Tuesday, October 18, 2005

Shadows On The Wall Of The Cave

Of late, my little commentaries and vignettes have been attracting a fair degree of attention, and I've been getting an increasing amount of email asking what I think is going to happen - how all this is likely to end.

Before I offer my cheery view, let me ask some questions, the likes of which were first asked in this column in March of 2005.

1) REFCO has significant contingent liabilities of heretofore unknown characterization. What percentage of the liability is naked short sales - failure to deliver? Specifically? (That one wasn't asked, but if you go back and read the rants, you will find it was, in a general way). REFCO has two DTC accounts, "REFCO Securities, Inc." and "REFCO Securities, LLC - Securities Lending." How big a part did the latter play in this?

2) Ex-Clearing (non-CNS settlement) is a large problem, and we know there are many hundreds of millions of FTD's from the FOIA requests. Where are those contingent liabilities booked and represented on the balance sheets of the publicly traded brokers? I've read their 10K's and can't find them. They are large enough to be material. So where are they?

3) How does the system deal with the legal risk of issuing electronic book entries that have no associated bundle of voting rights, nor any of the other rights of a genuine share, in the event of a class action lawsuit against the issuing company? Given that the FTD's are not entitled to legal redress as they aren't real, who shoulders that liability, and where is that liability represented on the books of these publicly traded entities?

4) When a clearing broker fails, like REFCO, what happens to the contingent liability of the fails? In a bankruptcy proceeding? Who is on the hook if the hedge fund client implodes (as they are doing frequently now) and then the clearing broker goes belly up? How is that handled?

5) Why are settlement failures occurring at all? Why does our system tolerate them? Rule 17A mandates that transactions be cleared and settled promptly. Why isn't that happening?

6) Who decided it would be a good idea to split clearing and settling apart, and pay all commissions and fees at clearing (the agreement to try to get shares), and require no performance in terms of delivery (settlement)? What other financial industry pays upon inking a non-binding contract to try to perform? Is that what Congress had in mind when it said both clearing AND settling had to happen promptly for there to be fair markets?

7) Why are participants given the ability to create electronic book entry shares at will, with no shares to back the electronic book entries? Why does the DTCC have an ex-clearing function that leaves the settlement up to the participants, out of view? Why wouldn't the participants abuse this as we see them doing daily? Who is stopping them?

8) The SEC and the DTCC take the position that they don't have the authority to get involved in settlement arrangements, as those are contractual. When did Congress authorize brokers to decide when, if at all, they will deliver, with no SEC oversight? That is the net effect of the ex-clearing and resultant SEC and DTCC passing of the buck.

The simple way of framing many of these is: Why won't the SEC make the system settle the trades promptly, as Congress mandates?

Those are some pretty decent questions that remain unanswered and ignored. Nobody fields them. My motives and CV are attacked regularly by anyone who is industry-based, but they don't actually answer the questions, or if a response is tendered, it is a carefully parsed non-answer, or partial answer.

Now to the big question - how do I think this will end?

My view is that it will end with a token reform of the current system that comes after the horse has bolted, at the expense of investors and taxpayers.

Here's how I think it will play out.

REFCO may well be swept under the rug - I heard a few minutes ago that Senate Hearings are to take place, and our first clue as to the direction this is likely to take will come from those hearings; by the questions that are asked, or rather aren't.

My fear is that we will have hours of acrimonious table pounding, long rants about how this is inexcusable, hangdog expressions from regulators who will make token attempts to defend their enabling these crooks to go public (we've already seen the first of this, where the SEC takes the position that they aren't in the business of verifying and double checking all the financial disclosures and such - begging the question what they are in the business of, in light of the 1933 Act) while facing sanctions for past crookery, hard line statements about how we won't tolerate this any longer, assurances that substantial parts of the business are viable, further assurances that the markets are healthy and viable, and ultimately blame being placed at the feet of the already acknowledged crooks.

What won't be done is a breakdown of the liabilities that caused the meltdown of the company. The question you won't hear asked is how much of the contingent liability arose from delivery failures. And if it is asked, expect a hubba de hubba answer, with plenty of hand waving, and assurances that it is minimal. But you won't hear a hard number, nor a commitment to make the facts known. Instead, you can expect to hear a lot of rhetoric, a fair amount of technical discussion, but the topic of naked short selling and the fact that the company was facing sanctions for participating in a massive scheme to serial kill companies will probably not come up.

This will be your signal that this will not end well.

If REFCO's failure is allowed to go through the media and the review process without any real examination of the impact that naked short selling played in bringing it down, then I would prepare for the worst.

So that begs the question, what's the worst? Total systemic collapse? Global meltdown? Hellfire and brimstone? Cats dancing with dogs, a rain of fire, locusts, Biblical-level calamity?

Nope. Unlikely. Too many asses on the line.

No, the likely end will be much more mundane. What we will see is a steadfast silence in the American media. Events like Dr. Byrne of OSTK being unable to get his shares for months will be ignored, as they have been to date. More of these clearing brokers will fail over time, and the domino effect will continue from REFCO - they are the first. There are more. Question is which one is next?

Once the next one fails, or a hedge fund implodes with significant exposure to fails, then you will start to see the cracks more obviously, and it will become clear to even the most dim that this is a significant systemic issue, not an isolated occurrence.

Consider this: There are many hundreds of millions of electronic book entries trading around in the system, treated as genuine by the participants, for which no offsetting share or parcel of voting rights exists. That wholesale stock creation machine has generated a second float for hundreds of companies, and is so large that it can never be covered without vaporizing the system - there isn't enough cash with all the folks out there that have played the game to cover all the shares. This is the systemic risk.

I don't for a second believe that the bad guys in this will be forced to do what the law requires, which is to settle the trades, and buy the shares in. Rather, I think that REFCO will provide some hints, as does the new law that quietly passed recently wherein the FDIC is empowered (read burdened) with moving "derivative contracts" from failed institutions to healthy ones. Those institutions include securities firms. The term market participants is used. I find this ominous.

One of the questions I've been asked is "what happens to the naked short obligations in a BK for a clearing broker like REFCO, assuming that the hedge fund clients have stuck them with contingent liabilities that they have been carrying on their books?" I don't know, and none of the attorneys I've talked to are sure.

I have a sneaking suspicion I know how it will play, though. I think that our regulators and elected officials will come up with some euphemistically termed workout, the "Fallen Soldiers and Grandmothers and Future Children of America, Anti-Terrorism and Drug Addiction, Good For the Environment, Protect Our Financial Futures" bill, which will come up with some sanctioned way to get the market system out of their bad trade - and the taxpayer will foot the bill. How will that work?

I envision a mandated cash return to shareholders at some premium, say $1.50 on the dollar, where the failed institutions can pay cash to shareholder owed the shares, rather than being forced to buy in the market to cover their debts. It will be lauded as a fair and decent ending to a dark period - who will be able to complain about receiving $1.50 for every dollar of stock they hold? Any ingrates will be branded as greedy opportunists who want to get rich off a national crisis, and thus reprehensible, or traitorous. Forgotten will be the fact that they bought it at $20 and that it now trades for a dime because of the hundreds of millions of fake shares the participants flooded the markets with. The cone of silence will descend on that too, and instead we will be treated to a flurry of feel good articles about the bright future of the newly sanitized markets, suitable for retirement savings, Grandma's mad money, your children's education funds.

I envision this being sanctioned "for the good of the markets, for stability, to put this bad period behind us and let us move forward, having learned our lessons." It will have to be an act of Congress, as it will be fundamentally illegal, and unethical, and will end this particular chapter of the rip off of the investor by the machine, and will require Congressional approval. But it will also be necessary, as the alternative will be the meltdown of the financial markets as desperate hedge funds and prime and clearing brokers struggle to cover a fraction of the open positions that made them hundreds of billions, and which long ago was converted into jets and mansions and ski chalets and pied a terres on Maui or Aruba or St. Baarts.

I don't see that happening.

What I see happening is the aforementioned bill, and healthy institutions taking on the contingent liabilities of the failed ones, and like Perelman in the S&L fiasco, being compensated for taking them over, likely with tax credits and concessions that will be a windfall for the new stewards of the problem - in the S&L crisis, Ron Perelman (Revlon king and a Milken adherent) took on the failed Vernon Savings and First Gibraltar, with a total of $12.2 billion in assets, and a sweetheart $5 billion FSLIC assistance package (to help cover the workouts). For this stewardship, he paid $315 million, and in return he got almost $900 million in tax deductions. Walter Fauntroy, the Washington, DC Representative, in the House Banking Committee hearings on the scandal, commented upon hearing all the pieces of the deal, asked one of my favorite questions of all time: "Why is it only white folks who get that kind of a deal?"

I fully expect that sort of a solution to a problem of Wall Street's own creation, a creature of regulatory complicity and unbridled greed triumphing over our rule of law.

I see the taxpayers ultimately bailing out Wall Street via some sort of the aforementioned mechanism, because Wall Street is too big, and too important, to be allowed to suffer the consequences of doing the time for the crime.

Wall Street is too important to be allowed to fail, even if it means shafting investors who have already been fleeced of their savings, and then shafting them again by creating a tax burden they will be forced to shoulder, so that Wall Street can keep the place in the Hamptons and the Maybach and the Gulfstream.

Most won't even know or understand what has been done to them. That will be the art of it. It will be so complex and so impossibly boring that they will doze off even as every man, woman and child is clipped for a future $3 or $4K, and investors robbed of hundreds of billions get $1 back for every $50 they lost.

That's the worst case that I can see, as the ramifications of allowing a clearing and settling system to print shares at will become clear. The wilder, destabilized markets scenarios are too fanciful. I'm far too cynical and pragmatic to believe that a worst case where the bad guys all go to jail, and the investors win as their stocks go through the roof, will ever happen. We may see covering in the larger issues, if there is liquidity. We will likely see a heating up of delisting companies, to clear maybe 30% of the problem by removing the liability at a stroke of the regulatory pen. But we won't ever see investors winning on this one.

That's now how Wall Street works.

I've spent the last 3 years studying it, and it hasn't ever worked that way.

But look at the bright side. It won't all be bad.

Just imagine how safe everyone will be in this new, improved market!

I really hope I'm wrong on this.



Blogger n-tres-ted said...


Is there a particular piece of evidence that convinces you the $430 million in liabilities hidden by REFCO is derived from naked shorting?

6:50 PM  
Blogger SECFOInfo said...

your doomsday scenario and the lack of accounting for the FTD's in the financial reporting is precient.

20% of NYSE and NAZ are afflicted with FTD's everyday.

6:54 PM  
Blogger bob obrien said...


They are big players in the hedge fund and naked short selling game. They have a DTC account called securities lending. Their reputation was as one of the go to guys for anything goes deals. They were caught red-handed in Operation Bermuda Short naked short selling Sedona into the toilet, on tape. They have a mark to market contingent liability approaching half a billion that they will do virtually anything to conceal from their auditors.

Yeah, you could say that the preponderance of evidence strongly suggests that some portion of the liability was naked short selling. The only question is how much. And then we have the Austrians coming into the mix with a "loan" to help a guy out. I've heard a very credible theory how that loan isn't as much of a risk as we might believe. It isn't mine to share, but it sounds like the real thing.

I keep asking, why secrecy around something that was used to defraud investors on this kind of scale?

Show us what the debt was.


They are publicly traded. That information is material. Why isn't it being disclosed?

SECinfo - It is a fair question, isn't it? Where is the non-cns clearing liability accounted for? Off balance sheet, we can see from the 10K's, but where? Special purpose entities a la REFCO? Anyone got any other credible way to move billions of liabilities off the balance sheet?

7:12 PM  
Blogger Tommy said...

"In its bankruptcy filing, Refco listed assets of $48.8 billion and liabilities of $48.6 billion. Just two months ago, Refco had listed assets of $74.4 billion, according to the prospectus filed with the Securities and Exchange Commission for the company’s initial stock offering."

So if the contingent liabilities have risen by $25 Billion in two months, the Austrian loan could have been for some sort of cash collateral to a clearing firm on naked sold shares.

The 25 Billion difference can be what the shares were sold for initially Vs. what they would cost today to buy them back, close out the naked short position and finally deliver them.

I doubt the Austrian Bank really knows what the use of the funds were for, As the loan was secured by Bennett’s 34 percent stake in Refco stock.

REFCO may partially be on the hook to themselves, one entity to another. The REFCO securities lending entity and also other brokers, to the REFCO clearing entity, as they're a self clearing broker/dealer and also offered clearing services to other brokers.

Perhaps it's the clearing service is what got them in trouble for the most part, doing what the NSCC would not have done, allowing FTDs to fester unsettled for too long, with too little collateral by the selling brokers and their client hedge funds - and now neither the brokers nor REFCO clearing services have enough cash to settle the trades. And the shares in REFCO's DTC account are not enough in value - even when liquidated - to cover the entire liability. So now REFCO is on the hook for all the contingent liabilities and files BK.

Suddenly $25 Billion gone within 2 months? This is a far bigger problem than just $430 million bucks. That alone would not have prompted the BK filing.

Why has nobody highlighted this $25 Billion change in value in 2 months and keeps focussing on a mere $430 Million loan?

7:13 PM  
Blogger n-tres-ted said...

Seems to me REFCO would be in the position of a broker-dealer implementing a naked short sale for its "preferred" clients. REFCO sells the stock, obtains the funds, deposits the funds in the client's account subject to the delivery of shares, commissions on the transaction are paid and REFCO releases the funds to the client(s) despite FTDs. In this circumstance, the client and REFCO are in the line of liability to deliver shares.

What we don't know is whether the client(s) who received the naked short sale funds is still viable or has gone "downriver." Also, we don't know why these clients were "preferred" by REFCO; e.g., were the clients controlled by the REFCO or paying him kickbacks on the funds received? Not being sure of these facts, we cannot be certain what obligations are still viable and what obligations were packaged into the subsidiary and put "offshore" intermittently when auditors were due to inspect. That may well be the reason, so far, there has been no disclosure of exactly what for the obligations, rights and liabilities in that subsidiary are. My guess is the subsidiary has both assets and liabilities roughly offsetting each other, but the assets are worthless (uncollectible, etc.).

Reasonable? Or where am I off?

7:33 PM  
Blogger SECFOInfo said...

Bob,FTD data rec'd from SEC combined with the admission from the DTCC that 6 BILLION DOLLARS in liability exists everyday but doesn't show up on anyone's SEC filings as a liability is extraordinary.

What accounting rule is that skirting?

The DTCC admits that many of the FTD's are "aged" , they must be on somebody's books at quarter end.

Is there a possibility that all the brokerages are hiding the liability the same way? Refco was just the dunce on the block that got caught?

7:36 PM  
Blogger bob obrien said...


Could very well be. The problem with opacity is that we are standing, trying to ascertain the true nature of reality, by attempting to gauge it like the allegory of the shadows on the wall of Plato's cave. So sure, there are a lot of possible explanations, just as there are a lot of possible explanations for the trading action in any of the badly damaged Reg SHO list stocks, like OSTK or NFI.

What should give you pause is that every time an independent verification is taken in OSTK, by virtue of Dr. Byrne being wealthy enough to run meaningful tests like buying an S-load of his stock to see if it gets delivered, is that the test comes back with the result that the worst case scenario would predict.

So sure, there are countless castles in the sky we could spin as to why nobody is talking. Maybe it is all for our own good. Maybe it is to protect the good people of the planet.

But having studied the history of Wall Street, I can assure you that would be a first.


If you weren't a cynic when you started, if you can't see how badly F-cked up putting Joe Kennedy in charge of the SEC as the first Commissioner, when he made his fortune by running stock manipulations and bootlegging, and effectively used the office to get back at all his old enemies, then you need to reconsider your understanding of the Street's roots.

The original bill that became the 1934 Act had teeth and was well crafted, by all accounts. Wall Street pulled out all the stops to get it neutered. They succeeded. We went from a law enforcement model to a civil suit entity that can't prosecute, and largely dances to the tune of the Street. The history doesn't lie.

And here we are. REFCO blows up, and it's all a secret. The FTD's are a $6 billion daily mark to market problem (and remember that counts the $20 Sedona shares as 10 cents today, as well as all the rest of the 1000% haircut open fails) that don't appear on any balance sheets that I can find.

What do you think the outcome would be if $6 billion mark to market shares of companies that are trading for fractions of their prior value, and for which, by some accounts, there are 2 and 3 X overhangs of fails to legit shares, were required to cover? What do you think the contingent liability would manifest into? $60 billion? $120 billion? $240 billion? More?

And does that $6 billion include the non-CNS fails? I've heard it doesn't. So if 80% of the fails go non-CNS and disappear onto the ledgers of the clearing brokers, as we KNOW they do (that is the definition of non-CNS), we can multiply that by 4 or 5. Now what do we have? A half trillion dollar problem? A trillion?

Starting to see why I say that this is too big to not require a government bailout, and further is the direct fault of the SEC for not enforcing Reg 17A? And further, that the opacity that has enabled this to grow into this large a problem is not the solution to the implosions it will cause?

Congress got it right. Clear AND settle the trades - in their lexicon, that meant simultaneously. Somehow that got decoupled by the brokers, and when it was decoupled, it created this mess. You now get paid without performing, and there's no mechanism to ensure that the product ever gets delivered - one could say there is tremendous incentive to NOT deliver. All you have to do is pick vulnerable companies, and you have a whole financial system incentivized to see them depressed, and finally de-listed. It's a windfall for everyone, except the company and the shareholders, but hell, the attitude of Wall Street historically has been they are speculators, so they deserve a speculator's fate - a gambler's death, so to speak, broke from their vice. The system is just helping them get there, you know?

That's the history.

Clearing and settling de-coupled. Everyone gets paid and nothing is delivered. The liability is shunted off to special purpose entities which are in reality alter-egos for the back office ledger, and the accountants collect their multi-million dollar fees to look the other way.

Just like REFCO.

Sound plausible?

It just happened. I maintained in March that it happens every day.

Seems like I might have been right, huh?

Just maybe?

8:03 PM  
Blogger n-tres-ted said...

Okay, let's assume REFCO has packaged all its naked short sales problems into a neat sale of "assets" to the related entity so as to get the whole thing off its own books. That leaves a lot of private parties, presumably entirely innocent, who have bought shares of stock which have shown up electronically in the buyers' accounts. How does a corporate issuer tell which shareholders are real and which are electronic counterfeits? Are there really thousands of shareholders who have paid for shares, but really don't own anything except maybe a marginally effective right to sue their brokerage?

8:36 PM  
Blogger Tommy said...

n-tres-ted :
"That leaves a lot of private parties, presumably entirely innocent, who have bought shares of stock which have shown up electronically in the buyers' accounts. How does a corporate issuer tell which shareholders are real and which are electronic counterfeits?"

Neither the corporate issuer nor the buyers have a clue. Not even the DTCC can tell.

Only the broker knows the two figures, namely, how many claims to real shares his customers have in their accounts and how many beneficial ownership interests the broker has in his DTC account to back up those claims.

Nobody else. Except when there is a share holder vote, then ADP has written permission to obtain the DTC position reports of the brokers to fix the vote and eliminate the inevitable over vote.

All this crapola is possible because there is no link between customer claims and DTC shares. The brokers are free to invent any reporting and clearing system they can dream up. The DTCC looks like the boy scout choir in comparison.

10:12 PM  
Blogger bob obrien said...


You got it.

You now have figure it out.



The only ones authorized to issue shares is the company.

Congress mandated in 17A that trades must clear AND settle promptly.

The DTCC (the brokers, as that's who owns them) somewhere along the way, in the quest for speedier transactions (ostensibly) decided to split off clearing (payment for and processing of the order) and settling (delivery).

When the Stock Borrow Program was approved in Addendum C of the NSCC's rules, it was for temporary delivery failures.

Since then, it has gradually been abused, as more and more participants discovered that they didn't have to worry about delivering due to the safety net provided by this service. And as the NSCC takes the position that they aren't in charge of buying participants in, they discovered that temporary was a relative term - to some temporary meant years.

Further, in an effort to maximize the number of trades it could process, the DTCC decided that it would pay everyone, including themselves and the SEC, when it cleared the trade, rather than when it settled. That's where the train ran off the tracks. You let folks get paid before they give you the goods, and don't penalize them in a material way for not delivering the goods, and you have a problem.

Anyone that has ever run a sales force will tell you that you cannot pay commissions before the transaction is concluded, or the incentive to perform is gone.

Wall Street is no exception.

To make matters worse, the DTCC came up with a non-CNS (Continuous Net Settlement) program where they handle the front end, but leave the back end up to the two brokers. They "trust" that the brokers will behave honorably and affect prompt delivery. Because there is such a long history of honesty on Wall Street.

So the net effect of the non-CNS system, or "ex-clearing", is that you have trades being made, checks being cashed, everyone getting paid, and the delivery gets handled off-line, between the two brokers.

Oftentimes, and this will shock you, both brokers share the same general ethic, and choose to let delays in settlement slide. Who wants to piss off the other guy when you have to see him every day and do business? Besides, you have stuff you can't deliver, too. So the system introduces "elasticity." Chronic non-delivery is not only tolerated, it is endemic. Just the way things are done. Nobody is going to jump down your throat, so why kill yourself to get the shares? Why not wait a little while on some issues, especially if they are in a downtrend, or you know they are being shorted? Why make your better customers (hedge funds) pay today's price when tomorrow's will be lower? Or why not just hold enough of their cash to buy IF YOU HAD TO at today's price, and forego the whole "buy" nuisance altogether?

And sometimes, the stock just keeps falling, and there doesn't seem to be any reason to buy and deliver. Why would you waste your money on that if you can just carry the dropping stock on your books, with no cost of goods sold? Why, that's like getting free money! Billions of dollars of free money. Pretty soon that adds up, and even the most ethical would be tempted, especially with fractionalization and deregulation having cut commissions to nothing. And if you are MS or ML, with your own trading desks trading your proprietary accounts, your interests are adversarial to your customers anyway, and by being the failed seller to your buying arm, you can make a fortune by waiting to deliver.

The downside is, of course, that "technically" all of it's illegal. Oh, and of course, the buyers don't know that they don't have shares. But you can fix that by simply representing to them that they have the shares. How many will actually ever check? 3%? 5%?

One brokerage is famous for laughing over simply increasing their fees from $20 to $40 for certificates a few years ago, and increasing the amount of time it would take to "get" the certs for their customers. Something that used to take 5 days was now a 3 or 4 week process. They shared with their colleagues that it cut down the requests by 90%. Problem solved.

These are smart guys who understand psychology. Most people won't do much heavy lifting, especially if they are simultaneously assured that they are dealing with trustworthy fellows, and that it will be a pain to get paper.

To your question about the corporate issuer, the corporate issuer used to be able to tell via the transfer agent. But once the DTC and the NSCC started the dematerialization push, CEDE & Co became the registered owner of most of the shares, in one big anonymous pool, thus the transfer agents and the issuer lost the ability to tell who was genuine and who was an IOU.

With no paper certificates, and the attendant signatures and special inks and seals and such, stock counterfeiting got a lot easier. A larcenous or lazy particpant just created a book entry, and then took it ex-clearing, and never delivered. Simple. And nobody would be the wiser, because there was no way to tell the real shares from the IOU's, and a whole second trading system that paralleled the first, but traded nothing but IOU's. The perfect crime, really, hence the DTCC's drive to get their last barrier, the states, to approve dematerialization at the state level (the argument being that it will save the companies in the state so much money on those silly old fashioned certificates).

In point of fact, when a bunch of corprorate issuers tried to pull out of the DTCC a few years ago, the SEC and the DTCC quickly passed a rule outlawing that - on the basis that it violated 17A!!! That having those companies trading using only paper would impair timely clearance and settlement!!! That is how critical it has gotten, how systemic - they couldn't afford squeezes in 50 companies who suddenly had 300% fewer legitimate shares than shareholders - so they passed a rule to bar that. I can't make this up.

Sorry for the long response, but I figured you'd want to understand how it got to where we are.

Most people don't own shares. They own a contractual right to shares, the "beneficial ownership", represented by an electronic book entry. Their broker owns the shares, or rather the DTCC actually does, or even more specifically CEDE & Co. does. And if there are no actual shares to back up the electronic ticks the broker represents as real to you, you own a contractual dispute.

Starting to get it?

Starting to understand why when Byrne tested the system, he got no shares? All he got was an IOU representing the contract rights, and he is savvy enough to know the difference, and further is rich enough so that you don't lie to him if you are his broker. So they told him the truth, as they told his dad the truth, and lo, it took two months for Byrne to get his shares, and his dad is still waiting for his 200K, representing 90% of the transaction.

That's because there are no real shares trading, just a lot of clearing, and fees being paid, and prices being driven down.

But no settling. No delivery.

Note that his broker didn't buy the selling broker in. Now, that is probably because, if there are no real shares, who would they buy the seller in from that would have real shares? There aren't any real shares trading, so why pretend that buying in MS by going into the market and buying the "shares" would do anything but piss off MS, and leave you with a higher priced fail from Bear, or Merril, or UBS? And then the whole thing starts over.

Starting to see how this is systemic?

Getting a feel for it?

Now, the interesting question is who is on the hook in REFCO's case, given that they were the clearing broker who would be in the line of collections if their end customer failed to deliver. What if the customer was mostly the other arm of REFCO, and what if it had pocketed most of the money from years of selling naked, driving prices down, and pocketing the declining margin dollars, which it is allowed to do? Who is on the hook for all those undelivered shares if the seller is arm one of REVCO, and the clearing arm is the other? Or a related party? Or a hedge fund or funds who long ago took the money and cashed it in as the price declined, and aren't about to put money back in if the impossible happened and the share price went up some, requiring additional dollars?

The crux of it is that we have a systemic crisis that this scenario highlights, and which our regulators, in typical regulator fashion, hoped they could "industry" away. By that I mean they made the same mistake as the regulators made in the S&L fiasco, where they hoped naively that they could "grow" their way out of the problem - except here I think they are hoping to shrink their way out of the problem - the shrinking being the NAV of the shorted companies.

Both approaches require complete secrecy, or there's a run on the bank.

That is what they are hoping to avoid. A run on the stock bank as people like you finally grasp what you paid for, versus what you have.

Hence the cone of silence. And the denial. And the monolithic, uniform face of it - we are talking everyone in the industry has a lot to lose. Everyone. So they are hoping to stonewall it away. Hoping this too shall pass, and the sheep will quiet down, and some new event will capture our attention.

Do you completely apprehend this now?

Every clearing and prime broker has an ex-clearing liability, likely huge. Every one. No exceptions.

So where are they listed on their books?

My gut is special purpose entities, a la Enron, or REFCO. My suspicion is you are seeing the rule, not the exception.

There's no other way to make it all add up.

10:18 PM  
Blogger n-tres-ted said...

Among the largest creditors in Refco's bankruptcy filing are two commodities index funds affiliated with Jim Rogers.
From NYT Wednesday edition:

The Rogers Raw Materials Fund is Refco's fourth-largest creditor, with $287.4 million owed, and the Rogers International Raw Materials Fund submitted a claim of $75 million. Refco Securities was selling units in the international fund, according to a prospectus filed with regulators last month; the minimum investment in the fund was $10,000.


10:20 PM  
Blogger bob obrien said...

Tommy. Boy scout choir. Very funny. In a sort of oily, ugly, if I don't laugh I'll start crying way.

I think people are just now starting to get it.

Waking up, as 'twere.

A lot of people read this blog now - I get emails from some of the most unexpected names. It gets passed around, and we now are in a world where very unexpected people are reading things, with no barrier to contact. That is a positive. There is still hope.

10:28 PM  
Blogger n-tres-ted said...

Thanks Bob and Tommy for the responses. The NYT excerpt I just posted illustrates that there are many players in the investment world, not just the "little people," who stand to be hurt big time by these illegal activities through brokerages.

10:37 PM  
Blogger bob obrien said...

The post just published a description of the bad debt leaked by an anonymous investment banker.

It will be interesting to see where this leads.

My sense is that we will all start hearing a lot of unconfirmed rumors about how this is all anything but FTD related.

Except for that niggling little issue of the sanctions the management was getting hit with by the SEC in the biggest naked short sting in history.

Oh, that.

Keep your eye on the ball. Good night.

10:48 PM  
Blogger SECFOInfo said...

Bob. what post? NY,Wash....

6:16 AM  
Blogger bob obrien said...

NY Post

6:53 AM  
Blogger n-tres-ted said...

Bob, I don't find a NY Post description of the debt. However, I read in an AP article that Bennett actually repaid the $430 million plus interest before he was put on leave. Please post the NYP description or a link.

8:54 AM  
Blogger bob obrien said...

The loan was repayed. I'm talking about the contingent liabilities that were large enough to warrant a BK filing.

Its nypost.com, I believe.

11:13 AM  
Blogger gvtucker said...

Contingent liabilities weren't what necessitated the bankruptcy filing.

It was customers pulling assets as fast as possible. Counterparties no longer wanted to do business with Refco.

Since Refco was ridiculously levered, it didn't take much to push them to zero. Like most Wall St firms, almost all Refco's value was in their brand equity with customers. When the brand equity disappeared completely, so did the firm.

12:44 PM  
Blogger SECFOInfo said...


Where is the $6 Billion in FTD's the DTCC admits exists everyday accounted for in the SEC filings of the brokers?

Thanks in advance

12:59 PM  
Blogger gvtucker said...

secfoinfo--FTDs are a zero sum game. If one broker fails on a delivery to another broker, that broker has excess in capital, and the broker that purchased the failed trade has a deficit in capital.

While it is possible that one broker has an inordinate piece of one side or the other, the odds are low that this is the case. And when you compare the $6 billion to the equity in any of the major brokers, even if that shortfall were concentrated 100% with one broker, it would still be a loss that could be tolerated.

There are certainly potential problems that could happen in the world of Wall Street. Excessively levered hedge funds with illiquid goods such as CDO's, highly levered funds with an excess of derivatives, broker/dealers with much too little equity to handle their gross exposure, et. al. There are certainly risks out there.

Delivery failure isn't close to the list of major risks. $6 billion really isn't all that much for the aggregate balance sheets of Wall Street.

Your welcome in advance.

1:57 PM  
Anonymous Anonymous said...

I want to thank you for all you are doing. I will thank you for others as well as so many are so unaware. I have been trying to do my job in helping getting your message out and have been essentialy ramming your blog down others throats regardless if they want to hear it or not. :)

Do you feel one should call for certificates if you are going to stay in the market?

3:03 PM  
Blogger SECFOInfo said...


What am I thanking you for. I am not an accountant.

What line item in the financial statements would reflect the six billion dollars if, for example, it was one brokerage that failed to deliver the entire six billion

3:26 PM  
Blogger Tommy said...

If the naked short seller, AKA, the crooked broker/dealers with all their derivatives and their ex-clearing activities, layer upon layer of obfuscation - can rig things to enable them to ever increase naked selling and introduce fake share claims into the market, I think a few smart minds can invent and execute a scheme to wash them all out.

The Wash & Rinse :

This will be a transaction, where all parties will know their roles, how the transaction works and how they will profit from it in advance.

1. A cash lender comes in to enable this transaction. The cash lent will be secured, more on this later.

This lender agrees to loan the company a certain amount of money, 2-5 times? it's market cap, to enable a buyout of all it's outstanding shares at a premium of 200-500%. So in NFI's case, management holds a share holder vote for the company to by back all it's shares at say $80 a share, with the money from the lender in hand, to buy back all outstanding shares. A condition of the buy back is the company gets to issue one put option for every share repurchased with a strike price equal to the purchase price. These put options are then to be pledged as collateral for the loan to the company.

2. Shareholders approve this and all outstanding shares are bought back at $80. This will force all shorts to pay off their IOUs at $80 as well. No short squeeze beyond that, as the price is set.

3. Now all shares, real and fake, are gone from the system, and many shorts are probably broke. Mayhem on Wall Street in some quarters.

4. Remember the condition of the buyback is that the company also gets to issue puts in equal number to the shares bought back, put to the existing shareholders. The strike price would also be at $80, equal to the purchase price, good for say 6 months.

5. Here's where the shorts get left behind for good : The number of puts the company issues, exactly equals the number of shares it is buying back. Not one more. So the shorts and naked short get nothing in return for their cash. They just pay off their IOUs and are out.

6. Before the puts expire, the company decides to put all the shares back to the share holders at the purchase price. From the proceeds of exercising the options, the company repays the lender.

7. The old short sellers, if they're not already broke, can short again at $80 - if they can find shares to borrow or buy puts from a market maker, etc....it all starts at $80 with no fake shares on the market. Sure the price will drop again to a lower level than $80, but with all those fake shares gone, I doubt back to the old level and the market in the security will have been cleaned for a little while.

8. Repeat as necessary. The only expense is the interest for borrowing the money.

9. The lender is never in danger of losing their capital, as it's always secured by the put options, which the company pledges as security for the loan.

10. To speed up the process, a separate master trust account would need to be opened for people who's brokers will not allow puts to be held in their accounts, like some retirement accounts. These shareholders would then transfer their entire accounts to the master account and back again - if they wish- once the transaction is complete.

10. An MREIT would need to maintain the minimum number of share holder throughout and could easily be solved. Concurrently to the share buy back, the MREIT would resell to the minimum number of share holders at 0.001 per share and also receive a call option for an equal number of shares from them at the same strike price as they are sold to them. This way when the shares are put back to the original owners, the shares are concurrently called back from these trustee owners for 0.01 per share and put back for $80 to the original owners.

3:37 PM  
Blogger bob obrien said...


Does the $6 billion include the non-CNS fails? If so, how do you know? Can you cite a link?

The $6 billion includes hundreds of companies that were once $15 and now trade for a dime or a penny. JAG alone has around 50 million shares authorized, and is thought to have at least 75-100 million naked. Ditto for Sedona, which REFCO was playing.

What would you estimate it should cost to cover that $6 billion mark to market today? How do you arrive at the number you select, i.e. what is your equation? Walk us through it.

I've noticed that the defenders of secrecy and of the participants are strangely reluctant to acknowledge that $6 billion could easily be 50 times larger once covering and speculation become involved. And that well might not include ex-clearing. Hence my first question.

It's like the fails number of shares. The PIPEs report highlights that there are around 150 million FTD's on average in NYSE and NASDAQ stocks, per day. Defenders of the brokerage community point out that isn't a lot compared to the billions traded. What they leave out is that those shares are concentrated in only a handful of companies, not the whole broad market, and thus represent a concentrated manipulation in those issue - count the number of US companies on the SHO list, today, then look at their volumes for the day, and you will start to get a feel for how concentrated the fails actually are. We are talking a hundred million on average in what, 60 companies? Starts to seem a little more interesting, no?

We have facts at our disposal, even with all the secrecy over the FTDs. We know that there is a non-CNS problem - listen to the Bear Stearns CC on NCANS.net if you want to take the position that there isn't. We know that 80% of the FTDs per day are not satisfied by the stock borrow program, per Thompson at the DTCC.

Where do you think those go, and how do you think they are satisfied?

We have enough info to understand that this is an endemic issue on Wall Street. Byrne tested the theory with his dad, and 90% of the shares they bought of OSTK weren't delivered in 2 months.

Is that prompt clearing and settling in your mind?

If not, how would you say that complies with Rule 17A?

Do you believe that is isolated? What would you say if I told you I know another guy who bought 50K and can't get his shares, either?

Starting to get it?

If you have reason to believe that FTDs aren't a problem, what is your explanation for all these prominent folks who can't get their shares delivered?

What do you say to the companies that had votes and had tens of millions more votes than they have authorized shares show up?

What do you say to OSTK trading half a million to a million shares a day in a downtrend but the CEO and his family unable to get delivery for months?

It all sounds fine when you dismiss things - "bah, $6 billion, I wipe my backside with that" - but if it is really more like $240 billion to cover using any sort of realistic assumptions, that isn't so laughable, now is it?

And here's the kicker: If a stock was shorted from $20 to to a dime, like many of these were, using FTD's, the sellers were able to withdraw their overcollateralization as the price decreased - so the DTCC is only holding a dime per share as the mark to market requirement for collateral.

What happens to the system when a hedge fund that is leveraged 10 or 20 to 1 has their 20 million share position go from a dime to a quarter on 3 stocks within a week? How's that collateral looking now? What happens to all the other positions that their cash is collateralizing when they have to now come up with 2.5 times the hard cash on an overnight basis. And what happens when that jumps to 50 cents the next day?

That's why I believe that the system doesn't want squeezes in these stocks, and wants to keep everything top secret. The regulators completely understand the domino effect that mass covering in just a few names would cause, vaporizing several hedge funds, which in turn would have a 10 to 1 or 20 to 1 impact due to their leverage, causing yet more failures.

And that, my friend, is the only logically consistent reason for violating Rule 17A and grandfathering in the past fails. There is no other explanation.

They know the systemic risk. They are fully aware of it. That is the answer. And they are hoping that they can grow out of it, just as the S&L regulators hoped they could grow out of that - and in both cases, the end lesson is the same - the longer you wait and hope the industry will solve its own problem, the larger the problem becomes.

Appreciate the responses in advance:

1. Does the $6 billion include the non-CNS failures, and if so, how do you know?

2. What is the true cost of covering the $6 billion, and what are the assumptions you are using?

3. How do you explain Byrne's experience with habitual non-delivery? In light of this, what evidence do we have that any of the OSTK electronic book entries being traded in the market daily have genuine shares associated with them?

4. What is the impact of the kind of unwinding I've described in highly leveraged, concentrated plays?

5. What alternative explanations can you come up with to justify the grandfathering, which violates the Congressional mandate for prompt settlement in 17A?

4:11 PM  
Blogger gvtucker said...

Hi, Bob--

1. Does the $6 billion include the non-CNS failures, and if so, how do you know?

Heck if I know. I got the $6 billion number from you, so you tell me.

2. What is the true cost of covering the $6 billion, and what are the assumptions you are using?

I have no idea. And I don't care, either. That's a problem for people short those stocks, not me. And since it isn't a significant number, it won't have an affect on the market.

3. How do you explain Byrne's experience with habitual non-delivery? In light of this, what evidence do we have that any of the OSTK electronic book entries being traded in the market daily have genuine shares associated with them?

Two instances is not "habitual". And until Byrne gives us the full story, there isn't any way to have a full understanding.

4. What is the impact of the kind of unwinding I've described in highly leveraged, concentrated plays?

The hedge fund in question blows up. Big whoop. Happens all the time. And the investors lose their money. That's what happens sometimes when you take that risk. None of the big time hedge funds lever 20 to 1. None of them. The multibillion dollar hedge funds are mostly not levered at all.

5. What alternative explanations can you come up with to justify the grandfathering, which violates the Congressional mandate for prompt settlement in 17A?

I don't have any alternative explanations. It isn't a worry for me.

4:53 PM  
Blogger gvtucker said...

secfoinfo, What line item in the financial statements would reflect the six billion dollars if, for example, it was one brokerage that failed to deliver the entire six billion

Retained earnings.

4:54 PM  
Blogger bob obrien said...

GV: Nicely done.

1) The $6 billion comes from the DTCC website. They have never answered any questions about any of their info there. Given that you are taking a position that it isn't significant, I was wondering how you arrived at that conclusion. I now have a good idea how.

2) Given that you have no idea how big the number will be, I find it somewhat amusing that you simultaneously say it won't be significant. Again, I think I'm starting to get a feel for your acumen and style.

3) A non-answer, or rather a rationalization for a non-answer.

4) Please cite a link to any resources at your command for the amount of leverage employed by hedge funds. International funds as well would be appreciated. Given the articles in the Financial Times last year by regulators over the huge leverage employed by massive hedge funds, I am confused, and I'm sure you will be able to help me understand. BW, you do know that hedge funds all emply leverage, right? All. By definition*.

5. So the answer is no, you don't have an alternative explanation.

Thanks for helping me out on these points.

* From Symphony of Greed, Financial Terrorism and Super-Crime on Wall Street, chapter 6, hedge funds:

"Hedge funds are collections, or pools, of private money, usually managed by a single director, who is free to invest the dollars under his control as he sees fit (within the constraints imposed by the operating agreement, assuming that any constraints are articulated).

The term “hedge” fund is generally thought to refer to the idea that the funds are being used to “hedge” traditional investments in the market, usually long positions, with offsetting short positions – hence they represent a hedge against declines in the other investments. In actuality, the term derives from the specific investing philosophy of the creator of the first hedge fund, A.W. Jones, who in 1949 gave birth to the investment class. Jones was a pioneer in that he combined two techniques, to minimize risk and increase reward - short selling, and *leverage*. Short selling is the borrowing of a security and selling it, in anticipation of being able to repurchase it at a lower price in the future. Leverage is the use of borrowed funds. Short selling and leverage are perceived as risky when practiced in isolation, but Jones’s breakthrough was to use the two dynamically, in unison.

Jones's theory was that there were two distinct risks in stocks: risk from selecting individual stocks, and risk of a general market decline. His philosophy broke out the two, and attempted to correct for the market decline risk by holding a collection of shorted stocks (hedging against a drop in the market). Having hedged away the general market risk, he then used borrowed funds to leverage and amplify his individual stock picks - he went long on stocks he considered "undervalued" and short stocks he felt were "overvalued." That left the fund "hedged" to the extent the portfolio was split between stocks that would increase in value if the market went up, and short positions that would increase in value if the market went down – hence the term "hedge funds."

6:00 PM  
Blogger gvtucker said...

Please cite a link to any resources at your command for the amount of leverage employed by hedge funds.

The large hedge funds do not advertise their positions. If you don't want to take my word for it, fine, that's understandable. You need to do your own homework.

Given the articles in the Financial Times last year by regulators over the huge leverage employed by massive hedge funds, I am confused, and I'm sure you will be able to help me understand.

I read FT every day. I have never seen an article that describes the huge leverage employed by massive hedge funds. By massive, I usually define it as more than a billion dollars. Could you cite a link for what you're talking about? Because I sure never saw it.
BW, you do know that hedge funds all emply leverage, right?

You are incorrect. Even looking at your definition, hedge funds do not have to be leveraged. And I can say for a fact that many are not.

There are only a couple of things that are pretty consistent with hedge funds: first, they're designed to keep from being regulated as much as possible. Second, they charge high fees. I cannot think of anything else that would be consistent across all hedge funds. Some aren't leveraged at all; in fact, more than a few multibillion dollar hedge funds are carrying a decent amount of cash right now. Others are levered, most often funds that play the game of risk arbitrage of different sorts, even though it really isn't arbitrage at all, usually.

6:19 PM  
Blogger bob obrien said...

This comment has been removed by a blog administrator.

7:51 PM  
Blogger bob obrien said...


You make quite a few claims here, and yet when pressed, don't cite anything to back up your positions. I am understandably skeptical of your claims, as anyone can claim anything - the meat is in the being able to cite references and links.

Here's a few for you to peruse:

The International Herald Tribune at http://www.iht.com/articles/2005/07/20/business/gflede.php

Some highlights:

"A particular source of concern would be if several hedge funds were forced simultaneously to sell their holdings to reduce exposure to the market and meet margin calls."

"Hedge funds borrow as much as 10 times their cash, using the leverage to control a larger amount of assets. Unfavorable market moves could force funds to sell their holdings to repay lenders, exaggerating the fall in price of the company credit the funds were betting on, Fitch analysts wrote."

And so on. Looks like the Herald Tribune is also mistaken about hedge funds and leverage.

Or how about this one from the Asian Times, a few years ago, who are also apparently in need of more homework.


Some select quotes:

"They employ a bewildering array of investment tactics, many of them centered on short-selling, which is the practice of borrowing stock and selling it in the hope of buying it back later for a lower price as markets fall - a sound tactic in the world's current three-year bear market, but an extremely dangerous one if markets suddenly turn up. Other strategies include *deep leveraging*, program trading, swaps, arbitrage and derivatives.

"If several credit-oriented hedge funds *de-leveraged*, this could result in price declines across multiple segments of the credit markets," said Ian Linnell, a managing director at Fitch in London..."

"A particular source of concern would be if several hedge funds were forced simultaneously to sell their holdings to reduce exposure to the market and meet margin calls. "

"Hedge funds borrow as much as 10 times their cash, using the leverage to control a larger amount of assets."

To your statement that if a few hedge funds blow up, hey, WTF, no big deal, The Financial Times, of all people, had this to say about huge (over a billion dollars) funds and huge leverage:


"... The business is opaque and little regulated. A big lesson of LTCM was that the banking system can be jeopardized by the ill-judged risk-taking of a single hedge fund."

Apparently the ill-judged risk taking of a single hedge fund could have catastrophic consequences, due to their leverage employed. I recall their total size was around $2.2 billion - a lot less than the $6 billion you dismiss as "not a concern" or somesuch. The concern in LTCM was of course, that huge fund's use of *leverage* and consequential damage potential as that *leverage* quickly caused the defaults to massively increase. They had *leveraged* their $2.2 billion of capital into collateral for $1.25 trillion notional value worth of derivatives, or around 416 to 1 leverage.

Huh. That's a lot of leverage for a multi-billion dollar fund.

I will try to find the Financial Times article I recall.

I'll leave you with a fun thought in terms of how leverage works on Wall Street and how much a $6 billion position can mean in implied leverage. JP Morgan, with $46 billion in assets, has 626 to 1 implied leverage in their derivatives exposure, representing a notional value of a staggering $26,276 billion - that's $26 trillion. Here's a fun commentary on it:


Maybe $6 billion of highly leveraged hedge fund exposure in naked short sales is a bigger deal than you think? Than anyone thinks?

Just maybe?

8:07 PM  
Anonymous Anonymous said...


Have you ever heard of Long Term Capital Management? They were a hugely levered hedge fund (something like 30 to 1) that the government had to bail out because they thought the ripple effects would have a devestating impact on the WHOLE financial community.

This was in 1998 when hedge fund assets were about a tenth of what they are now.

So when you say big deal it's the hedge funds problem to deal with I think your vastly misunderstanding the situation here.


8:21 PM  
Blogger SECFOInfo said...


Retained Earnings? Interesting

So the brokers have manufactured 6 (six) billion dollars in false earnings that can be called back if the SEC forces them to cover the grandfathered fails.

While the brokers "might" survive, it would kill their stocks, especially if the market finds out they will be forced to cover. That six billion could become twelve very quickly.

8:51 PM  
Blogger mfairview said...

Are we forgetting Refco? Didn't they report 49B in assets back in feb and now down to 16B and halted because there was no way to meet their obligations. I see 3 explanations (none of which are good):

1) They were supremely leveraged
2) They were lying back in Feb to their assets.
3) They managed to lose an inordinate amount of money in the last 6 months

As many have asked, how they were able to go public only to declare bankruptcy 10weeks later is beyond belief. With that many eyes on this ball, I find it a tough pill to believe only 2 people knew of the issues.

GV's "not my concern" approach is puzzling given his hard stance on "it's a non issue" explanation. Even if we believe bob is at one extreme, there is certainly enough evidence to warrant investigation. Heck, Jeff "It's the victim's fault" Matthew's is starting to concede there are real issues-- there are simply too many coincidences and too many predictions coming true to explain away.

BTW- Looks like Dr. Byrne is in DC today, wonder what that's about?g

3:16 AM  
Blogger bob obrien said...

Read today's WSJ article on the connections between REFCO and Sedona and the whole naked short selling thing.

Isn't that something.

Folks, you absolutely should remember that you heard it here first.

Actually, you heard it at Dave Patch's site in August first - InvestigatetheSEC.com, and you heard about ex-clearing and special purpose entities being used to hide the FTD's here.

A message board post containing much of the text is linked on the NCANS.net news page.

7:03 AM  
Blogger gvtucker said...

Maybe $6 billion of highly leveraged hedge fund exposure in naked short sales is a bigger deal than you think? Than anyone thinks?

Just maybe?

No, Bob, because you confuse equity with the gross amount of a position.

The $6 billion is a gross position amount, a total value of equity. If a hedge fund was heavily levered in short positions like this, the equity that would control it in a 20 to 1 leveraged fund would be $300 million. You've got your leverage backwards.

And on the leverage question in general, please read your links closer. None of them say what you maintain.

7:35 AM  
Blogger gvtucker said...


Are we forgetting Refco? Didn't they report 49B in assets back in feb and now down to 16B and halted because there was no way to meet their obligations. I see 3 explanations (none of which are good):

1) They were supremely leveraged
2) They were lying back in Feb to their assets.
3) They managed to lose an inordinate amount of money in the last 6 months

First, it is a fact that Refco was suprememly leveraged.

Second, they DID lose a ton of assets. That is because customers lost their faith in Refco as a counterparty or agent and thus pulled their money out of Refco.

GV's "not my concern" approach is puzzling given his hard stance on "it's a non issue" explanation.

Well, I'm sorry you're puzzled. There are many reasons I don't worry about this. One is that people like Byrne who are very public about what they maintain is a huge problem aren't very credible to me. And others like Bob O here are highly misinformed about the markets. Also, most of the companies that show up on the Reg SHO list are, in my opinion, poor investments. Are they ALL poor investments? No. But when I see complaints that naked short sellers are the reason companies like KKD are in the tubes I laugh.

This, of course, is only my opinion. But that is why I hold the opinion that you guys are way, way overstating this issue. Brokers have failed in the past, and failed spectacularly. The markets somehow survived. And the past failures had nothing to do with naked short sales. Refco has failed. It has nothing to do with naked short sales, either. And the markets will survive just fine.

7:43 AM  
Blogger gvtucker said...

So the brokers have manufactured 6 (six) billion dollars in false earnings that can be called back if the SEC forces them to cover the grandfathered fails.

No, that's not how it works. You mistakenly assume that the brokers maintain an open position on one side of a naked short sale. That doesn't happen very often. They haven't recorded $6 billion in profits on those short sales. The amount that would get taken out of retained earnings would be the loss of the buy in.

7:45 AM  
Blogger gvtucker said...

Last one here....

Uncleeward, RE: Have you ever heard of Long Term Capital Management? They were a hugely levered hedge fund (something like 30 to 1) that the government had to bail out because they thought the ripple effects would have a devestating impact on the WHOLE financial community.

This was in 1998 when hedge fund assets were about a tenth of what they are now.

So when you say big deal it's the hedge funds problem to deal with I think your vastly misunderstanding the situation here.

Yes, hedge fund assets have grown since then.

But banks no longer lend that kind of money against equity. The LTCM blowup made the banks much more hesitant to lend large amounts of money to funds that are leveraged. It is impossible these days for a hedge fund to lever the way that LTCM was levered.

And they were levered a lot more than 30 to 1, by the way. And lo and behold, somehow the financial markets survived. Heck, the government didn't even need to bail them out; IMO that was an excessive panic by the Fed. There were bids on the table that would have left things just fine without the government involved at all.

I'm out for a while now, so don't expect any responses beyond this. It's been fun exchanging thoughts with y'all.

7:50 AM  
Blogger bob obrien said...


I don't confuse anything. You understand my point. If $6 billion of buy-ins were required, every dollar of buy in is likely hugely leveraged and thus would cause further domino effect as the hedge funds that hold the failed positions are required to delverage other positions to create cash with which to cover thiese.

That is a very clear explicate in the articles.

You said that you aren't familiar with any large hedge funds that are leveraged. I posted several links and mentioned LTCM, and you simply shifted topics. You have not shown the articles in question to be in error. You have tendered no evidence to show that their repeated statements that hedge funds are leveraged at 10 to 1 is false, but rather you simply repeat your assertion as though by repetition it will become more factual.

It hasn't.

Did you read the WSJ article on REFCO? It's a good read.

You don't know how much of an impact naked short selling had on REFCO, besides what you read it the paper. Neither do I. I'm saying tell us, we want to know. You are declaring that there's nothing to know.

How do you know what isn't there to know?

How many more articles need to be posted discussing systemic risk from hedge funds unwinding their leveraged positions before you acknowledge that this is a risk? 5? 10? They are out there, you know, and Google works wonderfully.

You claim LTCM wasn't a big deal either. You "know" that they didn't require a big bailout. I'm familiar with Monday morning quarterbacks that hold that position, but apparently the Fed felt it was that big a risk at the time.

You are entitled to your opinion.

You are of the opinion that this isn't a big deal.

You admit that you don't know what the size of the problem is. You admit that you don't know how much systemic risk there is.

And yet in the face of complete ignorance of the size of the problem, as well as the systemic risk, as well as the amount of leverage involved with those that hold the most risk, you express that you aren't worried.

I see.

You know the expression. Ignorance is bliss.

Thank you for your explanation of your views. It is always helpful for us to understand what those with divergent views are using as the basis for their logic, if logic it is.

I understand.

8:06 AM  
Blogger gvtucker said...

Well, Bob, it's true, you might not be confused.

If that's the case, though, you're intentionally misleading people.

8:15 AM  
Blogger bob obrien said...


The facile insults are fine for the yahoo boards, but here, I'm afraid you have to prove your case.

How am I misleading people? Which part of the articles I cited were the most misleading, in your opinion?

Do you have anything to contribute of a factual nature?

You admit you don't know the size or scope of the FTD and ex-clearing problem. Am I confused, and you do, and I missed where you explain it for us? Apologies in advance - where did that take place?

You admit that you don't know what the systemic risk is. Do you? How? Can you share your info source, so that we don't all just have to "take your word for it?"

You don't know what exposure REFCO has to failed trades, or what their contingent liability is from those. Nobody does. The SEC isn't telling, which itself is dissonant, given that they are a publicly traded company, the information in question would be material.

You breeze past the fact that they were involved in a naked short selling scheme, and thus are highly likely to have exposure there.

You offer no illumination as to where I have run off the tracks in my explanation of the non-CNS clearing system and its impact on the system.

In short, you call names, you make declarations with no support, you argue with no references, and when challenged, fall back on "take my word for it."

I'm not sure any more bandwidth is productive here. If you can address the above points, knock yourself out. If not, it has been interesting hearing your "views."

But please, stick to information that can be verified independantly or has some basis in testable fact.

Thank you for your time.

8:35 AM  
Anonymous Anonymous said...

Keep up the good work. What would be nice would be to have a nice concise webpage with charts and graphs and a very simplistic explanation of first how naked shorting works. I would estimate you lose 90% of your audience when it is difficult for the layman to even understand the basics of what is going on. Chasing links all over and reading lengthy articles and you probably lose another 9% of your audience. An email with an effective explanation with a few key current events would be able to be forwarded easily.
Just some ideas.

8:45 AM  
Anonymous Anonymous said...

How are short sales & covers counted at the time of the trade? Is there any difference when it is a Naked short?

11:17 AM  
Anonymous Anonymous said...


It seems all to easy after the fact to say the fed overreacted. Reasonable minds might differ. I don't know your background, but I doubt you are/were privy to all the same info the fed had, working intimately with all the players involved.

Maybe the fed overreacted, maybe they didn't, who knows. IMO, they thought there was a HUGE risk to many financial players, so they opted to be safe rather than risking a calamity. I think a main concern that the fed had, was a game of confidence, and the daisy chain affect the situation potentially could have had. LTCM had such huge positions and their situation was becoming public and obvious that you had other traders, funds, etc. starting to front run. If they were forced out in a short time things could have become catastrophic, having a daisy chain effect throughout the whole system. I think this is the same negative potential scenerio that Bob O is eluding to if all "fake" shares were forced to cover. The potential liability could be crippling, much more than the 6 billion figure thats been talked about.

Also, I think if anything money has become looser and easier to obtain. I agree banks won't lend funds money to leverage 40 to 1, however I think with the game having become so competitive more funds have elected to leverage in their search for market beating returns.


1:08 PM  
Blogger bob obrien said...


A trade is a trade. They are supposed to now mark it short if it is short, but my hunch is that they just sell it long, and then let God sort it out at T+3 - it isn't really a short if you "meant" to deliver, but never really got around to it....right?

I also agree completely about LTCM - the systemic shock potential prompted gov intervention. In my next piece I describe how you not only have the leverage inherent in hedge funds to contend with, but an additional layer of leverage as funds are made available while the price of the FTD descends, clearing a portion of the collateral dollars for further use...to collateralize more FTD's!!!

Mark my words, this is a huge risk, and $6 billion is a sneeze compared to what the actual contingent liability is.

I noticed that a hedge fund blew up in Canada, and we don't hear a peep about it - Porteus. Anyone got any info on this?

Also, note that every day the REFCO situation is turning up more uglies. Today there's a second "unnamed" hedge fund that was in the larceny mix.

Is anyone in doubt as to where this goes?

2:42 PM  
Anonymous Anonymous said...


There was also a hedge fund highlighted in the most recent businessweek that was having problems, I think the name was woodriver. Have you heard of it?


3:20 PM  
Blogger bob obrien said...

Its Strange.

You are the proud recipient of being deleted from this string. Your agenda appears to be nothing more than to name call and harrangue, which won't be tolerated. If you have a problem with whoever you think I am, or how I "make my living", then I would encourage you to create your own blog and discuss it till blue in the face. This isn't the forum.

FWIW, this is about messages, not messengers, although I am continually amused at how the bad guys attack anyone critical of this illegal trading tactic. The question is really why they are so defensive about an illegal manipulation technique - it's almost as though they are admitting they are engaged in it and have a lot to lose by having the technique exposed.

So good bye, good luck, you are welcome back if you have anything of substance to add, but if it is personal attacks/insults you will be deleted immediately.


12:45 PM  
Anonymous Anonymous said...

Just a heads up, ALL hedge funds do not employ leverage, in fact, many do not. I happen to know a few of these miscreant types, and trust me, the ones I know are plain ol vanilla, value equity investors. as someone earlier pointed out, the only two similarities among the 8000 or so investment partnerships that are now for whatever reason grouped together as "hedge funds" are that they are loosely regulated and charge high fees.

LTCM was such a problem, not because of the leverage it employed, but because of the idiotic ways that the banks had become ensnared in the situation. this occured a number of ways:

1) many of the banks had their own fixed income arbitrage desks, who had many of the same trades on as LTCM, just in smaller sizes. So they were losing money on the trades just the same as LTCM, and when they realized that LTCM was in trouble and might have to start liquidating positions to meet Bear Sterns $500M "in the box" requirement, their positions were suddenly in much bigger jeopardy.

2) Some of the banks were investors in LTCM and did not want to lose their investment. It is true that LTCM had redeemed most investors money just prior to August of '98, but UBS in particular still had massive exposure.

3) The banks had gotten so desperate for LTCM's trading volumes, that they had effectively reduced the haircut on repos to 0.

Now it is true that we do not know what lurks inside Refco Capital Markets, the unregulated offshore unit, that was... a prime broker to hedge funds. And it is true that some of those funds may be tied up in naked short sales. But as a market participant, I am far more worried about the coming debacle in derivatives than I am in naked short selling. The derivatives market is now $240T in notional outstanding, dwarfing the equities market. I don't buy into this notion that there are "contingent liabilities" on the bank's balance sheets related to short selling. In any case, what I suppose you mean is off balance sheet liabilities. The derivative time bomb is much worse than any potential dislocation from potential short squeezes in a handful of stocks. The reason I know, let me repeat, know, that many stocks are not naked shorted is the upward bias of the market. From 2000-2005 many many stock have made huge upward advances, primarily micro to mid cap companies. The reason that the broader averages (Dow, NASDAQ and S&P) have not advanced is that they are dominated by large cap companies whose valuations had soared to nosebleed territory while the thousands upon thousands of companies stocks went nowhere in the late 90's.

2:26 PM  
Anonymous Anonymous said...

Bob: Jim Rogers (famous for his bow tie and suspenders on CNBC, retired at 37 and now 62 from investments) heads up Rogers Int'l Commodities Index made the decision to go with Refco as their trading partner just a month before this all hit the fan. John Henry, President of JWH Global made the switch as well. Fund assets were to be kept segregated from Refco Cap Mngt. in a customer acct. with Refco LLC (regulated by the CFTC and NFA).

Those funds are now listed under "unsecured creditors" on the BK listing of assets. Investors in the Manged Futures funds of these respected companies have now been sucked in to this gigantic mess!

I've got to think that John Henry (owner of the Boston Red Sox) and Jim Rogers have some very influential friends. We'll see how long their money is tied up in this money game. Good thing Greenspan left when he did huh?

6:29 PM  
Blogger bob obrien said...


So how do you respond to the PIPE's Report's FOIA's showing 100's of millions of FTD's per day? Or the SHO list? Or Byrne's inability to get a lousy 200K shares for months? When theory and belief intersect with fact, which prevails?

I seem to recall many stocks in the 2000-2003 period lost 70-99% of their value.

How are the DOW and the NASDAQ doing since then?

If FTD's aren't a huge problem, then how about the SEC just tells us precisely how large the problem is, and we can all go home?

I don't disagree that the derivatives market is a bomb waiting to explode. Better minds than mine have discussed this with alarm.

By contingent liability I am refering to a liability on the books, or off balance sheet, which is represented at today's mark to market of $1, but in reality is a $20 liability once covering starts.

My speculations as to leverage are really nothing more than repetition of the observation that many hedge funds emply 10 to one or greater leverage. You can google things like Hedge fund leverage risk for hosts of articles on the topic.

7:55 AM  

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