Rolling Stone Reports that Naked Short Selling Killed Bear Stearns and Lehman Brothers

[Joanne98]

Matt Taibbi has published a story in Rolling Stone magazine that nobody should miss. It’s not yet available on-line, so you’ll have to pick it up at the newsstands, but here’s a quick summary.

Taibbi writes:

“On Tuesday, March 11th, 2008, somebody – nobody knows who – made one of the craziest bets Wall Street has ever seen. The mystery figure spent $1.7 million on a series of options, gambling that shares in the venerable investment bank Bear Stearns would lose more than half of their value in nine days or less. It was madness – “like buying 1.7 million lottery tickets,” according to one financial analyst.”

Bear’s stock would have to drop by more than half in a matter of days for the mystery figure to make a profit. And that is what happened.

As Taibbi explains, “the very next day, March 12, Bear went into a free fall…Whoever bought those options on March 11th woke up on the morning of March 17th having made 159 times his money, or roughly $270 million. This trader was either the luckiest guy in the world, the smartest son of a bitch ever or…Or what?”

Taibbi speculates (as has Deep Capture) that these options might have been purchased by somebody who was abusing the options market maker exemption to engage in illegal naked short selling. And Taibbi goes beyond speculation to state, as an obvious fact, that illegal naked short selling helped bring Bear Stearns to its knees.

Presumably operating under that assumption, the SEC issued more than 50 subpoenas to Wall Street firms in the wake of Bear’s collapse, but “it has yet to indentify the mysterious trader who somehow seemed to know in advance that one of the five largest investment banks in America was going to completely tank in matter of days.”

Taibbi continues: “The SEC’s halfhearted oversight didn’t go unnoticed by the market. Six months after Bear was eaten by predators, virtually the same scenario repeated itself in the case of Lehman Brothers – another top-five investment bank that in September 2008 was vaporized in an obvious case of market manipulation. From there, the financial crisis was on, and the global economy went into full-blow crater mode.”

Taibbi notes that there were many other factors that made the economy weak. But he says that naked short selling is what pushed Bear and Lehman over the edge. If it weren’t for naked short selling – a massive “counterfeiting scheme,” in Taibbi’s words — those banks would likely have survived, and we might have avoided an all-out financial catastrophe.

This cannot be stressed enough. Criminals deliberately destroyed two of America’s biggest investment banks, precipitating the greatest financial cataclysm since the Great Depression. And the government has done absolutely nothing to bring those criminals to justice. In fact, as Taibbi makes clear in his story and on his blog, the most likely culprits are feted by top government officials in closed door meetings.

continued>>>
http://www.deepcapture.com/rolling-stone-reports-that-naked-short-selling-killed-bear-stearns-and-lehman-brothers/

[Fresh_Start]

1. surely there's a way to determine who got the proceeds?

or is the money sitting somewhere unclaimed?

[frylock]

2. can we get this guy a freakin pulitzer already?!

knr

[truedelphi]

3. + 10. n/t

[starroute]

4. Why am I reminded of those strange pre-9/11 transactions?

I'm not pushing any theories here -- just saying that the story sounds hauntingly familiar.

[tanyev]

6. Nobody seems to have ever figured out who purchased those options, either.

Funny, isn't it?

[Lucky Luciano]

5. I remember those option trades for bear.

My sales trader called me the next day to point them out. I think it was like 60K each of the march 30 and 35 puts when bear was @ $60 with some wild volatility and a big dislocation from other brokers. Some of those brokers were having a great day - and the brokers generally traded with a high correlation, but bear was off $10 from $70 to $60. Something was wrong. Our desk bought 3000 puts Oct 10 puts last year at the beginning of September when leh was $16ish. Paid a hefty $0.77 per put. Bought the puts due to leh stock exhibiting similar volatility and kurtosis that bear had experienced. Unfortunately, that bet paid off.

[dixiegrrrrl]

7. Do you have the English translatin for what you just said?

for people like me who do not speak trade-ise.
and it is good to see you again, btw......:hi:

[Lucky Luciano]

8. A few definitions...

Sales Trader - basically a broker whose clients are institutions. I was on a proprietary trading desk at a big bank and I would trade with my sales traders - or I would do it using algos when I could to avoid commissions with more liquid stocks.

Options - For our purposes, these are either "puts" or "calls."

Calls - These give a buyer the right, but not the obligation to buy a stock for a predetermined price (called the strike price) at any time prior to a predetermined expiration date. For example, A Nov 27.5 Call for Microsoft (MSFT) gives the buyer the right to buy MSFT for 27.5 any time before the third Friday in November. If MSFT does not go over 27.5, the call expires worthless since you could just buy MSFT for less than 27.5 in the open market - if MSFT is $30 at expiration, you can "exercise" the option and buy MSFT for $27.5 and sell at $30.

Puts - Similar but they give the holder the right to sell a stock before expiration at a predetermined strike price. For example, for the puts above, the Bear Stearns (BSC) puts were traded around the second week of March and were to expire on Friday, March 21. At the time BSC was $60 because it had tanked from $75 just a few days earlier while other broker stocks such as LEH, MER, GS, etc had traded very well. Then some nefarious character bought 60K March 30 and 60K march 35 Puts on BSC. Each put contract is a put on 100 shares. Since there was only a bit over a week to expiration, the puts only cost a about 30 cents each (I forget the exact price) - which would usually be very expensive with a week to go and such a large move to be required to go "in the money."

Well, BSC was $4 on Marc 21, so the put buyer had the right to sell 6M shares short at $30 and $6M shares at $35 - and then buy them back for $4 or so...not a bad deal! It is possible that it was 30K each and not 60K each, but you get the point. I can check to see what happened with more precision easily at work.

Volatility - very roughl speaking, more volatile stocks take more wild swings. The wilder the swings the more likely an option can land in the money. Hence, more volatile sotcks have more expensive options.

Kurtosis - Also, very roughly speaking, this refers to the unusually large moves for a stock - like big gaps up and down. If stocks exhibited returns that had a normal distribution, then you would probably never see a stock make a 6 standard deviation move, but such moves do happen a good deal more frequently than they should if returns exhibited a normal distribution - hence it is a consideration that one needs to make when trading.


Good to see you too....it is an exhauting game...come Friday, I am totally wiped out and I always crah early or dick around on the internet like tonight! Being in the office by 7am and coming home at 8pm is rough!

[Joanne98]

9. I tried to learn how to play options since they are cheaper to buy but I'm not that smart.

[Lucky Luciano]

10. Probably not about smarts and more about the willingness to

put in the work. I would not recommend trading options if someone only understands the payoffs because there are so many dynamics involved. If someone really were to care, I would recommend a wiki reading on the Black Scholes formula to get started:

http://en.wikipedia.org/wiki/Black%E2%80%93Scholes

I would say a solid understanding the option's implied volatility and delta are very important for the novice. The other stuff should be learned too - partly to teach someone not to take the concept lightly because it is easy to blow up all your money real fast if you don't know what you are doing.

[voteearlyvoteoften]

11. Renewed my Rolling Stone sub for Taibbi

I strongly reccomend you read his articles. Very strong.

[HamdenRice]

12. I wrote about his last fall. It wasn't naked short sellers. It was credit default swaps!

No one fucking gets perhaps the biggest scandal of the financial meltdown. Lots of people seem angry and outraged by credit default swaps but 99.9% don't know how truly dangerous they were.

Only about 3 people really get it -- and one was Andrew Cuomo, NY Atty Gen.

Here's the deal. A credit default swap is like insurance on a bond. You are betting the bond WON'T default or else you'll have to pay.

If it was an insurance policy, you'd have to put aside reserves. But issuers of cds didn't have to do that.

So suppose you had issued a cds on a bond, like a mortgage backed security or a Lehman bond or note. You had no reserves, and suddenly it looks like the bond is going to default.

How do you cover yourself?

Answer: You sell that same bond short! You cover yourself but at the same time make it much more likely that the company will go under because you drive the price of it down to junk level. If you can't short the bond, you short a security that moves with it, like that company's stock, which is just as bad.

There's even a name for it -- dynamic hedging.

Dynamic hedging, imo, is what brought the system crashing down.

It's like issuing fire insurance on a house, and when there is the slightest risk the house may burn down, you burn it down pre-emptively.

[Lucky Luciano]

13. Lots of holes here, but on an iPhone it is not easy to type a good response.

Corporate CDS was much less troublesome overall than the CDS on all the Wacky mortgage products out there. Leh and NSC were insolvent due to those instruments and extreme leverage - the short sellers simply accelerated the signing of their inevitable death warrants.