Saturday, October 03, 2009

Squeezing the Lemon, and coming up short

Blogging Stocks notes that there was 38.2 million Failure To Delivers (naked shorts) in the collapse of Lehman Brothers.

This whole concept of capitalism is premised on the idea that companies could use their capital for re-investment. The regulations that allow naked short selling create a feedback loop where power-brokers seeking a quick buck can launch a naked short attack against any firm that has leveraged its capital.

A naked short attack launched on a company with leveraged stock magnifies the hurt of a down quarter and can throw even the largest companies into insolvency.

It is important to remember that naked short selling exists because regulations within stock clearinghouses. Clearinghouses justify the regulations claiming that naked short selling assures liquidity.

I mention this as Blogging Stocks supports Barney Frank's solution. Barney Frank wishes to force all stock transactions through clearinghouses.

We need transparency for each and every trade done by each and every financial institution. That means that all trades must be done on a listed exchange and cleared through a clearinghouse.

As it is the regulations in the clearinghouses that cause the problem, my mind had fallen on the exact opposite solution.

Companies and investors wishing to protect themselves from the corruption of the clearinghouses would be wise to pull sizable chunks stock from the clearinghouses and trade directly.

Trading shares in real time closes the artificial gaps in the trade where naked short selling occurs.

A real time trade is like a transaction at the grocery store. The groceries become yours when you hand the clerk your cash.

I could understand a requirement forbidding short sells outside a clearinghouse. A person trying to sell stocks that don't exist should be recognized as a counterfeiter. Investors should be allowed to take legal action and sue brokers that sell counterfeit stocks.

In conclusion: The massive naked short attack which deepened the fall of Lehman Brothers is a great example of the way that short selling (a contrivance of regulators) is anti-market. The solution is for investors to demand that they receive the shares they purchase. If the clearinghouses are captured then investors need to pull their stock from the clearinghouses.

The black box clearinghouse system appears to have created a structure open to capture. Barney Frank's demand that we give a broken clearinghouse system absolute power seems absurd.

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