Mr. President, Settle the Trades

The new president must ensure that Wall Street delivers what it sells

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.

* * * * * * * *

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.

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?

  1. There has to be one person amongst the vast array of personel within the DTCC that knows enough about the inner sanctum of the bowels of the DTCC that is so disgusted, so morally disturbed that their sole knowledge would unravel this armegeddon of fanancial terrorism.

    One person.
    One short phone call to the right number

    DO IT!


  2. I’m probably not the first to say it, but I’ll go ahead. Robert Shapiro for Chairman of the SEC!!! He can then proceed to hire Gary Aguirre as his Director of Enforcement. That’s as good a way to start doing something right as any, so pass it on. Thanks again,

  3. You are smart to emphasize the black box nature of the DTCC.

    I am left wondering why you are writing to the president. If your goal is to reform a black box program, your best course of action is to start an open source project to replace the black box system, and announce the project on SlashDot.

    If you can make reforming the DTTC a cause celebre of the Linux community then you will have an army of people skilled at setting international standards on your side.

    BTW, I bought the domain name (Open Source Real Time eXchange) and offered to donate it to such a cause.

  4. I just find it hard to beleive that Mr. Obama would go after any of Charlie Schumers friends or even Shelby for fear of blowing the whistle. I see status quo.

  5. Didn’t some major Wall Street money come his way?

    If I heard it right Obama got more than the other guy…whaz his name?

  6. Why is everyone scared to use the DTCC name? What is the big secret about? Thanks Mark. This is the common denominator in all this corruption. This BLACK BOX!!! Cox and all befre him were just pawns doing their masters’ bidding!!! Lets keep politics out of it and hope we can get a fair SEC Chairman this time.

  7. Mark, on your use of 2 billion shares as the extent of known failed deliveries, I think the $258 billion figure that was shown on SIFMA’s balance sheet as of March 31, 2008, gives a reasonable estimate of total FTDs and FTRs including ex-clearing. SIFMA has modified its financial statements now so it no longer shows the balance sheet. I am confident the figure has gone up considerably during the bear attacks experienced this year.

  8. If reform and oversight are to return to the SEC at the end of january, I expect the market beatings will continue at an unprecedented level for the remaining lawless months. Batten down the hatches.

  9. I am brand new to this game…
    I will be running for Congress here in California – sometime in the future – this madness has got to stop! It starts at the top with Obama – get some frigging balls and step up to the plate…
    bottom line – rule by karma principle and this would have never happened…
    Where are the ethics? Do we sell out just to make a quick buck? Does anyone ever think that the Big Guy upstairs doesn’t like the Big Buy???
    Comon guys – I’m a woman who thinks the boys clubs need to be busted up….and now!!!!!!!

  10. The slide presentation/video that was prepared showing Shorty, Abe Lincoln, basketball player, etc. was excellent.

    I believe others will “get it” when they see the slide where phantom stocks magically keep multiplying …one stock certificate…two stock certificates..three stock certificates, etc.

    The above mentioned slide coupled with the slide showing how “phantom stock increases volume” and subsequently drives down price is a homerun.

    (It might also be compared to the American Greed episode where a tenant takes out multiple mortages (totalling hundreds of thousands of dollars) on a house he is renting.)

    State and City officials along with Calpers have a fiduciary duty to protect the assets entrusted to them. They may be just the pressure needed to persuade the Powers To Be to conduct a full blown investigation into this subject. After all, their own retirements and those of the largest union are at stake.

    I wonder if the European Leaders will propose a complete ban on shorting on their exchanges as one of their new regulations? Would companies list on such an exchange? Would investors do business with brokerages using such an exchange?

  11. Your blog Mr. President, Settle the Trades | Deep Capture: exposing the crime of naked short selling was interesting when I found it on Saturday by accident while searching for robot vacuum cleaner price online. It’s funny what you could find on the internet sometimes. I’d have to agree on what you have to say, although it may seem like a wrong choice, but nontheless an interesting subject. Enough said, keep up the good work my friend!

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    you will be a great author. I will always bookmark your blog and will often come back in the foreseeable
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