Bernard L. Madoff’s fraud is “stunning,” says the SEC. It is a crime of “epic proportions.” But, says the SEC, we have nothing to worry about. The SEC caught the bad guy. It “moved swiftly” to protect the integrity of the financial markets.

Nonsense.

The only thing “stunning” is that the SEC continues to condone and even fraternize with the organized mob of hedge fund miscreants who have destroyed hundreds of companies, wiped out the jobs of countless ordinary folks, and brought our financial system to the brink of ruin.

The Madoff case may one day prove to be “epic,” but right now it can best be described as “pathetic” – or just plain “weird.”

Apparently, the SEC began receiving tips from Madoff’s enemies (rival brokerages, private investigators working for rival hedge funds, etc.) several years ago. The commission made inquiries, but took no action.

Then, earlier this week, Madoff purportedly had some kind of nervous breakdown, announcing to his sons that he was a criminal.

If we can believe the news reports, the sons then called the FBI, which dispatched an agent to Madoff’s apartment.

Madoff, dressed in a baby blue bathrobe and slippers, opened the door, and said, “I know why you are here.”

With that, the agent arrested Madoff, and within a few hours the FBI and the SEC had whipped out cases accusing Madoff of wrong-doing, but providing few details.

Indeed, it is clear from reading these cases that the FBI and the SEC know nothing about Madoff’s market making and hedge fund firm except that two employees (Madoff’s two sons) have made the vague claim that Madoff told them, vaguely, that his hedge fund was “a giant Ponzi scheme.”

Madoff’s lawyer says his client has admitted to no such crime.

Children do not usually turn in their fathers to the FBI unless they bear other grudges. And it is standard operating procedure for shady high-finance predators to sniff out and prey on feuding relatives who are in business together.

This in no way suggests that Madoff is clean, but it raises the possibility that even dirtier people orchestrated the demise of Madoff and his hedge fund in order to absorb his more lucrative (and crooked?) market making operation.

An alternative explanation comes from Bill Cara, one of the nation’s more perceptive business writers. He concludes that Madoff “is just the beginning. I don’t know, of course, more than you, but…I think he has in fact indicted himself to cause prosecutors to investigate the entire corrupt system.”

Whatever the real story, it is clear that market makers are accessories to a scheme that is much, much bigger than Madoff.

The key players in this scheme are 20 or so mega-billionaire hedge fund managers, who operate with a supporting cast that includes not just market makers, but also smaller hedge funds, rogue prime brokerages, corrupt lawyers, dishonest journalists, bogus one-man credit rating agencies, dubious index trackers, bribed “experts,” skalawag statisticians, compromised professors, private investigators, crooked financial researchers, captured government regulators, hustlers, felons, thugs and mafiosi.

The mega-billionaires masterminded their scheme in the 1980s, and ever since, they and their progeny have been working together – raiding and destroying public companies for profit. In the rubble of these attacks (there are hundreds of examples) one can almost always find evidence of unrestrained naked short selling (people selling things that they do not possess – phantom stock, phantom bonds, phantom mortgage backed securities, phantom CDOs, all manner of phantom derivatives).

This is the organized exploitation of our national clearing and settlement system – a system that fails utterly to ensure that traders actually deliver that which they have sold. If the SEC and FBI are looking for a “Ponzi scheme” of “epic proportions” – this is it.

Mr. Madoff surely knows something about this scheme. Market makers (Madoff’s operation was among the better known) are exempt from rules prohibiting naked short selling. They can sell stock that they have not yet borrowed or purchased, so long as they are legitimately “making a market” (i.e. maintaining liquidity) — and only if they intend to settle the trade soon after. In practice, however, billionaire hedge fund managers have rented market makers’ exemptions to manipulate markets with phantom securities – a blatant crime that is rarely prosecuted.

While Mr. Madoff is talking to the SEC and the FBI, I am going to begin telling you more about the scheme that is bigger than Bernie. Soon, I will name those 20 mega-billionaires, their supporting cast — and the man who is their guru. The evidence is pouring in – there is much to reveal.

But for now, let me leave you with a quotation from the Financial Industry Regulatory Authority’s “Notice 93-77.” Published in 1993, it reads:

Shortly after the market crash of 1987, “then Treasury Secretary Nicholas F. Brady referred to the clearance and settlement system as the weakest link in the nation’s financial system…Gerald Corrigan, President of the Federal Reserve Bank of New York noted: ‘The greatest threat to the stability of the financial system as a whole was the danger of a major default in one of these clearing and settlement systems…”

“The connection between a crisis in the clearance and settlement system and the financial industry was highlighted by the bankruptcy in 1990 of Drexel Burnham Lambert Group…As described in the [SEC’s] testimony before the Senate Banking Committee, near gridlock developed in the mortgage-backed securities market and in the corporate debt and equity markets where Drexel was an active participant.”

Now that our financial system has come to a screeching halt, read those words for clues as to how much worse things can get – and whom we need to stop to prevent that from happening.

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Mark Mitchell is a reporter for DeepCapture.com. He previously worked at the Wall Street Journal editorial page in Europe, Time magazine Asia, the Far Eastern Economic Review, and the Columbia Journalism Review. Email: mitch0033@gmail.com

If President-elect Obama is serious about pulling the economy out of its death spiral, he must urgently appoint a task force to investigate our nation’s clearing and settlement system. Specifically, the American people need to know how it has come to be that a black box outfit on Wall Street is empowered to handle (or, rather, completely fumble) securities transactions worth more than $1.5 quadrillion – that’s 30 times the gross product of the entire planet – without any real government oversight.

This black box organization–the Depository Trust and Clearing Corporation (DTCC)–claims to “centralize, standardize and streamline processes that are critical to the safety and soundness of the capital markets.” In other words, if somebody sells a security, the DTCC is supposed to make sure that a real security is cleared, settled, and delivered to its purchaser.

But it does not do that. We have long known that the DTCC enables brokers to routinely fail to deliver the stock that they have sold on behalf of their hedge fund clients. All the while, the DTCC has waged a fierce and grossly misleading public relations campaign aimed at convincing the public that illegal naked short selling (which results in extended failures to deliver) is not a problem.

This is appalling given that even the exchanges’ limited data show that failures to deliver peaked at more than 2 billion shares last summer, just before the SEC issued its temporary “emergency order” protecting 19 financial companies from naked short selling. That is, on most days in June, there were more than 2 billion phantom shares circulating in our markets.

In fact, the problem is much larger than that. Many fails occur “ex-clearing” and in other parts of the system that are not monitored by the exchanges. But we do not know precisely how large the problem is because the DTCC has refused to release complete data.

What is certain, though, is that 70% of those failures to deliver were concentrated on no more than 100 companies – driving down the companies’ share prices, and making it difficult for them to raise the capital they needed to survive. The affected companies included Bear Stearns, Lehman Brothers, Washington Mutual, Merrill Lynch and several dozen other now-defunct financial firms.

And it is not just stock that isn’t getting delivered. Euromoney, the most respected financial publication in Europe, has revealed that there are massive failures to deliver even of U.S. Treasuries. “Failures in U.S. Treasuries were 8.6% of all treasuries outstanding in the first five months of this year, compared with 1.2% in the first five months of 2007,” Euromoney reported last week. “That has ballooned further over the past three months, hitting more than $2 trillion for almost the entire month of October – more than 20% of the daily treasuries trading volume.”

More than $2 trillion worth of phantom Treasuries – that cannot be good for the economy.

Bloomberg Newswires, meanwhile, recently reported that investors are complaining that Goldman Sachs is routinely failing to deliver corporate loans that it sells. According to the complainants, Goldman’s traders are selling debt that they do not own in order to further the destruction, and profit from the short selling, of public companies that are its own clients.

This is not surprising. Goldman is the proud owner of what used to be called Spear, Leeds & Kellogg – a brokerage that was long known as the most egregious perpetrator of naked short selling. Goldman has, of course, joined the DTCC and few miscreant hedge funds in trying to cover up the problem.

A similar outrage is occurring in the market for credit default swaps (bets that borrowers will default on their debt). Hedge funds and brokers are selling (quite often to themselves) virtually unlimited numbers of these swaps, even when they do not correspond to any real underlying debt. These are phantom swaps – and the increased volume creates the perception that target companies are on the verge of collapse, which of course, benefits the hedge funds, which are simultaneously short selling the phantom stock..

The DTCC has the authority to crack down on delivery failures. It has the power to tell us who, exactly, is committing the crimes.

Unfortunately, the government has no power over the DTCC. Officials from the Securities and Exchange Commission, which has limited oversight, admit that they have no clue how the DTCC operates and that they visit the organization only once a year.

So, of course, the DTCC protects the criminals. It protects the criminals because it is owned by the criminals. That is, the DTCC is a quasi-private organization owned by Wall Street brokers – the very same people who serve the hedge funds who seek to profit from the destruction of our economy.

This seems to me like a pretty big scandal.

And yet, aside from the excellent but sporadic reports from Bloomberg and Euromoney, the media continue to act as if there is nothing to see. The financial crisis, we read over and over in The Wall Street Journal, was caused by those bad subprime mortgages—end of story.

This is what we read because too many journalists have only two kinds of sources: hedge fund managers and people who do nothing more than repeat what they hear on CNBC. And CNBC has two kinds of sources – those same hedge fund managers and people who do nothing more than repeat what they read in The Wall Street Journal.

And thus is the conventional wisdom woven from a vicious cycle.

We can only “hope” that the new president’s economic advisers are honest people who know that truth resides in the details – not in the noise, not in a black box, and not in the tacky mansions of Greenwich, Connecticut.

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P.S. One encouraging sign is that former Deputy Secretary of Commerce Robert Shapiro has been named to Obama’s transition team. Shapiro is one of the world’s foremost experts on naked short selling and failures to deliver. He has plowed through the data – he knows all the details – and he understands the seriousness of the problem. Maybe he can make the president understand, too.

Journalists who write about short selling hedge funds fall into three categories.

The first category is comprised of a very small number of journalists who have deliberately whitewashed the dubious activities of their short selling sources. These journalists–such as Herb Greenberg (whose stories for MarketWatch.com invariably served the interests of the same short sellers who are now paying Herb’s salary), and former BusinessWeek reporter Gary Weiss (who works with a cast of convicted criminals and flimflammers to smear the reputations of people who are critical of short selling crimes)–are, at some level, corrupt.

The second, larger category is comprised of journalists who gorge on the junk food fed to them by the hedge fund lobby, subsequently farting out the predictable fog – “short sellers are vital to the markets;” “short sellers are vital media sources;” “short sellers were right about company X because company X is now bankrupt.” To which you say, yeah, but some of those short sellers commit crimes that destroy companies – and the journalists say, yeah, that might be, but it’s hard to prove a crime, deadlines loom, and sloth has its appeal, so “fart, fart, fart.”

The third category is comprised of the small but growing number of journalists who have actually spent some time chewing on the data and the evidence – and are now digesting this nourishing roughage into something a bit more solid – something like stories that show that short selling shenanigans just might have contributed to the near total collapse of the American financial system.

As evidence that the latter sort of journalists do, indeed, exist, consider that no less than five Wall Street Journal reporters spent several weeks working together on an investigative story about how short selling might have helped fuel the panic that nearly took down Morgan Stanley in September.

The result, published yesterday, revealed that:

• Hedge fund managers Dan Loeb and Israel Englander pulled their money out of Morgan after taking large short positions in the company. Jim Chanos, head of the short seller lobby, also yanked his money, though he claims not to have been short Morgan. (The unstated suggestion is that the shorts might have worked together – simultaneously pulling their billions in order to create the illusion of a run on the bank.)

• At the same time that the hedge funds were yanking their money and taking big short positions, somebody bombarded the market with false rumors about Morgan losing access to credit. New York Attorney General Andrew Cuomo and the Securities and Exchange Commission are looking into whether short sellers were responsible for these rumors.

• While the false rumors circulated, the price of Morgan Stanley credit default swaps soared. The New York AG and the SEC are examining “whether traders bought swaps at high prices to spark fear about Morgan’s stability in order to profit on other trading positions [short sales], and whether trading involved bogus price quotes and sham trades.”

• This “pattern of trading, which previously had battered securities firms Bear Stearns Cos. and Lehman, now is dogging Citigroup, whose stock fell 60% last week to a 16-year low.” (The unstated suggestion, contrary to what the Journal used to tell us all the time, is that it is not just “bad management” that causes stock prices to lose half their value in a few days.)

The Journal might have done one better by noting that Loeb, Englander, and Chanos are part of a tight clique of hedge fund managers who tend to attack the same companies.

The Journal might also have pointed out that when these hedge fund managers attack, they often “share ideas” (ie., spout the same false information and distorted analysis about their victim companies, sometimes anonymously on Internet message boards).

And it would have been worth noting that the companies targeted by these hedge fund managers are invariably victimized by naked short selling. That is, whenever these particular hedge funds are swarming, somebody is selling a lot of stock that they do not possess, and therefore failing to deliver the stock on time.

The SEC’s “failure to deliver” data for September will become public in a couple of weeks. If the data shows, as I suspect it will, that Morgan Stanley was targeted by illegal naked short selling, then maybe The Wall Street Journal will do a follow-up report.

Before that, The Journal’s reporters could take a look at the data through June, which shows quite clearly that in addition to the “pattern of trading” cited in yesterday’s story, Bear Stearns was buried under waves of naked short selling, beginning in January. On the day that CNBC’s David Faber reported the false news (fed to him by a hedge fund “I have known for twenty years”) that Goldman Sachs had cut off Bear’s access to credit, more than a million shares of Bear Stearns were sold naked, failing to be delivered within the allotted three days. Most of those shares – and another 10 million Bear Stearns shares sold short in March – have, to this day, never been delivered.

Then there is the data that shows that, market wide, “failures to deliver” doubled between 2007 and 2008, and peaked at 2 billion shares at the end of June – just before the SEC issued its July 15 “emergency order” protecting 19 big financial institutions from naked short selling.

While the “emergency order” was in place, stock prices increased dramatically. Within weeks after the “emergency order” was lifted, a number of those 19 protected companies – including Lehman Brothers, Merrill Lynch, Morgan Stanley, Citigroup, Fannie Mae, and Freddie Mac – saw their stocks plunge to crisis levels, and were then vaporized, nationalized, or bailed out.

The data through June shows that nearly all of those companies had been hit with massive levels of naked short selling, with between one million and 12 million shares failing to deliver in multiple spurts of several days. Washington Mutual, IndyMac, and a few dozen other now-defunct financial companies were clobbered with even higher levels of fails — day after day for weeks on end. Many non-financial companies have been hit even harder.

In fact, the available data understates the problem. There could be ten, 100, or many more times as many failures to deliver, but we cannot know for sure because that black-box Wall Street outfit called the Depository Trust and Clearing Corporation refuses to release more complete data. It also refuses to reveal which criminal hedge funds are engaged in naked short selling.

Meanwhile, the DTTC vehemently denies that naked short selling is a problem and attacks journalists, critics, and former DTTC employees who say otherwise – all part of a disinformation campaign orchestrated with help from the corrupt former BusinessWeek reporter Gary Weiss and his criminal accomplices, some of whom are paid by Dan Loeb, the hedge fund manager who features in yesterday’s Journal story.

Gary has gone so far as to hijack Wikipedia in cahoots with a Wikipedia administrator and former MI6 agent named Linda Mack. Anybody is supposed to be able to edit the online encyclopedia, but until recently only Gary and Linda Mack could touch the entry on “naked short selling” (which of course said there is no such crime). Gary flat out denies working with the DTCC and says that if somebody saw him go into the DTTC’s office, it was to “use an ATM machine.” He also continues to flat-out deny that he has ever edited Wikipedia, even though he has been exposed by The Register, a respected British publication.

After The Wall Street Journal figures out why the DTTC is protecting criminals, it could investigate why the SEC has never prosecuted a hedge fund for naked short selling, and why the Wall Street cronies who run the commission quashed at least two major investigations into suspected short selling crimes.

One of those investigations (targeting research firm Gradient Analytics, but meant to be the beginning of larger inquiry into the activities of Gradient’s short selling clients, was shut down under pressure from the aforementioned corrupt journalists, several of whom (Herb Greenberg, Jim Cramer, and Carol Remond of Dow Jones Newswires) had received government subpoenas because of their unusually close ties to Gradient and the aforementioned clique of short sellers.

Another investigation (into suspected naked short selling that SEC whistleblower Gary Aguirre described in a letter to the U.S. Congress as having the potential to “seriously injure the financial markets”) was shut down under pressure from Morgan Stanley CEO John Mack, who apparently had “juice” at the SEC. (For details see the U.S. Senate’s 700 page report on the matter. When the Senate refers to “market manipulation,” it is describing naked short selling.)

In yesterday’s story, The Journal notes that “sales of credit-default swaps were a profit gold mine for Wall Street. But, ironically, during those tumultuous few days in mid-September, the swaps market turned on Morgan Stanley like a financial Frankenstein.”

The Journal should have noted that naked short selling, too, was a gold mine for Morgan Stanley, and that given Mack’s role in shutting down the SEC investigation, it is kind of ironic that the Morgan CEO later found himself complaining to the SEC that short sellers had illegally manipulated his stock to single digits. Indeed, this was a stunning admission that a crime long denied by Wall Street does, in fact, occur.

The Journal could also investigate why the aforementioned corrupt journalists smeared Gary Aguirre, circulating the story (completely false, according to the U.S. Senate and the SEC inspector general, and all available evidence) that the SEC whistleblower had been fired for poor performance. There is also the question as to why these journalists, most of whom have yet to publish a story that was not sourced from the aforementioned clique of hedge funds, went to such lengths to smear other critics of naked short selling – everybody from Deep Capture reporter Patrick Byrne to the blogger who calls himself the Easter Bunny. .

The Journal might also be interested to know that one of those short selling hedge funds, Kingsford Capital (managed by corrupt journalist Herb Greenberg’s former co-editor at TheStreet.com) announced that it would begin paying my salary at the Columbia Journalism Review (where I was then an editor), just before CJR was going to publish a story about naked short sellers (including Kingsford Capital) and captured journalists (including Herb). Indeed, three of the four journalists who have begun work on major stories about naked short selling have ended up shelving or watering down their stories, not long before receiving funding or salaries from this same clique of hedge funds (more on this in a coming dispatch).

Perhaps a shifty hedge fund will offer jobs to the Journal’s hard-working reporters, too. Either that, or they will get smeared as “conspiracy theorists” or “knuckleheads who don’t understand markets and were fired from their previous jobs.” Maybe the hard-working reporters will give up.

Or maybe they’ll keep chewing on the facts and publish a story about how captured regulators, corrupt journalists, a colorful cast of convicted criminals, the black box DTTC, and the aforementioned clique of hedge funds all sought to cover-up a crime that is now implicated in the greatest market cataclysm since 1929.

Now, that would be some good shit.

* * * * * * * *

Tipsters, crusaders, and thinkers — feel free to contact me at mitch0033@gmail.com. Same goes for journalists wishing to obtain data and evidence — free of charge, of course.

History was made last night.

At 9:30 pm, CNBC broadcasted these words: “naked short selling is what’s causing a lot of the problems in the market.”

The words came from former SEC Chairman Harvey Pitt, who added that “there’s a very simple solution…if you want to sell a stock short, you have to have a legally enforceable rule to produce that stock on settlement day. That’s all it takes.”

Force hedge funds to actually deliver the shares that they sell. Force them to actually purchase or borrow real stock before they sell it. If market manipulators sell what they do not possess, put them in jail.

Yes, that’s “all it takes.” It really is that simple.

But until last night, we’d never heard it on CNBC.

If the SEC completely stops naked short selling, then demand will more closely reflect the supply of real stock. Prices could get a boost, as they did last summer, when the SEC issued an “emergency order” temporarily cracking down on naked short selling of stock in 19 big financial companies. And the massacres of public companies would stop.

Of course, it might be too late. A sinking economy can’t revive a sinking market – no matter who threw us down the well. The criminals should have been stopped before they put us in here.

It says something awful about the state of the nation that we began having a half-conversation about this issue only after CEOs of big Wall Street banks – the very banks whose prime brokerages happily profited from the naked short selling of their hedge fund clients – found themselves looking down the gun barrels of their former partners in crime.

A few quivering Mafiosi pee in their pants, and now we wonder whether one Mob boss should be protected from another Mob boss. Not a word about the hundreds of smaller, innocent companies that have been brutalized by these goons.

How sad that when CNBC airs a simple truth – “naked short selling is what’s causing a lot of the problems in the market” – we have to call it “history.” How sad that this “history” took place at 9:30 pm, when nobody was watching. How sad that it took place only because the CEO of Citigroup has been begging for an ill-advised, outright ban on short selling.

Sure, Jim Cramer has been ranting about “diabolical” naked short sellers on “Mad Money.” Tonight he said (with some justification) that naked short selling was destroying capitalism. But never on CNBC proper. Never in the segments that CNBC portrays as “news” — as opposed to the loony rantings of a bald sociopath.

I am reminded of Russia, where the television news stations are tools of the government-mafia oligarchy, but make sure to air the occasional late-night interview with some dissident – carefully selected for his squirrely appearance and checkered background. The illusion of “balance” makes the propaganda all the more insidious.

America is not yet Russia. But with its ransacked financial system, its billionaire cronies, its captured regulators, and media like CNBC, our nation is not quite “America” either.

By some quirk of human psychology, it remains difficult for a certain segment of the population to accept the “deep capture” thesis – the notion that our nation’s regulatory bodies and parts of our media have been “captured” (at times, outright “corrupted”) by a powerful, moneyed elite. “No way,” we are told. “Maybe in Nigeria. Europe, sure. But to think it happens in America? That’s a conspiracy theory.”

Yeah? Well, read this:

That is an email to Paul Berger, then the associate director of enforcement at the Securities and Exchange Commission. The author, a Washington lawyer, is referring to Ralph Ferrara, a former SEC lawyer who apparently managed to parlay his government service into mansions, maids and millions – by way of a plum position at a law firm called Debevoise & Plimpton.

As you can see, the email was sent in January 2005, soon after the SEC had launched an investigation into alleged naked short selling, insider trading and other misconduct at Pequot Capital, a powerful hedge fund. That same month, the SEC’s lead investigator in the case, Gary Aguirre, was shut out of meetings in which the Commission’s top officials gave Pequot’s lawyers privileged information about the investigation.

By the summer of 2005, some of the SEC’s top officials, including Paul Berger, were maneuvering to have the Pequot investigation whitewashed. When Aguirre tried to interview John Mack, formerly chairman of Pequot and then CEO of Morgan Stanley, he was told to lay off because Mack’s lawyers had “juice” with Berger and SEC Director of Enforcement Linda Thomsen.

Aguirre complained about this in a formal letter to Berger. In response, Berger arranged for Aguirre to be fired – never mind that the SEC had just commended Aguirre for his “unmatched dedication.” At precisely the same time, Berger told Mack’s law firm that he was quite ready to leave public service, and that what he’d really like is to have a job at Mack’s law firm. The name of Mack’s law firm (the law firm with “juice”) was Debevoise & Plimpton – i.e., the same law firm whose multi-million dollar paychecks to former SEC officials had inspired that salivating email.

Perhaps the lawyer who sent that email was merely updating Berger on his colleague’s career trajectory. I have no evidence that the lawyer was trying to influence Berger or the SEC. But the email is a good example of the kinds of conversations that occur with disturbing regularity at our nation’s market regulator. No doubt, those maids and millions were top of mind as the SEC’s associate director of enforcement considered whether he ought to bury an investigation into some serious crimes, fire the whistleblower, and simultaneously apply for a job at the alleged criminal’s law firm.

In the summer of 2006, Aguirre wrote an 18-page letter to the U.S. Congress, blowing this scandal wide open. In this letter, Aguirre noted that his rank-and-file colleagues at the SEC believed that the naked short selling they were investigating had the “potential to seriously injure the financial markets.” So it was all the more appalling when–in November, 2006–the SEC leadership officially closed the investigation into Pequot. In doing so, the SEC said it had found no evidence of insider trading, but it said nothing about the far more serious charges of naked short selling and market manipulation.

Two U.S. Senate Committees spent more than a year looking into this matter. In multiple reports (one more than 700 pages long), Senate investigators did not refer directly to “naked short selling,” but from their descriptions of “market manipulation” and “wash sales” (which are often used to hide naked shorts) it is clear that they believed that Pequot engaged in naked short selling, and that this crime did, indeed, have the potential to “seriously injure the financial markets.”

The Senate concluded that everything about the case – the special treatment received by Pequot and Mack’s lawyers, Aguirre’s dismissal, Berger’s solicitation of Debevoise & Plimpton – was as seedy as can be.

“At worse,” the U.S. Senate stated in one report, “the picture is colored with tones of a possible cover-up.”

Last month – after naked short selling and other hedge fund tricks contributed to the biggest financial cataclysm since 1929 – the SEC inspector general issued a 191-page report confirming just about everything in the U.S. Senate reports. It is impossible to read these reports without concluding that this is the biggest scandal in the history of the SEC–a scandal that entailed a cover-up of precisely those same crimes that “severely injured” (or rather, nearly vaporized) our financial markets.

The SEC leadership responded to the inspector general last week by assigning an SEC employee, who happened to be an administrative judge, but who had no jurisdiction and was not acting in her capacity as a judge, to issue a short document stating that the SEC was innocent – that nobody had acted inappropriately in the case of Aguirre and Pequot Capital. With this document in hand, the SEC announced that it had been “cleared” by “a judge” – making it sound as if there had been some sort of official, independent ruling.

In other words, the corrupt SEC leadership tried to convince us that the corrupt SEC leadership would have the final say on whether the SEC’s leadership was corrupt. The cover-up continued. There was a time when the nation’s journalists would swarm on an abomination such as this. But, alas, there was hardly a peep from our media. Indeed, The Wall Street Journal and other publications helpfully reported that a “judge” had “cleared” the SEC leadership of wrong-doing.

But this scandal is not under the rug yet. And it might grow in magnitude. In a civil case brought by Aguirre, a federal district court ruled earlier this year that the SEC is far from “cleared,” and that it must hand over thousands of internal documents pertaining to the Pequot investigation. The SEC has largely ignored the ruling, turning over documents with much of the relevant stuff blacked out, but it is doubtful that the commission will get away with this. Tomorrow, the court will hold a hearing at which the SEC will likely be ordered to hand over more documents – including those containing evidence of the “market manipulation” (read: “naked short selling”) that helped “seriously injure the financial markets.”

Meanwhile, Paul Berger, the former associate director of enforcement who tried to bury this case, has been made partner at the law firm of Debevoise & Plimpton. I’d tell you how much he’s getting paid for his “juice,” but I hesitate to incite a citizen insurrection.

* * * * * * * *

Mark Mitchell previously worked as a writer for the Wall Street Journal editorial page, chief business correspondent for Time Magazine in Asia, and as the editor responsible for the Columbia Journalism Review’s online critique of business journalism. Send tips to mitch0033@gmail.com

There was an article in The New York Times yesterday about the SEC’s disgraceful ruling that it will take no disciplinary action against the SEC cronies at the center of the Gary Aguirre scandal. Read through the Times’ false veneer of objectivity, and it seems that reporter Walt Bogdanich is trying to say that it’s pretty damn strange that a corrupt SEC has been allowed to adjudicate its own corruption.

Stranger still, no other journalist has expressed outrage over this. Meanwhile, the nation’s mainstream media (The New York Times included) has yet to deliver a story describing the Aguirre scandal’s most important component – the bit that makes it the greatest scandal in the history of the SEC and which helps explain why the commission failed to stop a crime that later contributed to the near total collapse of the American financial system.

Readers of the mainstream media know only that Aguirre is the former SEC attorney who claimed that he was fired for political reasons after pursuing an “insider trading” case against Morgan Stanley CEO John Mack and a hedge fund called Pequot Capital. The real story – the one you don’t read in the papers – is that Aguirre has, all along, made it perfectly clear that his investigation – the one he says that Mack “stopped in its tracks” – was about much more than the relatively minor crime of “insider trading.”

Aguirre blew this scandal wide open in 2006, when he wrote an 18-page letter to the U.S. Congress. The letter reads: “I believe our capital markets face a growing risk from lightly or unregulated hedge funds just as our markets did in the 1920s from unregulated pools of money – then called syndicates, trusts or pools. Those unregulated pools were instrumental in delivering the 1929 Crash….There is growing evidence that today’s pools—hedge funds—have advanced and refined the practice of manipulating and cheating other market participants.”

Aguirre then described the investigation that he had led at the SEC. “The investigation was two-pronged,” he wrote. One prong concerned “insider trading.” However, the second, and far more important prong, concerned “market manipulation.” Specifically, Aguirre and his colleagues were investigating “two suspected violations: wash sales and naked shorts.”

“My colleagues,” Aguirre wrote, “believed [the naked short selling] held a greater potential to severely injure the financial markets.”

That is, Aguirre and his colleagues believed that naked short selling (hedge funds selling stock that they have not yet purchased or borrowed in order to drive down prices and destroy public companies) ranked high among the tactics that “were instrumental in delivering the 1929 Crash” – a repeat of which now seemed entirely possible since the tactic had been “refined” by hedge funds intent on “manipulating and cheating other market participants.” But the SEC rank-and-file’s attempt to investigate this crime was “stopped in its tracks” by SEC leaders who had been corrupted by Wall Street fat cats.

At the time when Aguirre released his letter, a small clique of influential journalists with close ties to certain Wall Street fat cats were going to great lengths to whitewash the crime of naked short selling (see “The Story of Deep Capture” for details). Unsurprisingly, some of these journalists quickly sought to discredit the SEC whistleblower. They reported that Aguirre’s investigation concerned only the minor infraction of insider trading, and that he had failed to present evidence that this minor infraction had occurred. The journalists also declared that Aguirre was untrustworthy – an eccentric who had been fired for poor performance.

After a year long investigation into the matter, however, the Senate Judiciary Committee completely vindicated Aguirre. It noted that Aguirre had been fired just two weeks after his supervisors had raved about his “unmatched dedication” in glowing written evaluations of his performance. It presented clear evidence that Mack’s lawyers were given special access to meetings in which Aguirre’s investigation was discussed. While the SEC was busy quashing the investigation and firing Aguirre for complaining about it, Paul Berger, then the SEC associate director of enforcement, was interviewing for a job at Mack’s law firm.

The Senate investigators concluded that they were “deeply troubled” by the SEC’s failure to look into Aguirre’s claims. “At worst,” the Senate report said, “the picture is colored with overtones of a possible cover-up.”

As part of this cover-up, the SEC eventually claimed that although Aguirre had been fired, the commission had nonetheless pressed forward with its “insider trading” investigation, finding no evidence that Pequot or Mack and committed any violations. However, the SEC has yet to reveal whether its rank-and-file were allowed to complete their investigation into the naked short selling that had the greater potential to “seriously injure the financial markets.”

SEC leaders remained uninterested in the crime until this past summer. Data for June showed that “failures to deliver” (phantom stock sold by naked short sellers) had peaked at more than 2 billion shares – an all time record. More important, the SEC’s cronies on Wall Street were now victims of the very crime that they had perpetrated and covered up. An avalanche of naked short selling, timed to coincide with a false news report on CNBC, had sparked the run on the bank that took down Bear Stearns. Now, other Wall Street institutions (including, yes, Morgan Stanley) were getting similarly clobbered. In mid-July, the SEC pronounced that naked short selling had the potential to “seriously damage” the financial system. It issued an “emergency order” protecting 19 big financial institutions (including Morgan Stanley) from the crime.

That kept the big banks safe for a time. But ultimately, short-sellers proved to be more skilled at cronyism than their former accomplices at the big banks. In August, under pressure from the short seller lobby, the SEC lifted its “emergency order.” In the next three weeks, a half-dozen major financial institutions were eliminated or nationalized. Morgan Stanley CEO John Mack (no doubt regretting that he had quashed the Aguirre investigation) hollered that he was next — that law-breaking short sellers were taking down his bank. The SEC responded by banning short selling outright in 900-plus companies. Meanwhile, everyone from Hillary Clinton to John McCain implicated naked short selling in the biggest financial cataclysm since 1929.

A few weeks later the SEC inspector general issued a 191-page report vindicating Gary Aguirre. The otherwise detailed report conspicuously failed to mention the naked short selling component of Aguirre’s investigation, but it contained many of the same findings that the Senate had described. The report, compiled over many months, concluded that Mack’s interference with Aguirre’s investigation raised “serious questions about the impartiality and fairness” of the SEC. The inspector general recommended that disciplinary action be taken against Aguirre’s supervisors, including SEC Director of Enforcement Linda Thomsen.

But last Friday, having spent no more than a few days reviewing the evidence, an SEC administrative judge declared that the SEC did not mishandle the Aguirre case, and that no disciplinary action would be taken. As Bogdanich’s story in The New York Times makes clear (though in not so many words), the ruling stinks to high hell.

For one, it remains unclear why in the world an SEC judge, as opposed to an independent court, is ruling on this matter. For another, it seems that the judge, Brenda Murray, was not even acting in the capacity of a judge. Rather, she issued her not-guilty verdict in the capacity of “an individual” who was asked by the SEC executive director to evaluate the inspector general’s findings.

In other words, there is good evidence that the leaders of our nation’s market regulator are as corrupt as Banana Republic cops on the brothel beat – that they have engaged in a cover-up that might have helped rock the very foundations of the American financial system – but this evidence will be evaluated in no court. There will be no legal proceeding whatsoever. Instead, an “individual” at the SEC, as a favor to the SEC executive director, says the SEC did no wrong…and that’s it – end of story.

Really, end of story. Because, aside from Walt Bogdanich at The New York Times (a paper that won’t call an “outrage” by its proper name, and which seems incapable of printing the words “naked short selling”), no mainstream journalist seems to give a flying hoot.

* * * * * * * *

Contact Mark Mitchell at mitch0033@gmail.com

A couple of days before Lehman fell and all hell broke loose on Wall Street, Floyd Norris, the chief business correspondent of The New York Times, published a blog (headline: “Short Sale Conspiracies”) wherein he implied that I was mentally insane for suggesting that Deutsche Bank Securities had been caught selling “massive amounts of phantom stock.”

I promise to take this up with my psychiatrist, but first let me tell you a bit more about the peculiar case that led the New York Stock Exchange to hand Deutsche Bank Securities the largest fine in history for violations of SEC rules designed to prevent the creation of what the chairman of the SEC has called “phantom stock.”

The NYSE’s disciplinary order states that Deutsche Bank’s traders “effected an unquantified but significant number of short sales…without having borrowed the securities.” Indeed, the traders sold the shares “without having any reasonable grounds to believe that the securities could be borrowed for delivery when due…”

This is a clear-cut case of abusive naked short selling – traders selling stock without bothering to even check whether the stock could be obtained. In other words, Deutsche Bank’s traders were selling phantom stock, and it appears that they were doing this systematically over the course of the 22 month time period (ending in October 2006) that the NYSE investigated.

I asked NYSE spokesman Scott Peterson how much stock Deutsche Bank sold without knowing that the stock could be borrowed. He said, “We’re not saying how much, but let me put it this way: It was A LOT.” (The emphasis was his.)

Interestingly, however, the NYSE pointedly did not include the words “naked short selling” anywhere in its written disciplinary action. And the Big Board’s spokesman went to great lengths to suggest that Deutsche Bank was not engaged in naked short selling. “This is a case of failure to locate stock,” the spokesman said. “We’re being careful not to call it ‘failure to deliver’ stock.”

Mr. Peterson referred me to a section of the NYSE’s disciplinary order where it says that “according to [Deutsche Bank’s] delivery records,” there were “only two failures to deliver.”

So Deutsche Bank systematically failed to even locate the stock that it sold, but the NYSE isn’t calling it “naked short selling,” and Deutsche Bank managed to deliver the stock in a timely fashion in all but two instances.

Does this seem strange to you? It should.

SEC rules give short sellers three trading days to borrow and deliver real shares. If the stock is not produced within three days, it is called a “failure to deliver.” If a company’s shares “fail to deliver” in excessive quantities, the SEC puts the company on the so-called “threshold” list of publicly listed firms that are likely victims of improper naked short selling.

When I pressed Mr. Peterson, the NYSE spokesman, he conceded that there were not “only two cases of failure to deliver.” In fact, Deutsche Bank routinely failed to deliver specific securities–all of which appeared on the SEC’s threshold list. When I asked how much stock Deutsche Bank failed to deliver, Mr. Peterson said, again, “a LOT.”

So what was this “only two cases of failure to deliver”? It turns out that there were only two instances (among the sample of questionable trades for which it was charged) where Deutsche Bank still had not delivered the stock after thirteen days. Surely the NYSE must have known that failures to deliver of three to thirteen days are considered by the SEC to be improper naked short sales. At the time of the Deutsche case (the rules have since been changed slightly) day thirteen was the point at which the SEC would hand the delinquent naked short sellers a pathetically light penalty, forcing them to forfeit their short positions by buying back (rather than borrowing) shares.

In practice, this 13-day rule only encouraged stock manipulation. Some traders, correctly reckoning that the SEC would do nothing, simply left stock undelivered for weeks or months at a time. But a great deal of abusive naked short selling involved traders who sold phantom stock and (obviously) failed to deliver it on day three, and then absorbed the “penalty” on day 13 – purchasing (rather than borrowing) the stock and delivering it.

As soon as they closed out their “short” positions (which were fake positions since they never intended to borrow the stock), the traders would immediately sell another batch of phantom stock and leave that undelivered until day 13. By the end of each of these 13 day periods, the phantom shares had, of course, diluted supply and watered down the price (at which point it was hardly a “penalty” to have to buy back the stock).

A great number of the companies that appear on the SEC’s “threshold” list have been subjected to precisely this pattern of abuse. And if I understand the NYSE spokesman correctly, this is what Deutsche Bank was up to – short selling phantom stock with no intention of borrowing shares, waiting to buy (rather than borrow) the cheaper shares at day thirteen, and then selling more phantom stock, targeting the same threshold-listed company, the very next day.

Deutsche Bank did this week after week for at least two years.

Predictably, the SEC has not gone after anyone in the Deutsche Bank case. Instead, it leaves the NYSE to render its “largest ever” fine – a mere $500,000, which is many millions, if not billions, of dollars less than what the bank earned from its illegal activity.

And the question remains: Why is the NYSE failing to call this illegal activity by its proper name: “naked short selling”?

When the NYSE levied its fine at the end of August, the scandal of naked short selling was beginning to receive nationwide attention. Indeed, the SEC had just lifted a temporary emergency order designed to prevent the crime – three weeks after stating that abusive naked short selling had the potential to topple the American financial system.

Moreover, Deutsche Bank had recently become embroiled in a multi-billion dollar lawsuit filed by shareholders alleging that Deutsche and several other banks were involved in a “conspiracy to engage in illegal naked short selling of Taser International Inc. and to create, loan and sell counterfeit shares of Taser stock.”

Clearly, Deutsche Bank had reason to keep its involvement in naked short selling under wraps. I asked Mr. Peterson whether the NYSE had cut a deal with Deutsche Bank, whereby Deutsche agreed to pay the fine, and the NYSE agreed to portray its case as something other than a clear-cut instance of abusive naked short selling.

Mr. Peterson told me to put my question in writing. I did this, and waited for several weeks for a response. No response was forthcoming.

Another interesting question is whether Deutsche Bank’s prime brokerage (which services hedge fund clients) was involved in the naked short selling. If it was, this would suggest that the bank was helping its hedge fund clients manipulate stocks, including, perhaps, Taser International, whose shareholders had filed that multi-billion dollar lawsuit.

The NYSE disciplinary actions makes it seem like only Deutsche Bank’s proprietary traders (who trade for the bank, not for any hedge fund clients) had broken the rules. When I asked Mr. Peterson about this, he said, yes, the prime brokerage was not involved.

However, the NYSE’s disciplinary action said, in legalese, with no explanation, that at least two of the five Deutsche Bank proprietary trading desks investigated by the NYSE “failed to adhere to the independent trading unit aggregation requirements.” This was a reference to SEC “unit aggregation” rules, outlined in Regulation SHO, which prohibit prime brokerage units and proprietary trading units from coordinating their short-selling activities.

In other words, it seems possible that Deutsche Bank’s proprietary trading unit was washing naked short positions for its prime brokerage, which had placed phantom stock sales on behalf of market manipulating hedge fund clients.

I asked Mr. Peterson if this was the case. He said to put the question in writing. I did this, and waited a few weeks for a response. No response was forthcoming.

Apparently, Mr. Norris, the chief financial correspondent of the New York Times, spoke to the NYSE, because he regurgitates its party line, almost verbatim. He says the case against Deutsche Bank is “largely about the failure to locate shares before they were sold short…But there do not seem to be many cases of sustained failures to deliver.”

He goes on to improperly define “failures to deliver” as occurring on day 13. He buys into the suspect claim that Deutsche Bank’s prime brokerage wasn’t involved. And he implies that the case could be a matter of “record keeping violations,” apparently unaware that these “record keeping violations” were in fact brazen failures to deliver of unborrowable stock – typically lasting right up to day 13, when the traders “penalized” themselves by buying back the shares, no doubt at a steep discount to the price at which they had sold them.

Mr. Norris concludes, “I don’t know if Mr. Mitchell’s suggestion [that Deutsche Bank sold massive amounts of phantom stock] is nutty or prescient, but I do not see how it is supported by what the Big Board says it found.”

Of course, what the Big Board says it found might be quite different from what the Big Board did find. That a prescient nut case has to point this out to the presumably sane chief financial correspondent of the New York Times speaks volumes about the media’s coverage of the naked short selling scandal and the state of America’s public discourse.

* * * * * * * *

“Morgan Stanley shares have been under extraordinary pressure as of late, for no apparent fundamental reason, as we estimate liquidity, the balance sheet, and long-term earnings, prospects are sound.”

- Fox-Pitt analyst David Trone in a research note, today

Here we go again. A giant bank has some weaknesses, but it is, in all respects, a going concern — except that short sellers are peddling rumors and phantom stock, so the share price is plummeting. With the share price in peril, the rating agencies (perhaps over vigilant after taking so much criticism from short sellers and the media) put the bank’s debt ratings on review for a downgrade.

Meanwhile, short sellers corner the market for the bank’s credit default swaps, and point to the value of the CDS as evidence that the bank is doomed. They feed the media with analyses and bogus indexes that mark the bank’s assets to nothing. They spread the news that the bank’s counterparties and trading partners could bail.

The clients and partners stay with the bank. Up until now they have no reason not to.

But then, there’s more naked short selling, the hedge funds flooding the market with stock they do not possess – phantom stock. Maybe the hedge funds send a fax to CNBC with one last rumor. Over the course of a day or two, the stock price is slashed in half.

Then, suddenly, the stock is in the single digits.

As a result of the low stock price – not as result of the balance sheet – the bank’s partners and clients freak out. This time, they really do pull their money.

End of bank.

And if there are one or two more like this — end of story. The financial system will be fried.

We’ve seen precisely the same scenario with Bear Stearns, Lehman, Merrill Lynch, Washington Mutual, and IndyMac. A variant of this scenario took down AIG, Fannie Mae, Freddie Mac, and perhaps 200 other companies before them.

Morgan Stanley could be gone by next week.

We have new data for September that shows that there was plenty of short selling of Morgan Stanley (and other companies) even during the SEC’s ban on short selling, which ended Wednesday at midnight. Some hedge funds ignored the ban, and the SEC did nothing.

Worse, in place of the ban, the SEC has offered only tepid new rules (cheered by the short seller lobby) that do little to prevent the sale of phantom stock. Under these rules, short sellers do not have to borrow real stock before they sell it. They merely have to “locate” the stock. The SEC doesn’t say how it’s supposed to know whether a short seller has actually located real stock as opposed to telling his broker, “yeah, I located it, it’s in your mother’s wig” (which is pretty much how these conversations go).

Furthermore, the SEC gives hedge funds three days to deliver the stock they sell. This would be fine if they were required to possess real stock before selling. But since they are not, a hedge fund can offload a large block of phantom stock and let it eat away at the financial system for at least three days.

Sometimes, the hedge funds settle the trade with another block of phantom stock, transferred to them by a friendly broker. But even if they fail to deliver the stock, the SEC stipulates no serious penalties. Meanwhile, it shows no inclination to actually prosecute anyone for the jailable crime of short-side market manipulation.

I’m willing to bet anybody a sizeable amount of money that when the SEC releases its “failures to deliver” numbers for October, they will suggest unbridled illegal naked short selling of Morgan Stanley during this past week, even on days when the ban on all short selling was in place. The data will show that naked short selling rose to unprecedented levels just before somebody floated Wednesday’s false rumor that Morgan Stanley was going to lose its $9 billion deal with Mitsubishi.

And the data will show that after the ban was lifted, the law-breaking shorts went nuclear – with failures to deliver of well over a million shares every day. Ultimately, many millions of Morgan Stanley’s shares will be sold and never delivered, just as hedge funds have yet to deliver more than 10 million shares of Bear Stearns that they sold during that bank’s final days last March.

As I write this, Morgan’s stock price is in the single digits, trading around 7 bucks, down an astounding 70% in the 36 hours since the short selling ban was lifted. A death spiral like that does not happen naturally. Because of the short-battered stock price – and only the stock price (again, this has nothing to do with the balance sheet) — Moody’s today put Morgan’s long-term debt ratings on review for a downgrade.

I suspect another 15% off the stock price, and one more well-placed rumor, will do the trick. There will be a run on the bank. Morgan will be gone. And the global financial fire will blaze still hotter.

It is beyond surreal that our most prestigious financial media continue to allow this to happen. It is beyond comprehension that journalists – in possession of the evidence, and presumably in possession of their faculties – continue to spout the line, originally formulated by short-sellers and now woven into conventional wisdom – that this crisis is only about bad mortgages and bad managers and bad balance sheets.

One can argue that, in the long run, the world is better off without half of Wall Street – without its ponzi schemes and paper profits, the sickening salaries and arrogance. Certainly, anyone with a Shakespearean state of mind will appreciate the fates of Morgan Stanley, Lehman, and Bear – all of which eagerly pimped their dodgy prime brokerage services to the very short sellers who destroyed them.

But it does not require Shakespearean nuance to see that this crisis is not just about scandalous banks. It is about criminals destroying banks that are tawdry, yes, but possessing of some virtue, and capable, if left unmolested, of carrying on and contributing to society – perhaps even staving off a global calamity.

Moreover, these same criminals are destroying many other companies, most of which are run by honest people who labor far from the insalubrious alleyways of southern Manhattan. The SEC maintains a list of companies whose stock has failed to deliver in excessive quantities. As I explained in an earlier dispatch, many victims of naked short selling (including some of the big banks) do not appear on that list. But surely it is a scandal that more than 300 companies, many of them financial firms that have nothing to do with Wall Street, do appear on the list.

Surely, it is an even bigger scandal that around 100 of those companies have appeared on the list chronically, day after day, for months on end, and though the sheriff posts the names of these rape victims on its wall, it has yet to prosecute a single rapist. The SEC tells us that a billion shares remain undelivered on any given day — and yet it doesn’t bother to find out which hedge funds sold the phantom stock.

It might be too late, but if Washington and the financial media really want to save the world, they ought to start by demanding that hedge funds borrow real stock before they sell it. And what the heck: Maybe some newspaper could offer the radical suggestion that the SEC should tell hedge funds that they can either go to jail or close out all unsettled trades – today.

If one hedge fund manager were to get cuffed, all the others with outstanding “failures to deliver” might scramble to buy real stock so they can settle. The markets might soar. The innocent victims might get some relief. And the delinquents on Wall Street would get some time to clean up their acts.

Meanwhile, would anyone care to guess which company the naked short sellers will take down after Morgan Stanley?

And would anyone like to share a bunker with canned goods and weapons?

* * * * * * * *

If you’d like to place that bet on the Morgan Stanley data (I’ll give 2:1 odds that it will show short sellers offloading massive amounts of phantom stock , with more than a million “failures to deliver” every day) feel free to contact me. Mitch0033@gmail.com.

* * * * * * * *

So the SEC today lifted its ban on short-selling, and all but declared open season for law-breaking naked short sellers to start destroying companies again – and who does CNBC have on for two hours as its honored “guest host”?

None other than Jim Chanos, the salamander-slick director of the short-seller lobby.

Asked about naked short selling, Chanos said, with a straight face: “Anytime a hedge fund or short seller shorts a stock, it is a legitimate short. We have to get a locate or pre-borrow from the broker….”

Chanos continued: “The one thing I have in common with Patrick Byrne, chairman of Overstock.com [and Deep Capture reporter], is that we are calling for strict, strict delivery…in terms of delivering shares…that is how to end this naked short selling…”

CNBC, which serves as a sort of seedy massage parlor to the short selling community, gave Chanos the usual treatment – lubrications and sweet nothings. No tough questions. No retorts to his outlandish assertions. No wondering aloud as to his absurd and self-serving logic.

Let’s get this straight.

Not long ago, Chanos insisted that naked short selling did not occur.

Now, he says naked short selling occurs. But it’s not short sellers who are naked short selling. Short sellers make sure their brokers borrow real stock before they sell it.

In any case, Chanos acknowledges that short sellers’ brokers are not borrowing real stock before they sell it. That is why they are not delivering the stock. And that is why he claims to agree with Patrick Byrne that there needs to be “strict, strict delivery.”

But Chanos is against a ban on naked short selling (which would force short sellers to borrow real stock, thus ensuring delivery). Chanos says that a ban on naked short selling would destroy “market efficiency.”

So, to summarize the Chanos position: Naked short selling didn’t occur, but now it occurs, except short sellers don’t do it, and the SEC shouldn’t ban it because the market would cease to function properly if short sellers were forced to stop doing what they don’t do.

And given that so many shares are failing to deliver (after being sold naked by short sellers who never sell naked), Chanos is calling for “strict, strict delivery” of stock (while praising the SEC for its “strict” new rules which stipulate that nothing happens to short sellers who fail to deliver stock).

CNBC treated us this morning to two hours of Chanos nonsense. At one point this charlatan even insisted that short sellers aren’t short selling financial stocks at all. Really, he said short sellers aren’t short selling. Period. Take his word for it. CNBC did.

That was around 7:30 AM, right after CNBC’s Becky Quick referred to Chanos as “the legendary short seller….er, investor.”

At 9:30 AM, the markets opened and the criminal naked short sellers…er, investors…went back to work, unfettered by the SEC’s “strict” new rules.

Within an hour, Morgan Stanley was down 25%.

* * * * * * * * *

In a few hours, the SEC will lift its ban on short-selling of 900 stocks. That is well and good, except that it appears that hedge funds will also be permitted to resume abusive naked short selling – offloading stock that they do not possess in order to dilute supply and drive down prices.

Given that naked short selling precipitated the collapse of Lehman Brothers, which triggered global panic, it seems fair to say that the resumption of naked short selling could precipitate the collapse of another big bank, which will fuel still more panic, and then we will really be screwed.

Say what you will about Lehman’s balance sheet, that company was not going out of business until its stock price hit rock bottom, making it impossible to raise capital, and triggering a run on the bank. The stock price hit rock bottom because it was bombarded by naked short selling and false rumors.

Some financial media have been cheering the imminent lifting of the short-selling ban. According to these journalists, the ban did not prevent the stock market turmoil of the last couple weeks. Therefore, lifting the ban should not make things worse and short-selling is good for the markets and blah blah blah.

The media never cease to astound on this issue. The fact that markets have been bad does not mean they wouldn’t have been a whole lot worse without the ban. And if short-selling is good for markets, this is fully besides the point. The point is that naked short selling is most definitely not good for the markets, and, as of tomorrow, that very not-good-for-the-markets activity is going to be allowed to resume with the full acquiescence of the SEC and the financial media.

Look, on September 16, Morgan Stanley was trading around $26. On September 17, it hit a low of $11. The stock was slashed in half in less than a day. That tends to happen when a company is under a full-scale attack by naked short sellers.

On the day after Morgan Stanley was slashed in half, the SEC banned short selling. It is fair to say that if the SEC had not acted, Morgan Stanley would not be with us today.

After the SEC banned short selling, hedge funds stopped circulating false rumors about the companies they had been attacking. Today, in anticipation of the short selling ban coming to an end, hedge funds began circulating false rumors about Morgan Stanley – the most damaging being that Mitsubishi had pulled out of an agreement to inject $9 billion of capital into the bank.

What happens tomorrow when those rumor-mongering hedge funds resume naked short selling?

As one prominent economist said, forebodingly, “We will see.”