In early September, the consequences of central banks’ new nakedness cascaded across Europe. In conversations like the one among Druckenmiller, Soros, and Johnson, traders convinced one another that recession-battered economies pegged to the deutsche mark were now hopelessly vulnerable. On Tuesday, September 8, the day that Schlesinger declared he could make no promises on German interest rates, a wave of speculative selling overpowered the Finnish central bank, forcing the government to abandon its peg to the ECU; the Finnish markka fell nearly 15 percent that day, handing traders instant profits and whetting their appetite for the next victim. On Wednesday there was a run against Sweden, which managed to attract capital back into the country by raising overnight interest rates to the extraordinary level of 75 percent; then the electronic herd stampeded the Italian lira. Italian interest rates stood at 15 percent, which ordinarily would have been enough to keep capital in the country, but the vast growth of currency markets had changed the game: Italy’s currency presented an asymmetrical bet; the trend cried out to technical traders to get on their surfboards; and smart speculators sensed that the wave of money crashing down on Italy’s authorities would overwhelm their best efforts to respond to it. By Friday, September 11, the lira had broken through the bottom of the band permitted by the exchange-rate mechanism. Over the weekend that followed, Italy negotiated the formal devaluation of its currency.
The lira’s collapse was especially sobering. Finland had not been formally part of Europe’s exchange-rate mechanism, and so could not expect the help of other European central banks when the speculators came after it. But Italy was a different case: Its devaluation represented the first time that a member of the exchange-rate mechanism had been so bloodied by the markets.26 Italy’s membership in the mechanism entitled it to support from the mighty Bundesbank, which bought DM 24 billion ($15.4 billion) worth of lire in the week before devaluation, an unprecedented intervention.27 But speculative selling of the lira overwhelmed the Bundesbank’s efforts, and traders bagged another payout.
Even after the lira’s fall, European officials struggled to come to terms with the new order. On Saturday, September 12, while the Italians negotiated devaluation with visiting German officials, Norman Lamont, the British finance minister, kept to his schedule as though nothing were amiss; that evening he honored a national musical ritual by attending the Last Night of the Proms and singing “Rule Britannia” with great gusto.28 After learning of the fate of the lira, Lamont assembled his Treasury advisers the next morning for a breakfast of croissants; but he and his team still did not believe that they were facing an immediate crisis. Indeed, one British press account of the breakfast described Lamont as “cock-a-hoop.” As part of the deal on lira devaluation, the Bundesbank was promising an interest-rate cut of a quarter of 1 percent. That might actually boost sterling.
Given the assumptions of the times, Lamont’s cheerfulness was not surprising. Financial analysts and journalists were arguing that Italy and Britain were not comparable cases: The first was the most shambolic rich country in Europe; the second was governed by a Conservative Party that had transformed Britain’s economic performance. The Bank of England had successfully fended off market pressure on sterling since August, and on September 3 it had improvised a new weapon against the electronic herd: Just as hedge funds attack currencies using borrowed money, so Britain announced it was borrowing 10 billion ECUs (£7.25 billion, or $14 billion) to expand its ability to defend sterling. The day of that announcement, the pound had experienced a sharp rise; currency traders believed that the government now had the firepower to fight off the speculators.29 To Soros and Druckenmiller, this was faintly amusing: The amount that Britain had borrowed to buy sterling was equal to the amount that the Quantum Fund alone aspired to sell.30 But in early September 1992, nobody outside the Soros offices could conceive that a single hedge fund, employing fewer than fifty people, might muster a war chest comparable to a government’s.
When the markets opened on Monday, September 14, Lamont’s optimism appeared vindicated. The Bank of England spent $700 million to support the currency; coming on top of the German interest-rate cut, that relatively modest intervention was enough to lift sterling slightly. But to an extent that Lamont and his advisers failed to grasp, Monday’s trading sealed Britain’s fate. Sterling’s small rise confirmed the speculators’ premise. Bets against currencies anchored by shaky pegs could be leveraged aggressively, because the worst that could happen was that they would move against you slightly.
Sure enough, the pound took a beating the next day. Spain’s finance minister telephoned Lamont to ask him how things were. “Awful,” Lamont answered.31
That evening Lamont convened a meeting with his Treasury team and Robin Leigh-Pemberton, the governor of the Bank of England. They agreed to support sterling aggressively the next morning; if that did not work, they would consider raising interest rates. As the meeting wound down, Leigh-Pemberton read out a message from his press office. Helmut Schlesinger had given an interview to the Wall Street Journal and a German financial newspaper, Handelsblatt. According to a news agency report on his remarks, the Bundesbank governor believed that a broad realignment of Europe’s currencies would have been better than a narrow adjustment of the lira.
Lamont was stunned. Schlesinger’s remark was tantamount to calling for sterling to devalue. Already his public statements after the Bath meeting had triggered the assault on the lira. Now the German was attacking Britain. Lamont asked Leigh-Pemberton to call Schlesinger immediately, overruling Leigh-Pemberton’s concern that the punctilious Bundesbanker did not like to have his dinner interrupted.
After completing the phone call, Leigh-Pemberton reported that Schlesinger had granted the interview on the condition that he could check quotations attributed to him, but he had not yet found the time to do that. Lamont protested that this was a dangerously leisurely response. Schlesinger’s purported comments were already on newswires; traders in New York and Asia would react overnight; Schlesinger needed to issue a denial quickly. Leigh-Pemberton placed more calls to Germany, but to no avail. The Bundesbank press office explained that the Schlesinger quotations were “unauthorized,” since they had not yet been approved; Schlesinger said he would check the article and issue an appropriate statement when he reached his office in the morning. Lamont seethed, but there was little he could do. Germany’s monetary master was in no hurry to adapt to a world of twenty-four-hour trading.
That night, Lamont went to bed knowing that the next day would be difficult. But he could not imagine how difficult. As he recounts in his memoir, the thought that Britain would be forced out of Europe’s monetary system the next day “simply did not cross my mind.”32
DRUCKENMILLER READ SCHLESINGER’S COMMENTS ON Tuesday afternoon in New York. He didn’t care whether they were “authorized” or not: He reacted immediately.33 Schlesinger had made it obvious that he was perfectly happy to see the pound ejected from the exchange-rate mechanism. The Bundesbank was not going to indulge weak neighbors with further interest-rate cuts. Given the recessionary forces in Britain, sterling’s devaluation was now all but inevitable.
Druckenmiller walked into Soros’s office and told him it was time to move. He had held his $1.5 billion bet against the pound since August and had started to do more since the conversation with Robert Johnson. Now a trigger had arrived, and Druckenmiller announced that he would build on the position steadily.
Soros listened and looked puzzled. “That doesn’t make sense,” he objected.
“What do you mean?” Druckenmiller asked.
Well, Soros responded, if the news story was accurate and there was almost no downside, why just build steadily? Why not jump straight to $15 billion? “Go for the jugular,” Soros advised him.
Druckenmiller could see that Soros was right: Indeed, this was the man’s genius. Druckenmiller had done the analysis, understood the politics, and seen the trigger for the trade; but Soros was the one who sensed that this was the
moment to go nuclear. When you knew you were right, there was no such thing as betting too much. You piled on as hard as possible.34
For the rest of that Tuesday, Druckenmiller and Soros sold sterling to anyone prepared to buy from them. Normally they left it to their traders to execute orders, but this time they got on the phones themselves, searching for banks that would agree to take the other side of their orders.35 Under the rules of the exchange-rate mechanism, the Bank of England was obliged to accept offers to sell sterling for DM 2.7780, the lowest level permissible in the band, but this requirement only held during the trading day in London. With the Bank of England closed for business, it was a scramble to find buyers, particularly once word got around that Soros and Druckenmiller were selling crazily. Banks that got vast sell orders from Quantum would alert their own currency traders, who would soon start selling too, and as their calls rippled out around the world, everybody understood that an avalanche was starting.36 Pretty soon the pound was knocked out of its permitted band, and it became almost impossible to find buyers of the currency.37
Late that day, Louis Bacon called Stan Druckenmiller. The two talked about how the drama might play out, and Bacon said he was still finding ways to dump sterling.
“Really?” Druckenmiller blurted out. He told Bacon to wait, and a few seconds later Soros joined the call.
“Where did you get the market?” Soros demanded furiously.38
SOROS AND DRUCKENMILLER EVENTUALLY WENT HOME, leaving their traders to search for opportunities to sell more sterling. Asleep in his New York apartment, Robert Johnson was beeped by Quantum’s head trader; he slipped out of bed and quietly returned the call, anxious not to alert his wife to the conversation since she was an official at the New York Fed. Around two the next morning, Druckenmiller returned to the office. He wanted to be at his desk when London trading reopened and the Bank of England would be forced to resume purchases of sterling.
Scott Bessent, the portfolio manager who had been based in London, arrived shortly after Druckenmiller. He could see the hulking outline of the boss standing in his dark office. Druckenmiller was taking off his coat, and the nighttime Manhattan skyline stretched out behind him. The only light in his office came from the telephone: Soros was on the line, and Druckenmiller had hit the speaker button. A disembodied eastern European accent filled the dark room. Soros was urging Druckenmiller to leverage himself up and redouble his selling.39
When the markets opened in London, the expectation of Bank of England support restored sterling to its band, but it was flat on the bottom of it. Acting on the plan that Lamont had authorized the previous evening, the Bank of England intervened twice before 8:30 A.M., each time buying £300 million. But the buying had absolutely no effect. Druckenmiller was manning his cockpit on the other side of the Atlantic, clamoring to sell sterling by the billion, and his clamor was driving legions of imitators to sell also. The Bank of England carried on intervening, not realizing how completely it was outgunned. By 8:40 A.M. it had purchased a total of £1 billion, but sterling still refused to budge. Ten minutes later, Lamont told Prime Minister John Major that intervention was failing. Britain would have to raise interest rates in order to protect sterling.
To Lamont’s frustration, Major refused to authorize a rate hike. He had been responsible for taking Britain into the exchange-rate mechanism. He feared that his credibility would collapse if the policy was seen to be failing; he might face a leadership challenge from a member of his own cabinet. Major pleaded that new economic data would come out later that day. He told Lamont to hang tough in the hope that the markets would subside eventually.
By now central bankers the world over were on high alert. Another call went out to Robert Johnson’s apartment, this time from the New York Fed; Johnson’s wife spent the remainder of the night monitoring the crisis, unaware that her husband had helped cause it. The Bank of England continued to buy pounds because it was obliged to do so by the rules of the exchange-rate mechanism. But it no longer aspired to lift the currency off its floor; it was merely providing liquidity to Druckenmiller and his cohorts.40 Every hour that went by, hedge funds and banks sold more sterling to the Bank of England, which was being forced to load up on a currency that seemed sure to be devalued soon. Britain was presiding over a vast financial transfer from its long-suffering taxpayers to a global army of traders. At 10:30 A.M. Lamont called John Major again to urge a rise in interest rates.
While Lamont was calling the prime minister, British officials did their best to project confidence. Eddie George, the number two at the Bank of England, went ahead with a long-scheduled meeting with David Smick, a financial consultant who fed political intelligence to Druckenmiller and Soros. Smick showed up at the Bank of England’s exquisite building on Threadneedle Street to find George in apparently fine form, decked out in a checkered shirt and striped tie in the manner of a London banker. “We have it all under control,” George said cheerily; in the extreme case, which was unlikely, to be sure, the Bank of England would raise interest rates by a full percentage point to see off the speculators. Smick wondered whether George understood the weight of the money that was crashing on Britain. The avalanche had begun. It might be too late to stop it.
Smick summoned up his nerve and asked George straight out: “Aren’t you worried that you may have slipped too far behind the curve on this thing?”
George’s look betrayed mild annoyance. He was about to respond when the telephone rang. After a minute of intense conversation, he hung up.
“I’ve learned we’ve just raised interest rates by two hundred basis points,” he said softly—a full two percentage points. Then he rose and shook Smick’s hand and left the room running.41
Lamont’s plea to the prime minister had succeeded this time, and the announcement of the dramatic rate hike had been set for 11:00 A.M. A few minutes before the appointed hour, Lamont walked over to his outer office at the Treasury to watch the Reuters screen. But when the announcement came, the pound did not respond at all. The line on the screen remained totally flat. Lamont felt like a surgeon who looks at a heart monitor and realizes that his patient has expired. All that remained was to unplug the system.42
Lamont had no time to negotiate a realignment of sterling within Europe’s exchange-rate mechanism. A realignment would involve lengthy coordination with other European governments; but with every minute that ticked by, the vast transfer of wealth from taxpayers to traders continued. Italy had been lucky to get into trouble on Friday, just before the respite of the weekend. But now Britain found itself on the edge of the same cliff, and unfortunately it was Wednesday. Lamont’s only recourse was to quit the European exchange-rate mechanism unilaterally. But this would require the prime minister’s approval.
The prime minister was not immediately available. Lamont had his staff call Major’s office repeatedly to stress the urgency of a meeting, but no audience was granted. Eventually Lamont led a team of advisers over to Admiralty House, the fine Georgian building that was serving temporarily as the prime ministerial residence; there they cooled their heels for at least another quarter of an hour before Major would see them. Lamont calculated that the nation was losing hundreds of millions of pounds every few minutes, but his boss looked annoyingly relaxed. He began the meeting by wondering aloud whether there was room for further financial diplomacy with Germany, then added that several other government ministers would shortly be joining the meeting to add their various perspectives. A meandering discussion ensued. Could Britain withdraw from the exchange-rate mechanism without offending its European partners? If it did withdraw, would there be calls for ministers’ resignations? It became clear that Major’s objective was to share responsibility for the crisis with the other people in the room—“We were there to put our hands in the blood,” one minister later commented.43 It was a shrewd maneuver, and from Major’s perspective it served to neutralize potential rivals to his throne. Meanwhile, Druckenmiller and Soros were adding to their positions.
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br /> The Admiralty House meeting broke up without the decision to quit the exchange-rate mechanism that Lamont had wanted. Instead, Major insisted on another interest-rate hike—this time of three percentage points, effective the next day—as a last-ditch effort to save sterling. Again Lamont watched the news break on the Reuters screen. Again there was no effect on sterling’s value. At their desks on the other side of the Atlantic, Druckenmiller and Soros saw the rate hikes as an act of desperation by a dying man. They were a signal that the end was nigh—and that it was time for one last push to sell the life out of the British currency.44
Lamont proceeded to warn his fellow finance ministers in Europe of sterling’s plight. His Italian counterpart, Piero Barucci, suggested that rather than quitting the exchange-rate mechanism, Lamont suspend markets to give himself time to negotiate a realignment. Lamont had to point out that it is not in the power of a modern finance minister to suspend currency markets that trade continuously and globally.
That evening, Lamont called a press conference in the Treasury’s central courtyard. At 7:30 P.M., facing a massive battery of TV cameras from all over the world, he announced Britain’s exit from the exchange-rate mechanism. The markets had won, and the government had at last recognized it.
DURING THE FIRST HALF OF SEPTEMBER, THE BANK OF England spent $27 billion worth of reserves in its efforts to defend sterling, and much of that sum was drained away during the last day of the crisis.45 After the pound left the exchange-rate mechanism, it fell about 14 percent against the deutsche mark, so British taxpayers could be said to have lost around $3.8 billion on their purchases of sterling.46 An army of banks and hedge funds were on the other side of that trade, but hedge funds led the charge, and Quantum was easily the biggest. By the time sterling broke, Druckenmiller and Soros had succeeded in selling about $10 billion of sterling short—less than the $15 billion they had aspired to dump, but still a monumental position.47 Of the almost $4 billion loss to British taxpayers, an estimated $300 million flowed to Bruce Kovner, the senior member of the Commodities Corporation trio, and $250 million to Paul Jones; the top seven currency desks at U.S. banks were said to have bagged $800 million among them.48 But Soros Fund Management’s profit on the sterling bet came to over $1 billion.49
More Money Than God_Hedge Funds and the Making of a New Elite Page 19
