its importance to the producers and users of farm commodities such as wheat, pork bellies, and soybeans. “We’re going to deal with that as a separate issue,” Rosenthal said. It was apparent that the chain of command in Congress was as tangled as it was among regulators.

A few moments later, Rosenthal observed that Stone had voted against many of the CFTC decisions in the silver matter. “The majority of the commission seems to be going down one road and you seem to be going down another road,” he said.

“There are certainly differences in philosophy,” Stone answered. “My philosophy tends to hold that where these markets affect the financial fabric of the United States, more regulation is needed. That is the case even if these markets do not in themselves pose substantial dangers.” He added, “I do not think that is the majority view of the commission.”

Indeed, the majority of the CFTC had done little to forestall the unfolding silver crisis except to “jawbone” the exchanges where the Hunts were trading, urging them to use their “self-regulatory” power to do something.

“The market, in a very real sense, cured itself,” one CFTC commissioner proudly testified. He and another commissioner stoutly denied that this uproar in their markets posed any threat to the nation’s financial health.

Then it was Harold Williams’s turn as a witness.

The SEC chairman was asked about concerns he had expressed at previous hearings about the “efficacy” of the CFTC. “I would say we have more concern today than we did last Tuesday—significantly more,” he answered.

From then on, as Stone sat silently at the table, the SEC chairman and, later, the deputy Treasury secretary who worked on the silver crisis rehashed the jurisdictional warfare that had beset the CFTC from the moment it was born. It was a discussion that would become numbingly familiar in the years to come.

The creation of the Commodity Futures Trading Commission in 1974 was initially resisted by the exchanges it was supposed to regulate, especially the two largest futures markets, the Chicago Board of Trade and the Chicago Mercantile Exchange. Those exchanges, whose informal motto was “Free markets for free men,” were each more than one hundred years old, and they had long resented any meddling in their own regulation of their trading floors. They had bowed to the CFTC only because they had played a sizable role in drafting the statute that created it, a law that would confound judges and frustrate other regulatory agencies for decades.

At the time of the silver crisis, most Americans had no idea what the “futures markets” centered in Chicago actually did.

Here’s what they did, and still do: they allow buyers and sellers of all sorts of things to protect themselves from damaging price changes. Here’s what else they do: they give the traders who stand between those buyers and sellers a chance to profit from those same price swings. The financial instruments that shift the price risk (to those who are willing to bear it, from those who aren’t) are called futures contracts. In Chicago, they are universally known just as “futures,” as in “they bought silver futures” or “he trades wheat futures.”

In 1980, when market news in the newspapers and on television focused almost exclusively on blue-chip stocks, futures seemed dauntingly complex. To some degree, the Chicago markets had encouraged the idea that futures were far too complicated for the average regulatory and congressional brain to comprehend. In reality, nobody needs to master how futures contracts work to understand the role they play in this story, but some basic details will help to explain why the futures markets exist. Futures are simply standardized contracts to buy or sell a fixed amount of something, at a fixed price per unit, on a fixed date in the future. Traditionally, that “something” had been something you could eat, such as corn, wheat, or pork bellies, or something you could at least touch, such as oil or silver. Businesses that produce those things and businesses that use them as raw materials rely on the futures markets to protect against adverse price swings.

For example, here’s how a wheat farmer could use futures to lock in a price for the crop he has just planted: Imagine the farmer expects to harvest 5,000 bushels of wheat and, to stay in business, he must get $3.50 a bushel for his crop, for a total income of $17,500. To guarantee that he gets that payday, he can sell a futures contract covering 5,000 bushels of wheat to be delivered in six months at a price of $3.50 a bushel. (The buyer of the contract could be a cereal company that wants to lock in the price it will have to pay for the next wheat harvest.) By selling the contract, the farmer makes $17,500—the same amount he needs to get at harvest. If the price of wheat then falls to $3 a bushel, his crop will fetch only $15,000. However, the farmer can now buy the futures contract back for just $15,000, closing out his position at a profit of $2,500. So his total income is $17,500—that is, $15,000 for his crop and a $2,500 profit on his futures trade. In effect, he got $3.50 a bushel, just as he’d hoped, even though wheat prices fell. The same arithmetic works in reverse: if wheat prices had gone up to $4 a bushel, the farmer would have gotten $20,000 for his crop and lost $2,500 on his futures trade—which still works out to $3.50 per bushel. (Yes, in the latter case he’d have gotten more money if he hadn’t hedged, but he opted to lock in a necessary profit rather than gamble between a windfall and a ruinous loss.)

The utility of futures contracts to farmers and cereal companies is obvious. However, the driving fact about those contracts is that they can be traded like baseball cards. That fact was the lifeblood of the giant Chicago futures exchanges, and about a dozen smaller futures exchanges around the country.

And the vast majority of futures contracts are traded: they are bought and sold, in pursuit of profit, by traders who have no intention of delivering or collecting the underlying commodity. Traders who sell futures contracts to grain companies, or buy them from farmers, are called speculators. Their goal is to profit from the same constantly fluctuating prices those hedgers want to avoid.

There is a long and ignorant tradition in America, especially in Congress, of blessing hedgers but denouncing speculators, who are blamed when consumers face higher prices for bread or gasoline, or when farmers cannot profit from their harvests. The fact is that you simply cannot run a marketplace without both hedgers and speculators. Speculators expand the community of traders ready to deal with the market’s hedgers, and they are willing to trade when wild price fluctuations might send the timid hedgers to the sidelines.

That is another essential fact to remember about commodity markets: luckily for the hedgers, speculators in those markets thrive on fluctuating prices. They relish price volatility—the wilder the roller-coaster ride, the more money they can make. Stock market investors might prefer small, steady price ticks—upward, preferably, but nothing too dramatic either way. But calm seas are unwelcome among futures traders. Stormy markets are their reason for being. If markets were quiet and predictable, nobody would bother to hedge and nobody could make any money speculating.

This tolerance for volatility was hardwired into the minds of the speculators who, by and large, were the people running the Chicago markets that the CFTC was struggling to regulate.

The futures contracts that really worried the SEC’s Harold Williams and his fellow financial regulators had nothing to do with tangible commodities such as wheat or corn or even silver. These regulators were worried about “financial futures,” newly designed contracts based on the shifting prices of intangible assets in the world’s financial markets.

The Treasury and the Fed were fretting about futures based on government bonds; the SEC was concerned about futures based on mortgage-backed securities and (still on the drawing board) futures based on major stock market barometers such as the Value Line index or the Dow Jones Industrial Average. The basis for all these fears was that these new futures contracts would somehow damage the markets that had long set the prices of stocks and bonds—the cash markets. Regulators of those cash markets feared that the speculative, freewheeling futures market would gradually usurp the power to set prices. That, in turn, could distort the way capital flowed through the stock market to finance the American economy. America’s ability to sell the Treasury bonds that covered its budget deficits could be affected. The Fed’s power to influence interest rates, which influenced inflation, could wane.

In the fight over financial futures, Jim Stone was clearly the odd man out at the CFTC. Just days before the silver crisis, he was dressed down at a public meeting by another commissioner merely for questioning whether futures based on the Value Line index, proposed by the Kansas City Board of Trade, would serve any useful economic purpose.

“Why not a futures contract for people who buy lottery tickets in New Hampshire?” Stone asked at the meeting. He couldn’t see what possible purpose a “stock index futures contract” could have except to gamble on the stock market without having to put up as much cash as it would take to place the same bet on the New York Stock Exchange.

That was for the market to decide, Stone’s challenger insisted. He went on to deplore the agency’s “inexcusable delay” in acting on the Value Line proposal, blaming it on “fear of the Fed, the Treasury and the SEC.”

There were other stock index futures proposals being developed, along with a host of other innovative futures contracts based on everything from bank certificates of deposit to “Eurodollars,” American currency held in overseas accounts. Other commissioners saw these new products as a boon to the Chicago markets, but Stone profoundly disagreed—and, unlike his colleagues, he was willing to listen to the concerns expressed by other regulators. Still, he was only one vote, and a Democratic vote, at that. In 1980 his tenure as chairman was only as firm as President Carter’s grip on the White House.

Copyright © 2017 by Diana Henriques