“Unrestrained financial exploitations have been one of the great causes of our present tragic condition.”
— President Franklin D. Roosevelt, 1933
Why did gold and silver stocks just get hammered, at a time when commodities are considered a safe haven against widespread global uncertainty? The answer, according to Bill Murphy’s newsletter LeMetropoleCafe.com, is that the sector has been the target of massive short selling. For some popular precious metal stocks, close to half the trades have been “phantom” sales by short sellers who did not actually own the stock.
A bear raid is the practice of targeting a stock or other asset for take-down, either for quick profits or for corporate takeover. Today the target is commodities, but tomorrow it could be something else. When Lehman Brothers went bankrupt in September 2008, some analysts thought the investment firm’s condition was no worse than its competitors’. What brought it down was not undercapitalization but a massive bear raid on 9-11 of that year, when its stock price dropped by 41% in a single day.
The stock market has been plagued by these speculative attacks ever since the four-year industry-wide bear raid called the Great Depression, when the Dow Jones Industrial Average was reduced to 10 percent of its former value. Whenever the market decline slowed, speculators would step in to sell millions of dollars worth of stock they did not own but had ostensibly borrowed just for purposes of sale, using the device known as the short sale. When done on a large enough scale, short selling can force prices down, allowing assets to be picked up very cheaply.
Another Great Depression is the short seller’s dream, as a trader recently admitted on a BBC interview. His candor was unusual, but his attitude is characteristic of a business that is all about making money, regardless of the damage done to real companies contributing real goods and services to the economy.
How the Game Is Played
Here is how the short selling scheme works: stock prices are set by traders called “market makers,” whose job is to match buyers with sellers. Short sellers willing to sell at the market price are matched with the highest buy orders first, but if sales volume is large, they wind up matched with the bargain-basement bidders, bringing the overall price down. Price is set by supply and demand, and when the supply of stocks available for sale is artificially high, the price drops. When the bear raiders are successful, they are able to buy back the stock to cover their short sales at a price that is artificially low.
Today they only have to trigger the “stop loss” orders of investors to initiate a cascade of selling. Many investors protect themselves from sudden drops in price by placing a standing “stop loss” order, which is activated if the market price falls below a certain price. These orders act like a pre-programmed panic button, which can trigger further selling and more downward pressure on the stock price.
Another destabilizing factor is “margin selling”: many speculative investors borrow against their holdings to leverage their investment, and when the value of their holdings goes down, the brokerage may force them to come up with additional cash on short notice or else sell into the bear market. Again the result is something that looks like a panic, causing the stock price to overreact and drop precipitously.
Where do the short sellers get the shares to sell into the market? As Jim Puplava explained on FinancialSense.com on September 24, 2011, they “borrow” shares from the unwitting true shareholders. When a brokerage firm opens an account for a new customer, it is usually a “margin” account—one that allows the investor to buy stock on margin, or by borrowing against the investor’s stock. This is done although most investors never use the margin feature and are unaware that they have that sort of account. The brokers do it because they can “rent” the stock in a margin account for a substantial fee—sometimes as much as 30% interest for a stock in short supply. Needless to say, the real shareholders get none of this tidy profit. Worse, they can be seriously harmed by the practice. They bought the stock because they believed in the company and wanted to see its business thrive, not dive. Their shares are being used to bet against their own interests.
There is another problem with short selling: the short seller is allowed to vote the shares at shareholder meetings. To avoid having to reveal what is going on, stock brokers send proxies to the “real” owners as well; but that means there are duplicate proxies floating around. Brokers know that many shareholders won’t go to the trouble of voting their shares; and when too many proxies do come in for a particular vote, the totals are just reduced proportionately to “fit.” But that means the real votes of real stock owners may be thrown out. Hedge funds may engage in short selling just to vote on particular issues in which they are interested, such as hostile corporate takeovers. Since many shareholders don’t send in their proxies, interested short sellers can swing the vote in a direction that hurts the interests of those with a real stake in the corporation.
Lax Regulation
Some of the damage caused by short selling was blunted by the Securities Act of 1933, which imposed an “uptick” rule and forbade “naked” short selling. But both of these regulations have been circumvented today.
The uptick rule required a stock’s price to be higher than its previous sale price before a short sale could be made, preventing a cascade of short sales when stocks were going down. But in July 2007, the uptick rule was repealed.
The regulation against “naked” short selling forbids selling stocks short without either owning or borrowing them. But an exception turned the rule into a sham, when a July 2005 SEC ruling allowed the practice by “market makers,” those brokers agreeing to stand ready to buy and sell a particular stock on a continuous basis at a publicly quoted price. The catch is that market makers are the brokers who actually do most of the buying and selling of stock today. Ninety-five percent of short sales are done by broker-dealers and market makers. Market making is one of those lucrative pursuits of the giant Wall Street banks that now hold a major portion of the country’s total banking assets.
One of the more egregious examples of naked short selling was relayed in a story run on FinancialWire in 2005. A man named Robert Simpson purchased all of the outstanding stock of a small company called Global Links Corporation, totaling a little over one million shares. He put all of this stock in his sock drawer, then watched as 60 million of the company’s shares traded hands over the next two days. Every outstanding share changed hands nearly 60 times in those two days, although they were safely tucked away in his sock drawer. The incident substantiated allegations that a staggering number of “phantom” shares are being traded around by brokers in naked short sales. Short sellers are expected to cover by buying back the stock and returning it to the pool, but Simpson’s 60 million shares were obviously never bought back to cover the phantom sales, since they were never on the market in the first place. Other cases are less easy to track, but the same thing is believed to be going on throughout the market.
Why Is It Allowed?
The role of market makers is supposedly to provide liquidity in the markets, match buyers with sellers, and ensure that there will always be someone to supply stock to buyers or to take stock off sellers’ hands. The exception allowing them to engage in naked short selling is justified as being necessary to allow buyers and sellers to execute their orders without having to wait for real counterparties to show up. But if you want potatoes or shoes and your local store runs out, you have to wait for delivery. Why is stock investment different?
It has been argued that a highly liquid stock market is essential to ensure corporate funding and growth. That might be a good argument if the money actually went to the company, but that is not where it goes. The issuing company gets the money only when the stock is sold at an initial public offering (IPO). The stock exchange is a secondary market – investors buying from other stockholders, hoping they can sell the stock for more than they paid for it. In short, it is gambling. Corporations have an easier time raising money through new IPOs if the buyers know they can turn around and sell their stock quickly; but in today’s computerized global markets, real buyers should show up quickly enough without letting brokers sell stock they don’t actually have to sell.
Short selling is sometimes justified as being necessary to keep a brake on the “irrational exuberance” that might otherwise drive popular stocks into dangerous “bubbles.” But if that were a necessary feature of functioning markets, short selling would also be rampant in the markets for cars, television sets and computers, which it obviously isn’t. The reason it isn’t is that these goods can’t be “hypothecated” or duplicated on a computer screen the way stock shares can. Short selling is made possible because the brokers are not dealing with physical things but are simply moving numbers around on a computer monitor.
Any alleged advantages to a company or asset class from the liquidity afforded by short selling are offset by the serious harm this sleight of hand can do to companies or assets targeted for take-down in bear raids. With the power to engage in naked short sales, market makers have the market wired for demolition at their whim.
The Need for Collective Action
What can be done to halt this very destructive practice? Ideally, federal regulators would step in with some rules; but as Jim Puplava observes, the regulators seem to be in the pockets of the brokers and are inclined to look the other way. Lawsuits can have an effect, but they take money and time.
In the meantime, Puplava advises investors to call their brokers and ask if their accounts are margin accounts. If so, get the accounts changed, with confirmation in writing. Like the “Move Your Money” campaign for disciplining the Wall Street giants, this maneuver could be a non-violent form of collective action with significant effects if enough investors joined in. We need some grassroots action to rein in our runaway financial system and the government it controls, and this could be a good place to start.
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Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt, her latest of eleven books, she shows how a private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her websites are http://webofdebt.com and http://ellenbrown.com.
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Ellen; that is another good article. Keep it up.
Super article! (I hope I can look forward to a follow-up, on high-frequency trading and volatility scams.) I have two observations
1. Last year, Goldman Sachs’ CEO described its market-making services as doing God’s work. That was before the SEC filed suit, attacking its market-making services in mortgage selling as fraudulent enrichment.
2. I need to reread and rethink what you’ve written, but there’s one item I doubt on it’s face. I believe it IS possible to “hypothecate” physical items such as cars and televisions. If I understand right (please correct me if wrong), on the commodities and futures markets, physical items — notably barrels of oil — are likewise sold by those who “borrow” barrels to sell (with a future delivery due date), which they don’t actually have, but which are nominally “promised” by someone who actually does have the barrels of oil, but who can promise each barrel to multiple sellers. Like fractional banking, it’s a form of “leverage” fraud that only results in “failures to deliver” when there is a real run (or equivalent reality check) on that commodity. Which of course does happen.
Come to think of it, I need to reread what I’ve just written. It’s all such a game of smoke and mirrors!
checking wikipedia : http://en.wikipedia.org/wiki/Lehman_Brothers
A study by finance researchers at the University of Oklahoma Price College of Business studied trading in financial stocks, including Lehman Brothers and Bear Stearns, and found “no evidence that stock price declines were caused by naked short selling”.[60]
what’s the general opinion meanwhile, would Lehman have survived if short selling had been forbidden in 2008 ? I can’t find it.
Great article and I’m distressed to realize I’ve been aiding the enemy. Since we know the Neocon NWO Banksters plan years in advance, it is interesting to guess how world economic implosions going on now fit in to their grand scheme of things. Could anything be going not as planned? Some will label me a racist, which I totally deny, actually I point my finger at a religion in which some of their members will not put a morsel of food in their body that has been touched by anyone outside their religion as the all time biggest racists; anyway, the timing of economic meltdown 2011 strikes me as a planned pre determined Rosh Hashanah surprise.
Yet another excellent article Ellen. The short-selling scam should be outlawed. What chance have ordinary decent hard-working people got in this world dominated by a corrupt International Banking Cartel. with people like my father who is a pensioner and has recently lost quite a lot of money on the stock-markets due to the fraudelent actions of these sort of criminals, speculators and Hedge-funds gambling with their savings. Grassroots direct action is definitely needed, preferably non-violent to bring these criminals to justice…….Bank run anyone?
Ellen you may find this video presentation by Roger Hayes of the British Constitution Group interesting, he is suggesting a Lawful Bank, basically to run parallel to the corrupt Debt-based system of the International Banksters, as a way to free people from their system, he also calls for a parallel society including courts, and police. As a lawyer you may find what he says about common law and statute law interesting too, freedom is certainly an illusion! They may find it difficult to succeed seeing as all or most of the utility services such as food, water and energy are in corporate hands, and i’m sure they will eventually face a hostile and violent response from the corrupt establishment, but at least they are trying to do something to oppose the criminals of the Banking, corporate plutocracy.
Shame the corrupt politicians on both sides of the Atlantic aren’t being forced by the masses to adopt your wise, good, common-sense and caring ideas. Looks like things will have to get alot worse before they get better!
Hi Ellen,
I posted the following over at the Dandelion Salad site where your article appeared on 10/2/ 2011; apparently, that was a poor place to put a comment. This copy corrects the first name of Mr J Bagley.
The Deep Capture blogsite was created by Patric Byrne, CEO of Overstock.
‘I initially started reading the DeepCapture blog site in order to get more insight into the methods/characters involved in ‘naked’ shorting. Judd Bagley’s articles involving the Dendron case got my attention because a number of the key players were legitimate biological scientists/administrators.
Click to access story-of-dendreon.pdf
an excerpt:
‘In fact Dendreon had witnessed even stranger occurrences – brutal naked short selling attacks occurring simultaneously with antics that simply have no precedence in the world of medicine. As will be described presently, these strange occurrences nearly destroyed Dendreon in 2007, and have since then prevented patients from having access to Dendreon’s treatment – a treatment that, as will become clear, should have reached the market some time ago.
And from the day of that first strange occurrence in September 2005, when Cramer predicted that Dendreon would become a “battleground” stock, to the latest strange occurrence in April 2009, when Dendreon’s stock nosedived by 65% in 75 seconds, more than 60,000 men in the United States died of prostate cancer.
So we must ask: Who did this? Who stood to profit from Dendreon’s demise? Were the extremely odd delays in getting Provenge to market purely accidental? Or, were the remarkable trading patterns and volatility accompanying those delays in fact an expression of stock manipulation? If so, who were the manipulators? Since we know that Dendreon experienced naked short selling, and naked short selling is a crime, who are the criminals? And when much of the medical community rallied around Provenge last month, which manipulators crashed the stock to single digits – possibly to make the company ripe for a hostile takeover by the very people who once sought to destroy it?’
I could go into detail, but would suggest your readers take a look at that blog site and check out the writings of Mark Mitchell (Columbia School of Journalism) and founder, Patrick Byrne, (CEO of Overstock).
http://www.deepcapture.com/
A word of caution, I find the extensive redundancy makes it difficult to follow MM’s articles. However, it seems clear that finding ‘fails’ is almost impossible because of the absence of oversight/regulaiton [politics].’
The behavior of the markets, understood in this light, is atrocious.
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