Monday, October 5, 2009

Matt Taibbi Reports on Naked Short Selling, and Gets Caught with His Pants Down

Wall Street can be a very complex place. I have often contended that you could sit and watch me put trades on for days, and if I didn't want you to understand what I was really doing, I could put trades on in a manner that would make it near impossible for you to know whether I was bullish or bearish on a stock or the economy.

In fact, it is sometimes necessary for me to fake out a broker or a trader I am using, so that they don't front run me. I have to teach them to stay away from my trading, and that if they try to mess, they will get burned:)

For any serious trader, front running should never be a problem, just make sure you let the front runners clear out your dogs every once and awhile. In fact, on an occasion, or two, I have allowed some scum bags to eavesdrop on a call to one of my brokers, that sent them scurrying to buy me out of some real dogs.

I bring the complexity of Wall Street up because of one, Matt Taibbi. He gained a bunch of groupie followers recently because of a column he wrote on the evil Goldman Sachs. Since I wrote of the evil doing by Goldman Sachs nearly two years before Taibbi, in a column called, Does Goldman Sachs Run the World?, I was able to get off the good lines and Taibbi had to go for seconds.

I wrote two years ago:
Does Goldman Sachs Run the World?

Not completely, but it doesn't mean they aren't trying. It seems that, literally, only flesh eating bacteria can stop these guys...

Goldman did have a man at the Bank of England, but their presence there has gone astray for the time being. Goldman man David Walton was on the Bank of England's Monetary Policy Committee from July 2005 until June 2006 when he died at the age of 43 from necrotizing fasciitis, i.e., flesh eating bacteria.
Since I had the necrotizing fasciitis story, two f'ing years ago, Tabbi had to go Hunter Thompson Gonzo-like and just make stuff up. He went with Goldman Sachs is "vampire squid wrapped around the face of humanity."

Not bad for gonzo stuff but, if you really have Goldman breathing down your neck, bring a vile of necrotizing fasciitis bacteria. I hear it even works against Paulson.

Anyway, back to Taibbi and his groupies. A line like "vampire squid wrapped around the face of humanity" can keep the groupies satisfied and in line for awhile, but eventually they will need a new fix.

For his new fix, Taibbi, because of his one Goldman story, now apparently considers himself an expert on finance, and settled for his next story on naked short selling. Talk about complex. There are guys who specialize in running circles around the SEC with their short selling scams. Taibbi has a better chance exposing himself naked in front of the Mormon Tabernacle choir for an hour or more, than he does getting to the bottom of naked short selling. But, he doesn't realize this. No, our new financial crusader will gain some war scars attempting to bust open naked short selling. Indeed, he has just been bayoneted through the brain, i.e. he was provided with a video of a huge (hee hee hee) naked short sale. I'll let Taibbi explain the video that was slipped to him:

Caught On Tape: A Naked Swindle

Continuing with the theme of naked short-selling, I have a video that was given to me last week that will allow people to see how naked short-selling can take place.

This video is only 31 seconds long (scroll on down to view it), and what it shows is a day-trader trying to sell short shares in a major NYSE-traded stock. To disguise the identity of the trader, I’ve had to edit out the name of the company in question — I’ll call it BANK X for short. What I can say is that the stock in question is one of America’s largest financial companies and the recipient of an enormous amount of public bailout money, so the fact that its stock can be manipulated is something that should be a concern to everyone.

In the video, which believe me doesn’t look all that sexy, the trader is using an online trading platform. His clearing firm is a company called Penson Financial Services, which, though not particularly well known, has in recent years suddenly become (by volume anyway) one of the biggest such firms in the country....

:00 If you look at the display in the first seconds, you will see that the customer is trying to sell 100 shares of BANK X short. You can tell it’s a short sale by the purple box near the top marked “Short.” To the left of that, you’ll see that “order quantity” is 100.

:01 Now if you look at the bottom of the display, you can see that the trade has been rejected, because BANK X that day is on the hard-to-borrow list. It reads REJ – HARD TO BORROW: SHRT 100. Without getting too technical, you don’t need a formal locate when a stock is on something called the “easy to borrow” list. But BANK X shares that day were not easy to find (without digressing too much into other complicated realms, there was something going on with BANK X that day that was inspiring lots of people to snatch up its shares). So the trade was rejected temporarily, and the trader was then forced to ask for a formal locate of BANK X stock.

:07 A prompt comes onscreen. Through this box, the customer is going to ask Penson to locate shares in BANK X. But how many shares? This is where it gets interesting.

:11 At eleven seconds, you can see the customer start to fill in the box in the middle of the prompt where it reads, “Locate quantity.” To disguise the identity of the trader, I’ve blocked out the first number in the sequence. But you can see that the number is in the tens of billions of shares. Now, the float for BANK X that day was only five and a half billion, meaning there were only five and a half billion BANK X shares in circulation. Without disclosing the actual number, I can tell you that the customer asked for a locate of shares in an amount that was at least five times the number of BANK X shares actually in circulation. Such a locate, in other words, could not possibly be filled.

:17 At seventeen seconds, at the bottom, you see that the firm Penson has now approved the trade and” located” the multi billion amount of shares. The trade goes through.

This doesn’t sound all that dramatic and as video sequences go, it sure as hell isn’t the Paris Hilton sex tape. But this is an example of how naked short-selling can happen. If you don’t need to actually find the stock before you sell it, there’s no real brake on speculative naked short-selling. If a clearing firm will give you a locate no matter how big your request is, there is no real barrier out there to stop this kind of activity.
Now the problem with Tabbibi's video is that it is bogus. There is no firm in the world that is going to take, or be able to execute, a multi-billion share trade in a matter of seconds. To believe so is amateur night. Taibbi is an amateur in an alligator tank and he now has a bayonet sticking out of his brain.

Now, I wasn't the first to catch the bogus video, since I rarely read Taibbi (only when I smell blood oozing), but John Carney, who I read regularly, busted the Taibbi video wide open in recent days. Here's part of his report:

Matt Taibbi’s journey down the rabbit hole of naked short selling is getting weirder and weirder.

Today he posted a video allegedly showing a “day trader” shorting tens of billions of shares of a stock with a float of only 5.5 billion shares. The trader allegedly executes his trades through the clearinghouse Penson...

There are plenty of things wrong with this video, and with the conclusion Taibbi draws. Clearing firms will not execute orders without regard to the size of the order, there are real brakes on speculative naked short selling, and real barriers exist to stop "this kind of activity."

Too Speedy. The first thing that rings false the speed with which the trade is executed. The trader apparently manages to short billions of shares in mere seconds. Penson may be a popular and efficient clearinghouse but there is no way they are that fast. There's just no way to have instant execution of a trade of this size.

“It takes minutes to a half-hour for a request to come back from Penson,” a trader who clears through the firm tells us.

Too Big Of A Trade. You cannot sell tens of billions shares without someone wanting and able to buy those billions of shares. This trade involves placing a sell order for more than the total volume of all US equity markets combined for any single trading day.

Too Much Leverage. More importantly, almost no trader using Penson as his clearing house would have the buying power to put in an order this large. This should sale would require billions of dollars of buying power. The buying power of any trader is a multiple of the money deposited with Penson. That is, it is determined by the maximum margin account available to the trader.

For ordinary, retail traders—the kind of people likely to be called “day trader”—the maximum intra-day leverage is 4 to 1. This is set by FINRA regulation. In order to short tens of billions of shares on any stock worth more than $1, the trader would have to have billions in his brokerage account.

Small hedge funds often use a more sophisticated kind of margin account that allows for more leverage. It's calculated by the clearing firm exclusively for each of their clients who get it based on their style of trading and track record. A risk averse day-trading hedge fund could get leverage as high as 7 to 1 intraday. These typically require a minimum of at least $1 million in the account with the clearinghouse.

Any trader with the billions of dollars necessary to get execution on the trade Taibbi describes would be unlikely to be clearing through Penson. He would be trading through Goldman Sachs or JP Morgan.

It’s too risky. There is a good reason for Penson and other clearing houses to limit leverage in this way, even beyond the regulations. They face counter-party risk when allowing traders to short stocks. If the stock increases in value and the trader cannot pay for the stocks he is short, the clearinghouse will have an obligation to make good with the Depository Trust Company.

This trade would be a disaster. If tens of billions of shares of a stock were sold like this, it would make headlines and single handily wipe out the stock. Likewise, when the trader bought up the shares to close the trade and deliver the shares to the buyers, he’d face a self-imposed massive short squeeze. Buying shares pushes the price up. He'd get crushed...

Update I: We heard from Penson. They say it isn't their trading system.
Carney is a sharp guy, and he has Taibbi nailed on this one, but, I repeat, naked short selling, like a lot of Wall Street, is a very complex game. Carney in some of his other posts suggests there is nothing wrong with naked short-selling, he is off on that one. Some of it can be justified as simple market maker operations, but some of it is major league abuse by very clever insiders, which is the point Taibbi is taking, but doesn't have the knowledge to back up properly.

Anyway, once you sit down an analyze the entire naked short selling thing, you realize that the bad naked short selling would go away if the SEC would stop issuing regulations that protect the bad guys. Basic common sense and commercial law would put an end to the bad naked short selling, real fast.

Bad naked short selling exists because there is a power source to manipulate, in this case the SEC, and the bad guys are running circles around the SEC.

What you want to understand naked short sales for yourself? Well pull up a chair, give yourself five hours and read this. It's a great first step.

But, I tell you, it will be much more fun watching Taibbi attempt to pull the bayonet out of his brain.


  1. great post, Bob. I'd been wondering about Taibbi myself. His instincts are good, though, even if he's out of his depth.

  2. Bob -

    I've re-posted on the Penson video. You might want to check it again.
    Penson's denial letter is full of legalese.

    The video might or might not be kosher. But that denial is definitely an odd one.

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  4. The market values of properties can work against you in a short sale more than you would think. Lenders are not fools and they are completely aware of what the market values are at any given time. If the current lender thinks that they can get a better deal on the home in foreclosure then that may wait it out. The only real time they will accept a short sale is when the short sale price meets the market value.

    Another reason is that the seller had paid too much for the home to begin with. If the home sold for 500,000 just a short few years ago and now is for sale 100,000 less, it does not mean that the buyer has just gotten some free money. It means that the seller has no equity at all in the property.