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Today's Silver Scandal

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Under-30 silver traders weren't alive to see the billionaire Hunt Brothers bankrupted by silver trades, and those under-45 years old probably never read about it. The Hunts' silver debacle occurred after the "soybean caper," but before the CFTC fined them $500,000 in a July 1981 out of court settlement for blatant violation of commodities laws in their attempt to corner beans. The Hunts had borrowed money to buy silver and leveraged themselves in silver futures in an attempt to corner the market.

On March 14, 1980, the CFTC staff reported to their commissioners that the Hunt Brothers could handle their short-term losses as silver prices fell, because "they bought at low prices." The CFTC was right about the low purchase prices (around $15 on average), but it was wrong when it thought the Hunt brothers could handle the losses.

Simultaneously, then Fed Chairman Paul Volcker instituted a new directive to U.S. banks as part of his anti-inflation policy. It was a "special restraint" on lending to speculators with holdings in commodities or precious metals. The banks knew better than to mess with Volcker, and they immediately closed the lending spigot to speculators in gold and silver.

Within three days, the Hunt brothers' cash had nearly run out, and they couldn't meet a margin call. Two days later, they had to deliver silver instead of cash in order to meet the margin call. Other speculators were having trouble raising cash against their silver, and prices dropped like a stone.

Back to the Future

Some believe the recent general commodities pullback was triggered by the series of CME margin hikes on silver within the past week, after the recent exponential run-up in silver prices. Whether or not that is true, holders of leveraged long commodities positions should have warily watched the action in the silver market. Some silver speculators may not have seen the margin hike as a constraint on lending, but it should have been a red flag for any speculator with a leveraged long position. Moreover, after silver markets closed, silver prices were getting "banged" lower in what looked like suspicious market manipulation.

Speculators rushed in as prices recently soared and rumors swirled that there will be a delivery default at the CME including one of the TBTF banks with a huge short position that it cannot cover. Are the rumors true? I don't know since those in charge of investigating these matters haven't put evidence in the public domain, even after a senior member of the CFTC claimed there was blatant silver manipulation.

The fastest way to collapse a recent run up in prices is to choke off the ability of those with leveraged long paper positions to raise cash. Another way is to rapidly hike margins; those with insufficient ready cash will be forced to liquidate. As they liquidate to meet margin calls, prices fall, and it creates a cycle which feeds on itself. I have no explanation for the recent ramp up in silver prices any more than I have an idea of where spot silver prices eventually hit bottom.

This isn't the first time there has been extreme price action and volatility in the silver futures markets, and it will not be the last. If anyone thinks that the Commodity Futures Trading Commission (CFTC) has the right stuff to regulate the commodities markets, look no further than its failure to check manipulation in the silver market.

The CFTC has the mandate to "regulate" tens of trillions of dollars in credit derivatives, but it is actually in the business of anti-regulation.

I highly recommend Stephen Fay's book, Beyond Greed (1982). A paperback version was titled The Great Silver Bubble (1982). It's out of print but available through Amazon or Abe Books.