Lesson 18: Anatomy of a Recession Part 3: Orchestrated Chaos Section A: Naked Shorts, A Fashion for All Quarters
"I'm having a very good crisis." Billionaire, short-seller and Democrat party financer George Soros, 3/25/9, the Daily Mail.
In 2006, the first winds began blowing on the straw mansion that was the housing market. New homes sales stalled and interest rates started to rise. The shortest of the teaser rates of the ARM's (see Lesson 17) started to expire. Two other things happened in 2006 : The Democrats won control of Congress and Henry Paulson was appointed U.S. Treasurer. Henry Paulson was a liberal Republican whose wife and friends were Democrats. He was also an investment banker, the CEO of Goldman-Sachs. He also made millions of dollars (like the Clintons did) aiding the interests of the Chinese government, sometimes against American interests. He was unanimously approved by the U.S. Senate. President Bush gave him free reign over economic policy, making him the most powerful U.S. Treasurer since another Goldman-Sachs veteran, Clinton Treasurer Robert Rubin. Paulson immediately appointed several Goldman-Sachs colleagues to high positions in Treasury.
After Paulson and the Democrats took power, 3 things happened that added volatility to the market, made a lot of investment bankers rich, and paved the way for the 2008 elections:
1. A 69 year-old law, The Uptick Rule, was repealed by the SEC (Securities and Exchange Commission) on July 6, 2007. To understand it, you must first understand Shorting. Most small investors own stocks and bonds without holding the deed. The certificate is held by your broker, your pension fund or mutual fund. If your stock (or other security) is expected to go down in value, a trader might pay a lender's fee and borrow your stock from your broker. The trader will then sell the borrowed stock, buy it back later, and return it to your broker. If your stock did actually go down in price, then your loss becomes the trader's profit. This practice of trading borrowed securities is called Short-Selling (or "Shorting" for short). It is a huge business. The problem with it is the problem of the self-fulfilling prophecy. When enough Short-Sellers (Shorters) set their sites on a stock, or even collude, their selling activity alone can drive down a stock value, from which they profit. A frenzy of repeated short-selling can artificially drive a stock's value into the ground, while making the Shorters rich. The Uptick Rule prevented this by requiring that any repeated sale of the same stock be at a higher price than the previous sale.
Sometimes, a Shorter will even sell equities that they haven't borrowed and that don't even exist. They do this because they have, by law, a couple of days to actually produce the sold security. They use that time to actually buy the shares, hopefully at a lower price. This is called Naked Shorting. It is illegal, but the law has been poorly enforced by the SEC. Naked short selling in recent years has amounted to hundreds of billions of dollars.