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.
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