The Financial Crisis Continues to be an Inside Job

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Over the weekend I saw the documentary movie Inside Job with a friend who is not a financial markets expert. After the show, I told her I was relieved to see that the movie covered the majority of the causes of the collapse of the financial markets in 2008. Part of my relief was from thinking that everything would be better now that “everyone” knows the facts. Then my friend pointed out that there were only six people in the audience – obviously “everyone” wasn’t seeing this movie!

The movie did a good job of covering virtually everything I’ve been writing about at NewGeography since 2008. They did leave out the part where Goldman Sachs and other Wall Street banks were issuing mortgage-backed bond without writing mortgages. This is totally understandable. It’s very difficult to show what doesn’t exist in video. It’s easy enough to show homes in foreclosure -- but what pictures and video can you use to show that there aren’t any mortgages behind bonds, especially when the bonds that aren’t even printed on paper? The pictures of hookers, strippers and cocaine make the movie ominous enough and have a certain visual appeal that producers look for in a story.

Inside Job included lots of stuff on who is funding the academic studies being used to justify wrecking the financial markets. They present more on the serious academic fraud in the crisis than I was aware of. I first posted Tweets about Duke University back in June 2009. A couple of Duke University professors published a research report about a model they developed that justifies manipulating stock prices and corporate votes. What I Tweeted was: “It should be illegal to write this crap.” Duke University’s research center is funded by a wide selection of the bailed out financial institutions. Your tax dollars at work!

The point I try to raise -- perhaps loudly because it's a little self-interested coming from me -- is that the perpetrators of the financial crisis are funneling billions of dollars to the academics who will write anything they are told for the sake of continued funding. In the meantime, those who are willing to take the adverse position are relegated to the Daily Show (no offense, Jon).

Then I sat through Inside Job and I saw this segment on former Federal Reserve Board of Governors member and current professor at Columbia University Business School Frederic Mishkin. Before the crisis, Mishkin took money from the Chamber of Commerce in Iceland to write a report about the “Stability” of their banking system. The source of the funding was not disclosed in the published report (an academic no-no). Then, after Iceland's banks completely collapsed, Mishkin changed the name of the paper on his resume to the “Instability” of Iceland’s banking system. This was shocking to me, as I didn't realize how deeply the desire to deceive ran among these guys. Mishkin resigned from the Federal Reserve Board in the middle of the crisis – yes, even the rats will abandon a sinking ship.

Last week, Mishkin was on CNBC’s Squawk Box (a chuckle-head fest about how to make money on the day’s stock trades) pontificating about Fed monetary policy. CNBC is no stranger to corrupting academics to support their bad habits. Inside Job included examples of a slew of academic economists taking money from Wall Street to write papers justifying the systemic failures. Here’s an example they didn’t have. Someone recently sent me a study penned by professors at the University of Oklahoma Price Business School. The study concluded that naked short selling (the practice of selling shares you don’t own and can’t borrow) is beneficial for making financial markets more efficient. (If you don’t know what short selling is, here’s a five minute video that explains it in a light-hearted way.) Insane, right? No reasonable person would agree that it is good for markets if you can sell things that don’t exist – yet it happens every day, even in the market for US government securities. It takes fewer than 6 degrees to connect the dots. The University of Oklahoma’s Price College of Business is named for major donor Michael Price. Price is "personal friend" of CNBC personality Jim Cramer. For more on Jim Cramer's ties to Naked Short Selling follow @deepcapture on Twitter and check out the March 12, 2009 episode of the DailyShow.com.

I was getting very discouraged about continuing to write about the causes of the crisis, since no corrective actions are being taken. A lot of work remains to educate the public about the issues and to come up with solutions. The old political ways are too corrupt to work anymore. It seems like we keep covering the same territory without progress, but I'm inspired by the closing line of Inside Job: “Some things are worth fighting for.”

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. She will be participating in an Infrastructure Index Project Workshop Series throughout 2010. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

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Ignorance or lie, neither is acceptable

"No reasonable person would agree that it is good for markets if you can sell things that don’t exist – yet it happens every day, even in the market for US government securities"

No one that understands securities would make the mistake of describing naked short selling as selling things that don't exist. At least if they were interested in an honest discourse on the subject.

At the time of a transaction that we describe as a naked short sale, the security exists only that the seller in the transaction doesn't own it.

It's quite common in our society for sales to occur before the owner owns the physical good. Dell's once vaunted business model involved them selling you a computer before they had the parts for it, let alone built one. People give tens of thousands of dollars in cash for a new house or condo that hasn't been built yet. Stores have rain checks. They don't have the physical good at the time of the sale, but like a naked short sale they promise to have it in the future even though they're taking your cash for it that day.

RE: Ignorance or lie

stmp692: There is a big difference between Dell selling computers before they are built and broker-dealers selling shares they don't own. Dell is doing the selling and Dell will be building the computer. In the case of financial securities, the broker-dealer doing the selling cannot make or create the securities. In fact, there are many documented cases where the number of shares in circulation exceeds the number of shares authorized and issued by the company. This is why I say that "naked short selling" (or the more technically correct term "failure to deliver") amounts to selling what does not exist. Some shares exist, but the broker-dealers are selling more than the supply of a product they will never be in the position to create.

Hope that clarifies,
Susanne

Follow me on Twitter: SusanneTrimbath