The Fraud in the Capital Markets

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[Editor's Note: This is another article from TDV Correspondent, Gary Kinghorn, in Cafayate, Argentina]

I’ve been talking to a friend who is trying to recover some-as-yet-to-be-determined amount of his money from the MF Global debacle. I’ve been following the events somewhat closely myself as well, when I ran across what we both think is the most insightful analysis of what happened there. This is a full interview with Jim Pulava at financialsense.com with Ann Barnhardt, formerly of Barnhardt Capital Management: http://www.financialsense.com/contributors/2011/12/02/ann-barnhardt/interview-transcript

It’s “formerly” because she closed down her independent futures advisory practice which she had been running for six years and returned all of her clients funds, indicating that our financial markets had become so corrupt and so rigged that she could no longer advocate her clients participating in them. These were just a few of the favorite quotes from my friend from the interview transcript:

We are now living in a lawless, Marxist, Communist, usurped, what used to be a representative republic but is no more. This is no longer a nation of laws. This has now transformed into a nation of men. It doesn’t matter what crime you commit.

The only lesson that these criminal degenerates learned from the 2008 situation was that they could do anything they want and that pimp daddy government would bail them out. You have to understand, people like Jon Corzine, these are evil, evil people. He went into MF Global looking to rape that company personally for his own good.

Anything that is on paper anything that involves a promise or a commitment is no longer valid because as we said there isn’t a rule of law anymore. People can steal from you. Your money can be confiscated.

I couldn’t agree more. For me, my own personal revelation into the depth and depravity of our capital markets occurred about five years ago, when I was a financial advisor at Smith Barney, and, I too, closed down my practice and went back to my career in high-tech.

In the movie, “The Matrix”, Neo has a déjà vu moment with a black cat, that his colleagues explained was like a window into the mechanics of how the matrix worked, and from which you could tell its presence. The information presented by Patrick Byrne, the CEO of Overstock.com, on his website deepcapture.com was that window for me into our financial matrix. Deep Capture is Patrick’s crusade against naked short selling, which he documents has permeated our markets, corrupted our institutions, and is only viable because all of the regulatory agencies have been “captured” (i.e., owned) by the organizations they are supposed to police. Don’t try to surf to deepcapture.com, however. More on that later.

Naked short selling is a very misunderstood term, and most people would not agree that it’s illegal, per se, as improperly defined. When you sell a stock you don’t own, you are taking a short position, hoping the stock will go down. However, to do this legally, you must borrow the shares from someone who is long, and pay his dividends to him while you are short the stock. You then deliver the shares you borrowed to the counterparty of your short trade, and in theory everyone is happy and everything is legal.

However, if you don’t borrow those shares from someone who is long, you have nothing to deliver to your counterparty who thinks he is long the stock. SEC regulations give you 3 days to come up with the stock certificate in a trade, the settlement period. If a legitimate stock certificate is not exchanged in your short trade, then you are termed to be in a “naked short position”, and a “Failure to Deliver” (FTD) notice is given to your counterparty who you did not provide a certificate to. Frequently FTDs clear a few days late, or maybe longer, but the trades (your short sale trade) is not unwound. There are now two people with “long” positions in our example, the guy who you didn’t borrow the shares from who still has them, and a guy who his brokerage statement is showing a long position with an FTD sitting in his account.

The stock that you “sold” short has effectively been counterfeited. Additional shares beyond the float, as represented by the FTD, have been created, and in fact, while the FTD is in circulation, it can be traded as if it were the real certificate. There are enormous problems that have now arisen, including: 1) who gets to vote the shares (so corporate governance is corrupted), and 2) when you increase supply (through counterfeiting), but have not otherwise affected demand, you will, according to economics 101, drive down the price of the stock.

Patrick has painstakingly researched the topic and provided some nightmarish insights from the SEC’s and stock exchanges own records that indicate that FTD’s are an appreciable(!) percentage of all stock trades. Also that naked short selling has been used, and is still being used, to drive down stock prices of targeted companies, as was particularly the case with the penny dot-com stocks, and that hedge funds can then scoop up the companies they have driven into the ground for cheap as they cover their positions. In addition, the SEC and the other regulatory agencies let this practice go on unimpeded. In fact a good percentage of these naked short positions involving FTDs are still circulating years(!) after the original trade. Imagine somewhere between 10-60% of all stock trades on the major exchanges involving FTDs, and you get some insight into how extensive the fraud is and what a joke the capital markets have become.

If you recall, about six years ago a hedge fund called Refco went under and it was big news because the fear was that Refco could take down the entire market (http://www.guardian.co.uk/business/2005/oct/14/usnews.money). Under normal circumstances one isolated hedge fund could not do that, certainly in a healthy market. But what insiders knew, was that Refco had been heavily involved in naked short selling, and had generated millions upon millions of FTDs that were circulating in the markets, and nobody, with Refco gone, would ever unwind the FTDs. Stocks that had a float of 40 million shares, might have 60-80 million long positions now, and when it started to unravel, the whole market could go down into the smoldering crater that was Refco.

The plot thickens: in an interesting twist, MF Global grew out of the corpse of Refco (http://www.nypost.com/p/news/business/sins_of_past_trades_Ixlj5YYj8GDglL3pcl7KQJ).

What does the SEC say in regard to naked short selling? Well, from Patrick’s presentation they definitely turn a blind eye towards justice and speak out of both sides of their mouth, first saying FTD’s are small in number and not a problem and yet, they can’t disclose their size and that they must be grandfathered in place, otherwise they have the potential to cause market volatility and expose the strategies of the people who are illegally benefiting from this practice.

Now, while doing some refresher research for this piece, I revisted the deepcapture.com web site, only to find out it had been shut down by court order about six weeks ago. Clearly, they must be on to something big! (http://mindbodypolitic.com/2011/10/23/why-was-deep-capture-shut-down/) Patrick Byrne and his associates have been vilified, and he has been casually called the most hated man on Wall Street. Some of his associates have had death threats. Most people dismiss this as paranoid conspiracy theory, but I’m here to tell you to research it yourself. The best place to start is with an online presentation that is still up at http://deepcapturethemovie.com. Hopefully the full web site will be back online soon. If you’re not scared out of your wits by this, you aren’t paying attention.

My contention is that the big financial players want to punish gold and silver owners. MF Global was just one scheme. A much more elaborate scheme is the naked short selling of the low-cost mining stocks, or even the majors. It’s virtually undetectable, unregulated and a fool-proof way of keeping a lid on the share prices (by counterfeiting shares as long-term FTDs). If JP Morgan is naked short billions of dollars of silver future positions, do you not think anyone is naked short all these mining stocks? Note: I am convinced this is going on in the US markets, but don’t have any insights into Canadian exchanges.

 I know there are a lot of folks that make a living promoting the mining sector, notably Casey Research, but I think they are somewhat naïve to the extent of the naked short issue, and the primary proof point I have is how badly all these stocks have performed compared to physical bullion, which is more difficult to control, although that’s clearly being shorted on Comex, too. If you think our capital markets are not rigged and still fair, then mining stocks may be a great way to leverage yourself to the price of bullion. But if Patrick is at all right about this stuff, the lambs are going to get fleeced and drowned in a sea of corruption and fraud none of us will live long enough to see the resolution to. MF Global traders may just be the start of it.