« "The Lobby Falters" Mearsheimer | Main | "Oil falls as U.S. inventories rise to 16-year high" Marketwatch »

24 March 2009


Feed You can follow this conversation by subscribing to the comment feed for this post.


"Contracts should not be violated." Let's hope they start to view pension contracts and Social Security Trust Fund Bonds with the same degree of sanctity as AIG bonus contracts.

Call me cynical, but I suspect that some contracts are more untouchable than others. Apparently anything done by a financial institution, irrespective of how stupid or fraudulent it was, remains inviolable.


wait a minute about "kontracts should not be violated."

that's okey dokey as b/n the original parties b/ when a third party steps in to do the bankrolling for the original bankrupt payor, he has every right to demand abrogation, recission, modification. there's doctrines in K law excusing performance such as force majeure, impossibility of performance, changed circumstances etc.

darm it does still hurt that i made a C in Kontract I after i made such a promising A on my midterm. i still made the law journal.)

Kudos to Cuomo for his sterling performance in all this. Obama better watch out, this AIG crap is starting to look like his Katrina moment! Or so the pundits say in the muffled zone.

Dave of Maryland

I've had women like that. They are rarely worth the bother.


A good start. I'd add the reinstatement of Glass-Steagal (sp?) and a prohibition on on the size of financial companies or the amount of risk any particular company can assume, whether outright or relative to hedging assets. No one should be too big to fail.

The AIG bonuses are a side show to the main issue. They are offensive and symptomatic of endemic corruption, but these particular bonuses are trivial in relation to the larger problem. I'm surprised these traders have jobs, to begin with. And I doubt their ability to unwind the trades and put their division back on track. Then, there's the issue of paying bonuses for horrible work - this seems much like the Baring Bank writ large. And what obligation is there to pay bonuses when there may have been improper trading, and deals done with knowledge that the underlying securities were riskier than their ratings? Plenty of room to reduce or eliminate the bonuses.

One of the larger questions is why are we so concerned to make 'investors' whole, when they were making trades based on the performance of derivatives that they had no financial interest in? Investing requires the assumption of a certain amount of risk. If you don't do your diligence, why should you be surprised when the investment fails?

William R. Cumming

Two quick points. First, the DOW should be abandoned since by dropping off frequently those firms that fail and be so restricted in the stocks on it becomes really misleading to investors and overimpacts investor psychology. Second, oil finally passed the $50 per barrel mark and we won't see lower in our lifetime barring drilling on the East Coast of the US, Florida, and Chesapeake Bay. Also 20th anniversary of Exxon-Valdez spill. Exxon did a nice job of ducking accountability for that spill and its continuing long term damage.


- Suspend "mark to market" accounting for a bit.

Let's assume the banks are not bankrupt, even though they are.

I agree that daily "mark to market" is dangerous - one could probably use some gliding average over a few weeks to determine the book-value of an asset. But totally ignoring the market price is an invitation to cheat.

- Forget about "clawing back" the bonuses. Contracts should not be violated. The Senate will probably fulfill its purpose in this matter.

The union workers at General Motors would be happy to seen that sentence a few month ago ...

- The "up-tick" rule should be reinstated.


- Stop "naked shorting" as a practice. Make it a felony if it is not already.

What about the 800 pound gorilla in the room:

Naked insurance contracts also known as Credit Default Swaps. Insurance on an item I do not know should not be allowed. But these CDS are still written daily with enormous notional numbers on them.

They are much more dangerous than naked shorting.

- Start regulating hedge funds and similar "casino" operations.

Most of them are sitting on the Cayman Island or some other tax-haven. One would have to tackle the tax-haven first (simply forbid ANY financial business with them, before one could really get at the hedge funds.


Col. Lang,

I'll sign that petition, good points, all.


Col. Lang: What's your objection to mark-to-market?


Start regulating hedge funds and similar "casino" operations.

I wonder how many people realize how this 'casino' works. Because if they did, the screaming would be louder than the AIG outrage.

Suppose Pat takes out insurance on that little municipal bond he bought and I get wind of it. So do 500 other people around the world. They all buy insurance on Pat's bond; none of whom know each other. If the bond fails, all 502 people have to be made whole on the full value of the bond.

This is worse than blackjack: you dont double-down. You 501-down (this excludes Pat). And there is no sheet at the end of the day that tells anyone anywhere that there are 502 bets on Pat's bond, including his own. Why? Because these guys are "so sophisticated," so financially out there that no one can comprehend how they operate, so there's no purpose in regulating this gambling. Not even a repository somewhere that shows the risk.

Well, they gambled with my health care, and my city's infrastructure, and my 401K, and my tax rates, and my retirement.

Furthermore, because this is not being addressed, they can gamble right now in foreign markets both ways that the market will go up and down. They can hedge their hedge.

Dont let anyone tell you that the CDS market is brain surgery. What you need to understand is the cost basis to get in the game. It's like being at the $5 million minimum-bet table in Vegas for high rollers. Except if these high rollers lose it all and get to the county recorder's office fast and reinvent themselves as a holding bank, they can take our dough to recoup.

John Howley

How about restoring limits on interest charged for consumer credit?

See Infinite debt: How unlimited interest rates destroyed the economy by Thomas Geoghegan in the April 2009 Harpers.

R Whitman

The CNBC on-air talent are entertainers and TV performers, not serious money people, no matter that they purport to be. I agree with your take on short selling, but I like the "mark to market" rule. It is truth in advertising.

If you oversee and regulate the hedge funds the criminals will migrate elsewhere.

Medicine Man

Col. Lang,

I did not ask at the time, as just about the entire blogsphere was talking about it anyhow, but did you see the Stewart vs Cramer interview? It seems to me that NBC's financial coverage is atrocious, with Cramer's public beating being just one moment when it was pointed out clearly.



Well, you're right about the merits of CNBC -- though some of the babes ARE good eyecandy. Earlier comments about contracts are on point. They're instruments of social intercourse, not part of the Ten Commandments. Better a few hundred destructive parasites be stripped of their ill gotten gains than the whole system be laughed off the stage, or carried away in tumbrels.

Cato the Censor

First and foremost, large financial institutions like AIG and Citigroup need to be resolved. Geithner's plan is simply Paulson's scheme to partially reinflate the bubble dressed up in different language. With respect to the sanctity of contracts: they're invalid if fraud's involved. This may well be the case with AIG and a number of other firms that went go-go crazy during the bubble.

Adam Stilson

Col Lang,

I am a longtime reader of this blog and thank you for all that it provides.


On to my point: I disagree with Col. Lang's view that "naked shorting" needs to be outlawed. The outrage against Naked Shorting (NS) that has recently arisen is unwarranted. The anger really should be directed towards "naked buying" (speculation) and over-leverage.

Imagine the annoyance and resigned sighing (and maybe anger) that is generated in Col. Lang whenever a dilettante gives borrowed talking points about the Middle East. That is the same feeling I get about NS: the talk against NS is 1. a weak talking point trotted out by folks looking for easy answers 2. is a 'meme' that has become implanted through repetition and 3. demonstrates a lack of understanding about the way complicated systems work.. that nothing in nature is monotonic and that the devil must always be given his due. In fact, Col. Lang, much of your blog is dedicated to educating and railing against just this type of simplistic thinking (and you are good at pointing it out) and that is why it surprises me that you don't recognize this pattern of thinking in the chatter about NS. Pardon the hectoring, but in my eyes declaring NS to be felonious is at the same level of thinking as someone saying "Of course Iragis want to be like Americans! Duh. It's obvious".

I am reminded, Col. Lang, of the time when you told the story about being invited to a Pentagon briefing about Iraq where they gathered all the retired military folks who were 'talkin-head-pundants' on CNN, MSNBC, and the like. They gave you guys special briefing in the hope that you-all would repeat the Pentagon talking points. You told us that you asked some uncomfortable questions and were never invited back. If you were a finance guy, I think you would be a Short Seller.


This is a long post. I hope it is helpful and generates discussion. Let me summarize the argument here and those who are interested can read the details below (I'll assume we are talking about he stock market even though it applies to many other markets):

1. NS is a complimentary action to the standard 'buying' of stock. The analogy is even closer if you limit it to speculative buying (then selling) of stocks.

2. Both can cause massive damage. Arguing about 'buying' being better than NS is like arguing that it is better to be severely overweight versus anorexic.. either way the human ain't too healthy. In reality, there is a time to every purpose under the heavens. There is a time for feasting and a time for fasting. Both can go off the rails and be destructive. But both are needed, in their place, to maintain good equilibrium.

4. Unbalanced 'buying' that leads to unsustainable asset appreciation/inflation may feel good and seem like everyone is winning, but it leads to serious problems that must be corrected or be fatal to system. NS is a potent (and sometimes brutal) corrective mechanism Ying to the Yang of fake and inflated asset prices. We can argue about the causes of the utter fiction that the financial system has become... but we can agree that assets have been massively mispriced. NS one of the ways that the market corrects itself. It greatly increases the speed (and yes, the violence) of a finding the sustainable price for a given asset. NS is a white-hot fire that helps burn away the chaff.

5. Can NS be destructive. Yes. Absolutely. The most egregious cases are when people start rumors to intentionally cause a drop in a stock price and these need to prosecuted as vigorously as the cases when a company lies to makes it's books look good to cause the share price to artificially rise. But I must point out that the best defense against egregious NS is the same as the defense again overvaluation: a good flow of information and sane, rational valuation of an asset based on real metrics. (Like dividends for stock)

3. The real sin against 'the market', like life, is to mis-value an asset. Whether you overvalue or undervalue, it is really the same in the end. And if the mis-valuation is severe, so will be the commensurate correction. From a macro perspective, NS, like buying, is a means to an end: it is a way of finding 'the value' an asset. Blaming Short Selling is shooting-the-messenger at it's worst.

6. The root of what we are facing today is not the Short Sellers. Not Even close. The root is that our finical system was rotten at the core and that the valuation of various assets was completely out of whack. There was massive 'fake money' not only 'printed' by the Fed though artificially cheap interest rates, but even more fake buying being done with money leveraged many times over. You might think that Short Sellers are making money off people's pain... but keep in mind all the people who skimmed massive amounts of money peddling this crap as the market rose. It is easy to single out the Short Sellers as profiteers but they are no more so than those that speculatively bought and sold.

7. Blatant rant/option: If NS raises the ire of people than GOOD! We have been lied to and cheated and any extra bit of outrage that could actually shake the average American out of his willful ignorance about finance should be encouraged. All the crap in the last 15 years about soft landings has been just that: crap. Soft landings should be sought for unforeseen circumstances (like the months after 9/11) but NOT for bad behavior by market participants. It only encourages them. And if the financial market's misdeeds cause havok in other parts of the economy, then good. That will make society in general wake to the need to watch the finical markets. And we have all been duped into thinking that we are better off then we are, all while being stolen from. At least the short sellers see it for what it is and make money off it, rather than living in a dream.


Adam Stilson

Here's the 2nd part of my post:


Naked Short selling in an integral part of the market and has been part of the stock market (and most other markets, including commodities... characters in the Mayor of Casterbridge short sell the corn market for example) since the beginning. It is part of the 'natural ecosystem' of markets and performs important regulatory/ecological functions that makes markets work better. Folks who NS are the ones sitting in the back of the room during a presentation watching with disbelief as the crowd eats up and claps at the speaker's overly-rosey, gilded, bullshit PowerPoint slides. They are the 'black hats' of the market who poke holes in the everyone's-making-money-we-are-all-in-this-together-pep-rally crap that has pervaded the financial system for years. Naked Short Sellers are (at their best) "the voice crying in the wilderness' preaching of the doom that no one wants to hear... and unlike most folks who bitch about how bad things are, those who NS are willing to put some real skin in the game and put lots of money on the line.

Nitty Gritty:

A. Naked Short sellers (NOT the SEC or IRS or DOJ) have revealed most of the major accounting scandals in the past 20 years. Enron, Worldcom, the list goes on and on.. All these are uncovered and brought to light by short sellers who poured through financial statements and sniff-tested earnings calls.

B. Naked Shorting ACTUALLY HELPS TO ESTABLISH A FAIR PRICE FOR A STOCK BECAUSE (ALMOST) EVERY NS ENDS WITH A BUY. Why? Let's go through how a Naked Short works: I own no shares of a company XXX. I decide to naked short 100 shares of Company XXX. I goto my broker and say "Broker, please lend me 100 shares of XXX. I promise to pay you back 100 shares of XXX, whatever the cost. The broker looks around to see if they can find 100 shares of XX to borrow (they usually can from client accounts for from market makers). They give you the stock. I immediately sell the stock and the money gets credited to my account. Times goes by and the price of the stock drops. I must now goto the open market and buy 100 shares of XXX to 'close' my position and give 100 shares back to the broker. Only then can I actually get the money from the NS free and clear (neglecting margin account stuff). So every NS ends with a purchase of the same stock (neglecting bankruptcies and companies being delisted. In those cases there is some other mechanism for stock repurchase). This process establishes a price floor for the stock. Imagine that I Naked Short Sell a stock at 20$ per share. Then is goes down to 5$. Great. I can make some money. Now the price bounces to 7$ a share. Then because I am worried that the price might go up more, I decide to close my short position out and buy the stock on the open market at 7$ a share. I have created upward pressure on the stock because I needed to close my NS position, helping to set the price. To repeat, (almost) every NS ends is a purchase of the same asset (this will be referenced again below).

C. Now let's switch gears. Let's say that you own no stock in a company YYY. So you decide to buy some. This is a "Naked Buy". Now we usually don't call it that, but the analogy with Naked Shorting is apt: you are taking a position in an asset that you did not own before the transaction. Now (almost) every "Naked Buy" ends (eventually) in a SELL in order to realize profit. I mention this because NAKED SHORTING and NAKED BUYING are, in theory, completely complimentary operations. The fact that buying 'feels' more natural or that NS feels 'wrong' is immaterial. Calling it 'naked buying' is more apt if we just limit our selves to speculative buying. So let's do that (even though long to medium term buying still shares some of the same properties) and say that 'naked buying' refers to speculative buying. I DON'T HERE PEOPLE CALLING FOR BUYING TO BE MADE ILLEGAL. IT'S JUST THAT BUYING HELPS PEOPLE THINK OF THEMSELVES RICHER, WHILE SELLING DOES NOT.


D. Can NS go off-the-rails and cause for harm-than-good? Yes. There are examples of a viable company being subject to rumor causing short sellers to swarm and devalue the stock. Or of short selling accelerating the fall of an already depressed market and helping to spread panic. But let's look at this in detail:

D-1: After a company first offered it's stock to the market (the IPO), the company gets no direct money from the resale of it's shares on the DOW or NASDAQ. The stock market most of trade in is actually a secondary market. So if the share price of a company falls, it should not effect the companies finances in any direct way.. if anything, it only effects the moral of employees who have stock options (and the ability to keep and hire new ones) and the amount of money the company could get if they decided to sell more shares to the open market (a follow on offering.. which is rare event .. maybe one a year if that). But we see that a company's financial health is effected by a falling stock price... Why? Because the company TAKES OUT LOANS (DEBT) USING IT'S STOCK PRICE AS COLLATERAL. The company's creditors get very worried when they see share price fall and then bad stuff starts to happen. SO HAVING A 'REAL', VALID (and conservative) appraisal of a company's stock price is important and has far reaching consequences. (Note that the same is true of Real Estate: it doesn't matter much if housing prices go up and down around you if you living in your house and can make the payments. It only matters if you want to sell and more to the point, if you borrowed against your house and can't make the payments due to this borrowing or the bank calls the loan because the value has dropped.)

D-2: THIS IS CRITICAL: Following the train of thought from D-1, we can see that 'naked buying' is a major source of financial destruction. If there is "irrational exuberance" then the price of assets is overvalued. This leads to individuals/companies overextending themselves with credit and excess production capacity (overestimating demand for their stuff). Then if the market hits a bump-in-the-road, the company's valuation cannot be justified, credit is pulled, and things spiral out of control.

5: Naked Shorting is part of the Yin-and-Yang of the market. The job of a functioning market is to find the 'optimal price' for some asset. Naked shorting accelerates finding this price by applying extra downward pressure to overvalued assets. Here is a super simplified example: Imagine that you want to keep a room at a temperature of say 70F. So you go and set the thermostat to 70F. If the temperature is 68F, the thermostat turns on a heater until the temperature rises above 70F, say to 72F. Then the room naturally and slowly looses heat until the temperature falls below 70F and the process continues. Now imagine a system where the thermostat not only controls a heater, but also controls an air conditioner... this way when the temperature rises above 70F, the thermostat turns on the air conditioner to actively cool the room (rather than letting the room just loose heat). A system with both active upward and downward has the ability to find the optimum temperature much more quickly (but may cause more volatility within a certain range around to 70F mark in our example). Things aren't this easy in real life, of course. It can be that the air conditioner causes an 'overshoot' and cools the room too much but then the heater kicks back in and the cycle starts anew. For a wide range of conditions, this sort of control system works well. But there are always catastrophic conditions where the system becomes oscillatory and never converges to the desired temperature (or price if talking about a market). In these broken states, it might actually be better to not have 'active cooling' from the air conditioner (or NS). But all bets are of in these states anyway.


Agree with MRW about the danger of unregulated CDS. I can imagine all sorts of mischief in the CDS casino.

An organized crime entity getting control of a small firm, getting 1,000 CDS written against its bonds, then blowing up the firm to collect on the CDS "insurance", is just one sort of gaming.

Thanks for that long informative post Adam.


If this were any other industry, these "banks" would already be gone, their leadership jobless, and the U.S. would already be starting over.

So i see absolutely no reason to "honor their contracts". These are our tax dollars we're giving them. We have every right to demand contingencies on their use. Now that the banks are insolvent, these bankers should be donating their time for free and taking pay cuts. Hell, they should be praying that we don't give the SEC some teeth and start sending them to jail.

In times of emergency, unions have taken cuts like that over and over again, these last thirty years.

Why should Wall Street be treated any differently than the rest of us?

Other than that, i agree with what you write, Colonel.

But those stopgaps will do little to bring the economy back. The world is now turning away from the Pax Americana Soon, the dollar will no longer be the world's reserve currency.

Once that happens, things will go from worse, to "Oh, lord -- what have we done to ourselves?"

Nick Ruffin

Giving up mark to market is an invitation to take more risk and to hide losses.
Do not suspend mark to market for securities that have a liquid market. When the spread between bid and offer is such that there is no liquidity, allow an alternative valuation.

With decimal pricing and trading on multiple markets the uptick rule is an anachronism. It's useless.

Concern about naked shorting is misplaced. The issue is leverage. If stocks are purchased using leverage, shorting can force liquidations of long positions and a cascade of lower prices. While shorting can cause a short term drop in prices, the value of a stock will ultimately be determined by the performance of the company. Shorting helps to keep overvaluation in check.

Once that happens, things will go from worse, to "Oh, lord -- what have we done to ourselves?" -- china_hand

The question will more likely be, "Oh Lord -- what have they done to us."

The definition of "they" will vary.

I am not being flippant.


Sorry I definitely am confused. Could someone explain the following: I thought the cds insurance was for holders of the securitized debt, in the event of default, the consumer gets foreclosed on. The holders still had some recourse through the foreclosure process and the insurance covered the difference. If this is not the case--where people are merely betting on what will happen--why do we need to cover their losses when they used an insurer who didn't adequately prepare? Would this force AIG's other divisions to declare bankruptcy? Who cares--we have insurance carriers in PA go belly up all the time. Who is receiving these payouts and at what rate (ie. 100%?) Why can't they be allowed to fail?


If this latest Summers/Geithner rerun of Paulson's bailout mania goes through, the estimated cost to U.S. taxpayers, in the immediate weeks ahead, will be over $6 trillion in additional bailout money, to try once more to keep the bankrupt banks afloat. I have seen estimates from very credible economists, including James K. Galbraith, that the maximum value of the debt and securities being auctioned by the Federal government on behalf of the banks, is 25 cents on the dollar--and that is a stretch. Under the terms of the auction, hedge funds and private equity funds are going to come in and "competitively" bid to set "market price." But the private funds will be liable for only 6 cents on the dollar, and the taxpayers will foot the rest of the bill. Whatsmore, the private funds will be PAID to manage the inflated assets until they are sold off. The fees alone that the hedge funds and equity funds will get from this swindle, will more than cover their 6 cents "risk." This has been described as the worst Rube Goldberg contraption yet imagined by the geniuses at the Fed and Treasury. It won't work, it will sink us deeper, and it is becoming clear that President Obama, with very little experience or know-how on financial matters, is being flim-flammed by his own advisors. This past day or so, some polls have shown the President's approval rating plunging from a high of 78 percent shortly after the inauguration, to 50 percent. There is a better way, and more and more economists are calling for a bankruptcy reorganization, rather than a bailout. Galbraith wrote a very insightful piece available online at Washington Monthly, and spelled out how the FDIC under law is restructuring banks that fail to meet their capital reserve requirements every Friday, in an interview with the German magazine Manager. How about equal treatment for the bigger banks, which are more bankrupt than the smaller, regional and community banks?

William R. Cumming

PL! A quick question for possible posts and understanding limited economics background of some of your commenters! Not all of course.
Is there a single milepost readers of this blog should look for as to rebound of world, not US, economy? Background, now many posts on other blogs are saying only China and India will escape actual GDP downturns in next 5 years!

R Whitman

Adam Stilson is incorrect in his description of Naked Short Selling as shown in Paragraph B of his second post. NSS is short selling without first borrowing the shares.(See definition in Wikipedia).This sometimes leads to more shares shorted than actually exist. Not exactly an orderly or rational market.


China Hand asked:

"Why should Wall Street be treated any differently than the rest of us?"

Well, the glib answer (but not necessarily the wrong answer)is the FIRE sector (finance, insurance and real estate, AKA Wall Street, owns the country.

The comments to this entry are closed.

My Photo

February 2021

Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
Blog powered by Typepad