REFCO, or Why I Learned to Love The Bomb
From a Newsday article today comes a hint of things to come: "In addition, the company's credit ratings were slashed, with Standard & Poor's warning that there was "substantial doubt" about the entire company's liquidity. And analysts said that although its other subsidiaries appear to be running normally, Refco's customers may decide to move their accounts elsewhere."
Substantial doubt. About the entire company's liquidity. Got it.
That's Wall Street's way of saying run for the hills, turn off the lights, it's all over but the lawuits. At least that is how I interpret it in my current pessimistic mood.
There are a couple of noteworthy observations to make here. The first is that *supposedly* everyone involved in the IPO missed looking for special purpose entities used to hide contingent liabilities, now turning out to be mainly naked short sales.
They could have read this editorial blog, where it was hypothesized repeatedly that exactly that is going on, at ALL the publicly traded investment banks and prime brokers, to hide the ex-clearing nightmare.
In fact, I recently had a chit chat with a regulator wherein my message was that I would bet a dollar that the ex-clearing larceny would make the S&L fiasco look like a trip to Club Med. I opined that special purpose entities were being used to hide the billions of dollars of failed shares being kited back and forth in the brokerage community outside of the DTC system, just ledgered back and forth, creating countless effective counterfeit shares for which the contingent liability, should the brokers ever have to cover them or deliver them, could easily outstrip the resources and NAV of that august community, in toto.
And then REFCO blows up, a week or so after that chat. And it turns out that their NAV is inadequate to cover the contingent liability, by all accounts.
My question is, how did the accountants and the investment bankers all miss what the Easter Bunny felt was clear as the whiskers on his face? Aren't these really smart guys? It's the same question I had when Enron and Worldcom and Adelphia were blowing up. Is it possible for accountants and Wall Street MBA's to completely miss fraud and larceny on a panoramic scale?
I don't think so.
I think that REFCO was taken public so that the investment bankers who were invested in REFCO, one way or another, either via equity, or relationships, or credit lines, could foist their bad bet off on the investing public. They laid it off on the rubes that bought the stock, and by the time the smoke cleared, they were whole and the investors were holding the bag.
I think that the investment bank that took them public had to understand what a lovable holiday rodent who specializes as a delivery system for chocolaty treats intuited the first time he got a good look at the system's true outline.
I think that the accountants had to know that there was a systemic, long term problem at the firm that was key in the Rhino/Operation Bermuda Shorts sting, that did Hilary Clinton's questionable commodity trades, that worked hand in hand with Laderman on so many PIPE deals.
I think that REFCO will mark the true end of innocence for many who believe that the financial markets are safe, and that regulators, accountants and investment bankers are any sort of a protection against wholesale fraud. I believe that this will signal the commencement of a run on the stock bank, as confidence in the system is deservedly adjusted to a realistic level - i.e. none at all.
There is no assurance that any of the shares traded today in your favorite company are actually shares. There is no assurance that you will ever receive what you are paying your hard earned money for. There is no assurance that you aren't being lied to, regularly and fluently, by a system that lies habitually and then pretends that it doesn't have any idea what you are talking about.
Witness that the folks being brought in to consult on how to manage the explosion at REFCO are the same folks who took them public, supposedly missing the entire scandal. Doesn't this look a trifle like they are being brought in so that they can cover their tracks and the tracks of the rest of the gang? I mean, you bring in someone else and they might pull the fire alarm within an hour and demand that everyone be arrested - at least if you are managing the process you can apply the same awe-inspiring skill set that cost investors everything, and likely find no fault in your own actions.
The fact that the SEC is allowing this farce to continue for even one more day is more shocking than the depth of the betrayal by the company and their underwriters and accountants. It signals that at all costs, the interests of criminals on Wall Street will be protected, even if it costs the investors (and ultimately taxpayers, if I'm right) hundreds and hundreds of billions, before this is all over.
If you think that's inflammatory, here's the math. REFCO has about half a billion of contingent liabilities largely in the form of naked shorted shares that they have never covered, as far as I can tell. As their liquidation takes place those shares will get bought, and the first shares will be bought for a dollar, the next for two, the next for five, the next for ten. Half a billion could easily go to tens of billions, and REFCO is just one small company.
Now imagine if I am correct, and this type of problem exists on a massive scale throughout the Wall Street community, as the FTD's and ex-clearing problem suggests. Let's say that it is a $25 billion problem today, marked to market. So then the first shares have to get bought in, and it becomes a $50 billion dollar problem. Then the next shares get bought in and it becomes a $100 billion dollar problem. And only 5% of the liability has been covered.
Starting to catch on to how the math works against the market pretty quickly, and how the interests of that market are in ensuring that certain "hot" stocks never go up very far?
Dr. Byrne couldn't get a lousy 25K shares he bought on August 8th delivered for two months because his OSTK shares were "hot". His dad, who bought 200K or so, still hasn't seen any, also because they are "hot".
There is an entire list of "hot" stocks, called the Reg SHO Threshold list. A lot of heat there.
So who deals with the fallout once this blows wide open? Guess what - it will be you, the taxpayer. The bad guys using offshore hedge funds won't be there to cover - their capital will be expended in the first few rounds of covering. The huge insurance companies that use those hedge funds to re-repatriate cash from their offshore subsidiaries sure as hell aren't going to step up to the plate. The dirty money being laundered through them isn't going to double and triple down to cover the cost of their past flim-flams. And Wall Street will quickly run out of NAV to cover the bill - all that money has already departed for accounts in places unknown, and it isn't about to come back to pay the piper.
No, what I see happening is some "Federal Investor Protection" boondoggle wherein the American taxpayer covers the cost of years of rampant larceny, to "protect the interests of American free markets" or some such horseshit. No doubt it will feature a grandmother holding a puppy baking an apple pie while singing the national anthem to a newborn draped in a flag. Fists will be shaken by "outraged" Senators who will ignore that the Senate Banking Committee had for years elected to sidestep holding hearings to find out WTF is up. The reason is because they know WTF is up, and it isn't good, and they are hoping to be gone by the time it all goes south. That's my opinion.
Alternatively, we the shareholders will get the pork put to us, and instead of forcing the community to make good on its liabilities, the elected officials will do some sort of back room workout, wherein they don't have to pay the bills - for the good of God and Country.
Either scenario, we, the investing and taxpaying public, lose big, and the bad guys walk away with our money.
Mark my words. REFCO and Dr. Byrne's lawsuit mark the beginning of an ugly period of revelation for an industry run badly amok.
Now you can ask yourself, or better yet, send Shelby on the Senate Banking Committee an email, and ask what it is going to take to get them to hold the hearings they should have a year ago, and that Bennett lobbied for? How many more REFCO's and OSTK's?
And where is the special prosecutor to go after the miscreants that have engineered this national fiasco in the first place?
Get your shares in paper form. If you are on margin, transfer your account, including margin, to another broker, forcing your old one to come up with shares. This isn't a game anymore, and you have been warned of what the future holds.
And try to have a nice day.