I will begin this preamble to the subject systemic risk with two quotes from Warren Buffett (by quoting him I do not mean to imply his support in these efforts of mine):

• Of excess leverage in the system, Mr. Buffett has said, “No one knows who’s been swimming naked until the tide goes out.”
• Mr. Buffett calls derivatives, “financial weapons of mass destruction.”

I would like to explore the meaning of this in the context of unsettled trades in our nation’s settlement system.

Mark Twain said, “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”

Consider this scenario:

• I loan you an umbrella.
• You use that umbrella as collateral to borrow 5 more from someone else.
• You take the 6 umbrellas and loan them out to your 6 brothers.
• Each of your six brothers now has one umbrella. Each uses that umbrella as collateral with which to borrow 5 more. Each brother now has 6 umbrellas, and loans them out to 6 of his friends.
• Each of those (6 brothers) X (6 friends each) = 36 friends now has one umbrella. Each uses that umbrella as collateral with which to borrow 5 more.
• There are now 6 X 6 X 6 = 216 umbrellas in all.

It starts to rain.

• I go to you and say, “I need back that umbrella I loaned you.”
• You say, “But that was collateral for the 5 I borrowed! If I have to return your umbrella, I’ll also have to return the other 5 I borrowed using your umbrella as collateral.”
• So you go to your six brothers and say, “I need those six umbrellas back!”
• Each brother says, “But I used that umbrella as collateral for 5 more!” So they go out to get each of their six umbrellas back by going to their 36 friends and saying, “We need our umbrellas back!”

And so on and so forth. It is easy to see how this situation, where balancing upon one umbrella were 216 borrowed and reborrowed umbrellas, could unravel in a chain reaction of “unborrowing” and returning of umbrellas.

Remove “umbrellas” in the above example and replace it with “dollars,” and you get a good image of excess leverage in our financial markets, and one of systemic failure as well.

How could the government stop this collapse? In the umbrella example, the government would take truckloads of umbrellas and inject them into the umbrella market (perhaps by loaning them out at low rates) so as to slow down and even stall that chain reaction. In the example of our financial system, the government would do it by taking truckloads of dollars and injecting them into the capital market.

This is exactly what the government has been doing for over a year. The broadest measure of the money supply is called, “M3.” The government reported the rate of change in M3 since 1959. After reporting M3 for 47 years, in March 2006 the government stopped disclosing M3. From other numbers that are disclosed by the Federal Reserve, however, it is possible to back into M3. An economist named John Williams does just that on the Shadow Government Statistics website. According to Mr. Williams’ calculations, the rate of expansion in M3 has reached 16.7% – higher than at any time since they started reporting it (the last time it reached 16%, Nixon reacted by instituting wage and price controls).

That is problematic because (very roughly speaking) the growth in money supply will equal inflation plus growth in US productivity (along with other factors like velocity and number of transactions: that is why I say “roughly). According to the Fed, productivity is growing at just under 3%. If money supply growth stays gunned at 16%, underlying inflation will heat up over 10%, at which point the dollar will crack some more, at which point interest rates will be hiked into the high teens in order to tempt foreigners to continue loaning us money to subsidize our fiscal and current account deficits, at which point we will be thrust into an inflationary recession that makes the early 1970’s look like a Sunday picnic.

That is to say, massive amounts of liquidity are being injected into the US financial markets to keep it from imploding. This will lead to inflation (”Inflation is always and everywhere a monetary phenomenon,” wrote Milton Friedman and Anna Schwartz) then a recession.

Or not, if, as some believe, M3 is too volatile to worry about.

The “rain cloud” which was the proximate cause of this situation was the home mortgage crisis that began to be exposed in the summer of 2007. People bought homes with borrowed money for which they signed IOU’s (“mortgages”). Those IOUs were aggregated and resold, chopped up, packaged and resold again to firms which borrowed even more on top of them. Unfortunately, since everyone in the chain made money from fees charged for that aggregation, chopping and packaging, they had incentives not to notice that many of the folks underneath it all were signing IOU’s they would not be able to repay. Once they stopped paying their mortgages (i.e., once those “umbrellas” started to be recalled), the system started to collapse on itself. A coordinated effort by the largest central banks in the world injected money into the financial markets to stop a runaway implosion such as that described in the umbrellas example above.

There are numerous articles out there explaining the mortgage crisis in far greater detail than the above. I present this explanation for three reasons only.

• The first is to provide the lay reader with the mental imagery by which to conceive of a systemic collapse.
• The second is so that I could point out that the mortgage crisis was the rain cloud that triggered the current crisis, but it may not be the only rain cloud. Lots of storms have more than one rain cloud.
• Third, the rain cloud is not the same thing as the underlying situation. It is merely the trigger which has caused an unhealthy underlying situation to manifest. It is important to understand not just the trigger but also that underlying situation: tremendous amounts of systemic leverage are, in the end, a giant confidence game (in the most literal sense), and if that confidence is disrupted the system can implode. What disrupts that confidence may be nothing more than a sudden, broad realization that more leverage has accumulated than has been generally understood, perhaps by accumulating in such a way that no one recognized it for what it is. I will argue in future posts that this is precisely what unsettled trades in our stock settlement system create.

Again, that third point is key: recognize that the mortgage crisis, while real, is a trigger but not the underlying situation. The dancer is different than the dance.

I would like to switch metaphors now, to discuss derivatives.

I ask you to imagine a special casino. On the ground floor, it looks like a normal casino. There are 100 people standing around playing craps, roulette, and blackjack. They each brought $10,000 so there is $1 million of betting on the first floor.

On the second floor, however, there is another casino. In that casino, people are watching television screens showing people gambling on the first floor. In the second floor casino, people bet each other on who they think is going to win and lose on the first floor. All the really big players are in that second floor casino, and they are betting hundreds of millions of dollars of action on various people in that first floor casino. Their outcomes are “derivative” of the outcomes on the first floor. A roll of the dice on the first floor that loses someone $100 may create tens of thousands of dollars of losses on the second floor (and if there is a third floor where people are placing even bigger bets on the outcomes on the second floor….)

I will argue that unsettled trades in the financial system bear the characteristics of such derivatives. However, they present a special kind of derivative. If you and I walk into the first floor casino and bet on whether the next roll of the dice is a 7 or not, no amount of betting on our part can affect the underlying event. Similarly, the underlying event will not be affect by any amount of betting by the people above us on the second floor (or by betting on them by people on the third floor).

Unsettled stock trades, however, can affect the underlying events upon which they are a bet. In fact, unsettled trades resulting from “the option market maker exception” are often the by-product of deliberate efforts to affect those underlying events. When an underlying event that someone deliberately affects is a stock price movement, it used to be called, “manipulation” (and was also called “illegal” until Wall Street captured the SEC, at which time it became known as, “a hedge fund business model”).

Because unsettled trades have this property of affecting the underlying events upon which they are a bet, they are derivative contracts with an especially nasty twist.

I tell you, that guy Buffett will go places.

PS Again, because I do not wish to imply endorsement of my views, I am going to give one additional quote, without comment. In May, 2007 Messieurs Buffett and Munger were asked to comment on the issues I am raising here in Deep Capture. Mr. Munger’s response was as follows (page 6): “Those delays in delivering sometimes reflect tremendous slop in the clearance process. It is not good for a civilization to have huge slop. Sort of like how it isn’t good to have a lot of slop in nuclear power plants.”

We often receive political complaints at Overstock .  I am posting this so that in the future, when customer service agents get harangued by people angry about statements they believe are being made by our decision to advertise certain places or carry certain products or sell certain books, music, or magazines, those agents can just send a link to this post.

During the 2004 election, we created a book page with books by Hillary and Bill Clinton on one side, and two books by Dick Morris criticizing them on the other side. On the left, another book by James Carvel (as I recall). On the right, one by Ann Coulter. All images were of the same size, and there were an equal number of them on each side.

We were inundated with complaints from the Left and the Right about featuring books from the other side. Go figure.

We hear from from Family Values folks about the movies and music we sell (even though we actually are quite conservative, selling, for example, Playboy, but not the steamy stuff).

When we advertised on AirAmerica, we got flack for it.

A few weeks ago we heard from the Ron Paul folks protesting our advertising on Fox, given his exclusion from a debate they covered. I wrote a letter to our customers about it, saying that while I happen to support Paul personally, I was not going to change our TV advertising to punish Fox. Then we heard from people angry that I had mentioned that I personally support Ron Paul.

Last week we heard from the Family Values folks protesting the TV shows on which we advertise.

This week we are hearing about the Hillary Clinton Nutcracker on our site.

I respectfully suggest that people should remember, Different strokes for different folks. It is not up to us to make statements with what products we do or do not carry or where we advertise them.  Playboy is often our fastest selling magazine. The Hillary gadget was briefly one of our fastest selling items.  We have about 1 million products, and I’m not going to police American tastes, beyond not selling hardcore or kiddie porn (like some other etailers), and firearms and ammunition and such.

There was one exception: when Rush made fun of Michael J. Fox, we yanked our advertising.

This is going to be a long and exciting campaign. I don’t recall anything like it since 1980. I hope the citizenry gets through it as friends.

Most respectfully,

Patrick

There is something that I have permission to divulge, but have refrained from doing so. As you will see, there are reasons I must do so now.

There are among the Bad Guys some with conscience. Months ago, one from within the network of Bad Guys got in touch with me and turned over 8,000 emails from a set of message board bashers, convicted stock swindlers, and financial journalists in their cahoots. Shysters all. (Wouldn’t it be funny if there were also some in there from hedge funds and the law firms they use to sanitize their communications, but the law firms did not know enough about hygiene?) They run up through sometime well into 2007.

I am breaking the news of these emails here, in the hopes that this will transfer the legal risk from a certain journalist who wishes to cover this, to myself.  I know that I have them legally, and that the person who gave them to me had them legally as well (I’d just start posting the 8,000 emails and let the world decide, but I want this journalist to get the scoop).

What makes for fun reading are the several thousand emails of those well-known New York financial journalists. Understanding how they operate, and with whom, will be the stuff of textbooks someday.

Among those communications are 1,841 emails from a bent reporter named Gary Weiss.  Among many other things, in several of those emails Gary Weiss freely discusses his editing of Wikipedia. What makes that interesting is that there is a civil war erupting within the Wikipedia community between those who believe Judd Bagley’s claims  (detailed on www.antisocialmedia.net) regarding how Gary has hijacked several Wikipedia pages using the sockpuppets ”Mantanmoreland” and “Samiharris” (with the help of several super-users, such as SlimVirgin), versus those who steadfastly deny that Gary has been editing Wikipedia.

All the normal rules that govern the discourse for 2 million other pages within Wikipedia have been suspended for this discussion. This has all been documented by TheRegister (a highly-regarded British tech journal, something like Wired but on-line). Literally, knowledge of Judd Bagley and his site www.antisocialmedia.net  (where he simply exposes these Wikipathologies) has became such a thought crime within the “open society” of Wikipedia that not only has mere mention of them become grounds for lifetime banishment, but Wikipedia ultimately blacked out 1,000 homes around Judd Bagely’s in an attempt to supress his evidence. (When I think of Wikipedia, I think of North Korea, where happy serfs toil in the sun weeding peas listening to endless “How Free We Are” propoganda blasted on loudspeakers hung from guard towers.)

Through heavily-documented stories on antisocialmedia.net, Judd carefully backed Gary into a corner and exposed him, at which point Wikipedia founder Jimbo Wales personally intervened to free Gary. However, it turns out (and we now also have incontrovertible proof of this also) that while Jimbo Wales has for months been publicly accusing Judd of being a “stalker” and such, Jimbo Wales has known all along that Gary Weiss  was indeed using the sockpuppets that Judd revealed. In other words, Jimbo knew that Judd was right, but he has been lying through his teeth to his own followers.

Again, I am stating this publicly here so that this evidence (including the emails of journalists), can be attributed to me, so that a good journalist can go ahead and publish without fear of legal repurcussion.

The “St. Smallcap” example conveyed the dynamics of the manipulation, but it was only a metaphor. This blog will provide an explanation whose truth is more literal.

You and I enter a stock trade. You buy a share of stock from me.  You hand over your money, and I hand over the share of stock. That is called, “settlement.”

It may surprise you to learn that there are loopholes in our nation’s regulations that permit some people, when it comes time to settle, to hand over nothing but an IOU.  By using one of these loopholes, when the time comes for settlement I can take your money but say, “I’m not delivering you any stock. I’m just giving you an IOU for a share of stock that I will deliver later.”

There are reasons these loopholes came into existence. If someone made a mistake by signing the wrong line on a form, for example, or mistakenly sold more shares than he really had, one would not want the entire system to vapor-lock as the mistake was rectified. So the system has been designed so that the gears do not get hung up on minor mistakes. The general idea is that, if someone sells shares it turns out he cannot deliver, he can create these IOU’s and send them on as though they were real shares, giving himself time to clean up whatever error he is experiencing, and sending the real shares a couple days later.

There is no system in place to alert you to the fact that you sent me your money and received nothing but an IOU. The system treats these IOU’s just as though they were real shares. Your brokerage statement will say that you got shares, even though I never sent anything but an IOU. You can sell them, and that IOU will pass on through the system into someone else’s account.

The problem is, suppose I (having mastered these loopholes) start using the system’s “forgiveness” strategically? Suppose I find a company that is likely to need capital to expand, or simply survive, in the near future? They plan on raising that capital by issuing shares of stock to the public (there is no crime in that: for example, lots of young pharmaceutical companies sip at the capital markets for years as they get going).  Imagine that I target one of them, and deliberately go out selling that company’s shares into the marketplace, yet instead of delivering stock, I deliver nothing but IOU’s. I flood the market with them, always standing ready to sell more than anyone wants to buy. My IOU’s are anything but temporary: they drift around in the market for weeks, months, and eventually years. If anyone gets mad and tells me that I have to deliver real shares against one of the IOU’s I sold, I say, “Sure, I’ll deliver shares against that IOU,” but what I deliver is … just another IOU. Eventually I flood the market with so many IOU’s that people end up reselling them, and they go and on until there are more share-IOU’s bouncing around than there are actual shares.

What will the effect be on the price of those shares? If I have chosen a company like, for example, IBM, the effect will be negligible (just as in the example of the preceding blog, if the hedge funds brought their money machines to Paris and printed off 100 million “temporary” Euros to spend around France and Germany, it would not cause any real harm before they bought them all back as they departed).

But remember how the hedge fund managers destroyed the economy of St. Smallcap, so that the “temporary” currency they had issued could be paid off in the end for next-to-nothing? Similarly, if instead of choosing IBM I choose a tiny company, and I generate more IOU’s than there are shares of stock in the company, then the market in those shares will crack just as surely as $100 million of fake currency would crack the tiny island economy of St. Smallcap. Once cracked, the stock becomes next-to-worthless. And if I manage to issue enough IOU’s in my target company’s stock that it cracks and becomes near-worthless, they become barely an obligation at all. Who cares about millions of IOU’s, if those IOU’s are for something with infinitesimal value?

I walk away with my winnings. The company, however, is in a fix: they planned on issuing stock to raise capital, but now their stock price has been destroyed through my manipulations, and they cannot raise capital. Maybe they run out of funds and disappear, or maybe they go into hibernation mode in order to nurse what capital they have. In either case, society is deprived of the output and the jobs that would have existed were it not for my villainy.

It may be hard to believe, but such loopholes really do exist (I will be explaining several of them in subsequent blogs). In reality, however, neither you (if you are like most Americans) nor I can actually use them.  Only large hedge funds and broker-dealers can access these loopholes to create IOU’s (just as, in the story of St. Smallcap, only hedge funds were allowed to own the currency machines with which to print off that “temporary” currency).  As we will see in more detail, these hedge funds and broker-dealers have learned how to manipulate these loopholes in the stock settlement system so as to flood the market with over a billion IOU’s (maybe many billion) in hundreds of companies. In doing so, they have disrupted the market for shares of companies that are researching cures for cancer and other illnesses, figuring out how to make blood substitutes to treat cases of acute blood loss, and building mine-resistant vehicles for troops in Iraq. Hundreds of such corporate “St. Smallcaps” have been damaged or destroyed. Thus, cancer patients are being deprived of treatments, accident victims are dying of acute blood loss, and soldiers in Iraq are dying from IED’s, so that some hedge fund ass-clowns can drive new Ferraris.

It really is that simple.

I have explained the issue through metaphor (”St. Smallcap”), and now, provided this literal explanation.  I will continue with more detailed explanations and citations for further reading for those who wish to gain a more thorough understanding of the workings of the US stock settlement system and precisely how loopholes permeate it. The general reader, however,  may feel satisfied with the account thus far and, feeling no need to learn intricacies of stock settlement, may wish to move on to subsequent chapters, where I discuss in greater detail the harms being done to society, who is doing it, and who has taken part in the cover-up.

I will briefly recount the sordid history of Sam Antar the Crook. Then, and only then, will the reader grasp the import of the question, “Whose interests are being served by the recent promotion of Sam Antar the Crook? Why him, why suddenly, and why now?”

1. In the 1980’s a New York electronics retailer named Eddie Antar, running a chain of discount electronics stores called, “Crazy Eddie,” perpetrated an enormous swindle. As a recent Fortune Magazine article put it, “The debacle cost investors roughly $145 million and involved just about every kind of accounting fraud then known to man, including receipt skimming, money laundering, and the counting of bogus inventory.” A key player in the swindle was the company’s CFO (and Eddie Antar’s cousin) Sam E. Antar.

2. When Sam was busted, he ratted out his two cousins, who each served several years in prison on the strength of Sam’s testimony (I guess Eddie was Crazy after all, to trust Cousin Sam). Sam Antar ratted out family members in return for a reduced sentence of six months’ house arrest and 1,200 hours community service.

3. Barry Minkow is a convicted stock cheat who, at the ripe age of 23, was sentenced to 25 years for his various stock fraud schemes (no small feat). He was released after 6 years. Recently he became entangled in a new stock manipulation case. Three months ago Minkow was subpoenaed and deposed, and in that deposition (pages 8-10), disclosed that Sam Antar the Crook had paid Minkow $250,000 (in two payments, one of $100,000 and one for $150,000) to turn his skills against a public company that he, Sam Antar the Crook, was shorting.

4. Within months of Sam Antar the Crook paying Minkow $250,000, the State of New York issued a $471 tax warrant against Sam Antar the Crook (it turns out that Sam has quite a history of these, so it cannot be put down to forgetting to put a stamp on an envelope). Is the fact that a fellow could not pay a $471 tax lien, but could wire a quarter-million dollars to an ex-con stock cheat, odd?

5. At the request of Sam Antar the Crook, Utah Attorney General Mark Shurtleff met with Sam on the condition that Sam not attempt to spin it as an endorsement of Sam’s views. Sam had his meeting then immediately welched on that promise. The Attorney General wrote a letter describing this chain of events, along with a disclaimer against believing Sam, that he twice attempted to post on Sam’s blog. Sam refused to let the Attorney General post it. At that point, Attorney General Shurtleff made public this letter scolding Sam for welching, and discouraging the public from listening to Sam about pretty much anything (”In light of Mr. Antar’s background as a convicted white collar criminal, we believe that the public should carefully scrutinize and objectively examine any public statements Mr. Antar makes.”)

6. Sam and Sam-cronies (Gary Weiss and Howard Sirota) regularly accuse those who disagree with them, or try to expose their shenanigans, as anti-Semites. Ed Manfredonia, one of the many whom they have repeatedly accused of anti-Semitism, asked the Anti-Defamation League to get involved. Displaying great class, the ADL got involved, and wrote this letter utterly rejecting those allegations. Notwithstanding the ADL’s statement, Sam continues to make endless allegations of anti-Semitism towards those who cross him.

7. These days Sam spends much time posting dozens of deposition-style posts directed at me and my colleagues, over-and-over, dozens if not hundreds per week (what an odd “hobby” for Sam to have). Generally they are inconsequential half-truths, quarter truths, or flat non sequiturs. Even people who formally tolerated him have begun pointing out his lunacy to him.

8. Sam attempted to intimidate one of my colleagues by posting on a public message board the names and address of my colleague’s wife and two little girls, ages 6 and 9:

___________________________________________________________________

How would reputable journalists treat Sam? They would not touch him with a ten-foot pole. Which would explain why several figures within the New York financial media are anxiously and suddenly promoting him.

That’s right: though Sam is a swindler who ratted out his own family, a $500 tax cheat capable of paying a convicted stock swindler $250,000, and a message board basher who threatens 6 and 9 year old girls, Sam Antar the Crook has recently received heavy, positive promotion from the New York financial media.

For example, Sam Antar has recently appeared on CNBC, Herb Greenberg has salivated over him at lunch, and Forbes columnist Gary Weiss cannot stop fondling Sam in print (more on them anon).

Most significantly, Fortune Magazine recently published a 2,738 word profile of Sam Antar (”Takes One to Know One”) in the style known among journalists as, “a lotion job.” What was most remarkable about Fortune’s profile of the reformed Sam was that, as Fortune mentioned 4/5 of the way through:

“As a would-be fraudbuster, Sam E. has yet to notch his first kill. (Although in fairness he doesn’t hold himself out to be a full-time 10-Q detective. ‘I don’t have 40 people working for me like the SEC,’ he says.) He hasn’t brought any companies down or caused any regulators to open any investigations.”

That is, Fortune wrote a lotion-job profile of an ex-con swindler whose discernible contributions to humanity consist of nothing noteworthy beyond taking part in an infamous and massive scheme of fraud and embezzlement then saving his own skin by ratting out two family members in return for a reduced sentence, and whose recent “reform” has amounted to being a paymaster to another ex-con stock manipulator and threatening two little girls, but nothing beyond this that Fortune can name.

Does that seem odd of Fortune? Because it seems a little odd to me.

Is the sudden, major promotion that Sam Antar the Crook is receiving from the New York financial media due to some inexplicable lapse in their research or understanding, or is there a motive behind it? If there is a motive, whose motive is it? What interests are being served?

Cui bono?

Which question brings us one step closer to the heart of the problem: Gary Weiss, The New York Post, Herb Greenberg & CNBC, and Fortune Magazine.

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Sam E. Antar, the Crook