Mercury Rising 鳯女

Politics, life, and other things that matter

The new growth industry: Abaddon (destruction)

Posted by Charles II on May 16, 2012

Via Barry Rithholtz, an article from Matt Taibbi, Rolling Stone:

It doesn’t happen often, but sometimes God smiles on us. Last week, he smiled on investigative reporters everywhere, when the lawyers for Goldman, Sachs slipped on one whopper of a legal banana peel, inadvertently delivering some of the bank’s darker secrets into the hands of the public.

The lawyers for Goldman and Bank of America/Merrill Lynch have been involved in a legal battle for some time – primarily with the retail giant Overstock.com, but also with Rolling Stone, the Economist, Bloomberg, and the New York Times. The banks have been fighting us to keep sealed certain documents that surfaced in the discovery process of an ultimately unsuccessful lawsuit filed by Overstock against the banks.

The lawsuit between Overstock and the banks concerned a phenomenon called naked short-selling [which amounts to selling a stock without owning its shares]

“Fuck the compliance area – procedures, schmecedures,” chirps Peter Melz, former president of Merrill Lynch Professional Clearing Corp. (a.k.a. Merrill Pro), when a subordinate worries about the company failing to comply with the rules governing short sales.

Was Goldman really disclosing “nonpublic data concerning customer short positions” to its big hedge fund clients?

Thus in this document we have another former Merrill Pro president, Thomas Tranfaglia, saying in a 2005 email: “We are NOT borrowing negatives… I have made that clear from the beginning. Why would we want to borrow them? We want to fail them.”

Trafaglia, in other words, didn’t want to bother paying the high cost of borrowing “negative rebate” stocks. Instead, he preferred to just sell stock he didn’t actually possess.

The process of how banks circumvented federal clearing regulations is highly technical and incredibly difficult to follow. These companies were using obscure loopholes in regulations that allowed them to short companies by trading in shadows, or echoes, of real shares in their stock. They manipulated rules to avoid having to disclose these “failed” trades to regulators.

The import of this is that it made it cheaper and easier to bet down the value of a stock, while simultaneously devaluing the same stock by adding fake supply. This makes it easier to make money by destroying value, and is another example of how the over-financialization of the economy makes real, job-creating growth more difficult.

this document all by itself shows numerous executives from companies like Goldman Sachs Execution and Clearing (GSEC) and Merrill Pro talking about a conscious strategy of “failing” trades – in other words, not bothering to locate, borrow, and deliver stock within the time alotted for legal settlement. For instance, in one email, GSEC tells a client, Wolverine Trading, “We will let you fail.”

More damning is an email from a Goldman, Sachs hedge fund client, who remarked that when wanting to “short an impossible name and fully expecting not to receive it” he would then be “shocked to learn that [Goldman’s representative] could get it for us.”

Meaning: when an experienced hedge funder wanted to trade a very hard-to-find stock, he was continually surprised to find that Goldman, magically, could locate the stock. Obviously, it is not hard to locate a stock if you’re just saying you located it, without really doing it.

Jail is too good for these guys. Maybe waterboarding has a place. Not to extract information. Just to give people a measure of justice on earth so they won’t face its full force on Judgment Day.

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6 Responses to “The new growth industry: Abaddon (destruction)”

  1. Words fail me.

  2. jo6pac said

    I loved this story, hell they didn’t even own the stock they were selling short how Amerikan is that. Greed is Good:(

    • Charles II said

      Naked shorting is common, though illegal. On small scale, it doesn’t do much harm. On an industrial scale, it can be very destructive.

      Oddly, Barry Ritholtz is in denial about short selling. He was very rude to me when I pointed out how disruptive it can be to small companies. Now he’s still ragging on Overstock.com for complaining about Goldman’s predatory short sales. Maybe Overstock didn’t have a viable business, but when a trillion dollar investment bank is trying to drive your stock to zero, it doesn’t help.

  3. MarkH said

    If the investment world is supposed to reflect the real economy, then allowing naked short sales is just market manipulation. It used to be illegal, but during the Bush years I heard anecdotes that it had become legal again. I don’t know if that really happened, but apparently lots of naked short sales were happening. I believe the Obama administration has noticed and either regulated it via Dodd-Frank or by SEC regulation. Given the lack of regulation by the Bush admin. SEC it’s possible they simply didn’t enforce and the market knew they could do anything.

    Would Mitt Romney allow naked short sales? If so, then no investments in the stock market would be safe.

    Better elect Obama and Congressional Democrats.

    • Charles II said

      Basically, enforcement is difficult until there’s actually a failure to deliver shares. In 2004, the SEC issued a rule stating:

      Regulation SHO also requires short sellers in all equity securities to locate securities to borrow before selling, and also imposes additional delivery requirements on broker-dealers for securities in which a substantial number of failures to deliver have occurred.

      In July 2009, they replaced this basically toothless rule with another rule:

      the new rule, Rule 204, requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale….if reasonable, a broker-dealer may rely on a short seller’s assurance that the short seller has located his or her own lender that can deliver shares in time for settlement.

      Supposedly fails are down. For how long, who knows.

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