Posted on 08/28/2008 5:14:05 AM PDT by StatenIsland
I will explain to you a financial crime that is occurring on Wall Street. It will not be difficult to understand. In fact, the crime’s simplicity will probably amaze you.
From three years of experience explaining this crime to many people, however, I know that there are two hurdles people face in understanding it. The first seems big but is, in fact, easy to surmount. The second is small, but is the one that trips people up. I have an easy way to get you over both hurdles, but to do so, I will ask you, esteemed reader, to make two promises to me. If you keep these promises you will overcome both hurdles.
Hurdle #1: Because it is a financial crime, people who are not too conversant with financial issues may shrink from technical-sounding jargon. The way over that hurdle is this:
1) I will start by giving a super-simplified explanation that any high school kid could follow. It will be accurate, but only metaphorically accurate.
2) Then I will give an explanation that is literally accurate, but is still somewhat simplified, and uses just a little jargon.
3) Next I will give an explanation that is literally accurate, and includes technical jargon.
4) Last, I will provide links to numerous articles, news reports, interviews, and explanations that have appeared in academic papers and the financial media, for those who want to bury themselves in the technical details.
In sum, I will start with simplified explanation, then move through the explanation again and again, getting more accurate with each pass, but also, more technical.
Promise #1: Please make the first promise to yourself that you will not plough through this material until it defeats you. Instead, start by reading the first, metaphorical explanation and, if you understand to your own satisfaction, stop. If you are not sure you understand or remain unconvinced, read through the second, literal-but-simple explanation. If you get it then, stop. If you still are not sure you get it or remain unconvinced, read on through the fuller literal explanation, etc. etc. That is, promise that you will not wade through this material until it leaves you defeated and unconvinced. Instead, just read as far as you need to before you feel you get it, then feel free to bail out.
Hurdle #2: I have discovered that, given the right explanation, anyone can understand this crime. The second hurdle, however, is that when people start to understand it, their minds react as follows: “No way. No way. There’s no way that could be happening in our country. No way.”
Promise #2: Please make a second promise to yourself. That is, when you reach the point where your mind is reacting this way, you’ll go back and read Promise #1.
I understand naked short selling and it ought to be a crime to buy and sell what is essentially something you do not have. Yet hedge fund managers do it every day.
BFL
In a metaphorical kind of way.
Got it.
However, it could be much more concise.
Naked short selling is a consequence of free markets. I don’t so much mind hedge funds doing it, I dislike bailing out hedge funds that do it and get caught short!
However, you should make the distinction between hedge funds and criminal enterprises (I know, I know, what distinction?) but the later should definitely be prosecuted.
Unfortunately I know of one painful example that I own stock in: Medis Technologies, a fuel cell manufacturer that actually makes a fairly good consumer product just entering the market.
The naked short sellers have been a particularly unpleasant eye-opening experience. Here is their related letter to the SEC regarding naked short selling of their stock.
“As soon as you can explain to me how these hedge fun guys can put a farm on a ship and move it out of the country, I’ll be able to follow this.”
If you wind up owning the company that owns the farm, you don’t have to put it on a ship.
We understand that when more shares are for sale than their are investors who want to buy the price of a share goes down, right? And we believe, usually rightly so, that when the price drops low enough, the stock will look attractive to more and more buyers, and the price will level off - maybe down a few percent from the beginning of the day, maybe up.
But what if the selling continued and continued and continued? What if a hedge fund not only sold the shares they owned, but sold short, which means they borrow stock to sell, and then buy back in at a later time to repay the stock they borrowed. That would put more downward pressure on the stock because it represented more selling.
But in this scenario the damage they could do would be limited - because they would have borrow stock that actually existed.
Now let’s take it to the max. What if they were short selling stock that they didn’t even borrow? Now there there is NO limit to how much downward pressure they could exert on a small cap stock. Buyers would eventually dry up and the stock would go into a freefall.
Small investors like you and I would either get stopped out or sell out of sheer panic, as we watched our investment fall to a fraction of its worth.
At the end of it all, a few things could happen. the naked shorters could cover at a fraction of the original price and make a killing.
Or someone could buy a controlling interest in the company for a fraction of its true value by buying a majority of the deflated stock.
Or the company could go bankrupt, making the naked shorters a 100% profit because they then never have to buy anything to cover.
You and I certainly aren’t buying back in - the company is a disaster, and besides, the financial media is now reporting whispers of accounting irregularities, or some other damaging rumor.
And remember, it is the small investor in small cap companies that is getting fleeced.
And if the farm isn't producing anything, it's worthless. What 'investor' in their right mind would deliberately destroy what they paid to buy?
L
self ping for later
L, they don’t destroy the farm, they simply devalue it. All the artificial selling pressure makes the farm appear worthless, so that it can be bought for a song.
And don’t forget they didn’t “buy” anything - they SOLD. That money is in their pocket already.
Very simply, “naked” shorting gives the manipulators a hundred times more leverage to put downward pressure on a stock than they would ordinarily have. It is NOT a free market in operation - it is artificial.
If I gave you ten million bucks in Monopoly money and told you to invest it in a small biotech company ALL IN ONE DAY, before you finally spent the whole ten million you’d have driven the price up wouldn’t you? Because there weren’t enough sellers to satisfy you, you would have to continually offer more to entice more people to sell.
The price of the stock would go up wildly - but it would all be artificial, wouldn’t it? Because it was money backed by nothing. The company itself is worth no more or less than it was this morning, but for the artificial paper gain you caused.
Now do the same thing in reverse. The Monopoly money is the naked short.
“Naked short selling is a consequence of free markets. I don’t so much mind hedge funds doing it, I dislike bailing out hedge funds that do it and get caught short!”
No, In, it is a perversion of the free market. It is a against the rules, and the rules are not being enforced. It is like me giving you counterfeit money to buy stock - you might cause the stock to rise, but it would have nothing to do with free market activity. The movement of the stock would be based on a chimera, a counterfeit.
Naked shorting is the reverse of that.
I urge you to go to the website, when you have the time, to digest this information.
Thanks so much for the education that wasn’t included in the original piece.
Bump
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