Economic Warfare

[bourbon]

Interesting stuff, there is an accompanying article by Bill Gertz in the Washington Times.

Being familiar with some of the threads in this, I believe this report will be deflected, ignored, or downplayed. I also believe that by publicly tugging on some of these threads, the author has just exposed himself to personal and professional danger.

Thus far it has the odor of someone with a hypothesis that went in search of facts to shore it up.

Could just as well have started with some of the answers, and then went looking for the OSINT to match.

[Dayuhan]

Interesting stuff, there is an accompanying article by Bill Gertz in the Washington Times.

Being familiar with some of the threads in this, I believe this report will be deflected, ignored, or downplayed. I also believe that by publicly tugging on some of these threads, the author has just exposed himself to personal and professional danger.


Could just as well have started with some of the answers, and then went looking for the OSINT to match.

From the cited article:

Paul Bracken, a Yale University professor who has studied economic warfare, said he saw “no convincing evidence that ‘outside forces’ colluded to bring about the 2008 crisis.”

“There were outside players in the market” for unregulated credit default swaps, Mr. Bracken said in an e-mail. “Foreign banks and hedge funds play the shorts all the time too. But suggestions of an organized targeted attack for strategic reasons don’t seem to me to be plausible.”

I agree with Mr. Bracken. I also doubt very much that anyone is going into "personal and professional danger" over this. I look at things like this:

explaining that those domestic economic factors would have caused a “normal downturn” but not the “near collapse” of the global economic system that took place.

I mostly just want to click somewhere else.

Plenty of causes out there without going into the conspiracy market.

Never attribute to malice that which is adequately explained by stupidity, greed, ineptness, short-term thinking or any combination of the above..

[bourbon]

The Miscreants’ Global Bust-Out: Preface, by Patrick Byrne. Deep Capture, 28 April 2011.

The Miscreants’ Global Bust-Out (Chapter One): Was the United States Attacked By Financial Terrorists?, by Mark Mitchell. Deep Capture, 29 April 2011.

I did not know if Zuhair Karam was violent, but I telephoned him because I thought his biography was interesting. For example, it was interesting that soon after making a home in Illinois, Zuhair Karam obtained finance to publish a semi-famous work of jihadi propaganda, and soon thereafter, became (without any relevant experience) a proprietary day trader of equities and derivatives at a small, unregistered brokerage in Chicago called Tuco Trading.

Most of the other people who operated through Tuco Trading also had interesting biographies. Among them (just to name a few) were a Russian Mafia figure who is knowledgeable about a brutal gangland-style murder in New Jersey; the top lieutenants of a Russian Mafia kingpin and oligarch who have been accused by U.S. officials of having ties to the Russian government’s intelligence apparatus; and an Iranian fellow whose family has high-level ties to Palestinian Islamic Jihad, and the terrorist-sponsoring Revolutionary Guard in Tehran.

Meanwhile, Zuhair’s little brokerage, Tuco Trading, maintained partnerships with several other brokerages, all of which had close business relationships with people of similarly colorful backgrounds. Among them were multiple associates of La Cosa Nostra; numerous traders with ties to the Russian Mafia; and a jihadi who not only was Al Qaeda’s most important financier, but also operated a secret bomb factory in a Chicago warehouse district before the U.S. government named him a “Specially Designated Global Terrorist”.

Aside from the amazing backgrounds of this cast of characters, it was also interesting that Tuco Trading was closed by an “Emergency Order” of the SEC on March 9, 2008 — just a few days before the March 13 collapse of Bear Stearns. Not that the SEC had any idea what was happening at Tuco; the Commission seemed primarily concerned that the brokerage was massively exceeding margin limits.

What the SEC seems to have missed (though a report by Tuco’s bankruptcy receiver made it clear) was that in the month before it was shut down, this tiny, unregistered brokerage transacted trading equal to more than 20 percent of the volume of the largest brokerage on the planet. Moreover, data and other evidence obtained by Deep Capture suggests that most of this massive deluge was aimed at manipulating the stock prices of America’s largest financial institutions, including Bear Stearns.

In other words, there is good reason to believe that Zuhair’s strange, little brokerage with all of its odd connections, contributed to the 2008 financial cataclysm that nearly brought the United States to its knees.

[davidbfpo]

Bourbon,

Yet again evidence that the current complex structure for regulation, reporting and enforcement we have in the West and elsewhere failed to cope with what was really happening.

[Dayuhan]

What the SEC seems to have missed (though a report by Tuco’s bankruptcy receiver made it clear) was that in the month before it was shut down, this tiny, unregistered brokerage transacted trading equal to more than 20 percent of the volume of the largest brokerage on the planet. Moreover, data and other evidence obtained by Deep Capture suggests that most of this massive deluge was aimed at manipulating the stock prices of America’s largest financial institutions, including Bear Stearns.

In other words, there is good reason to believe that Zuhair’s strange, little brokerage with all of its odd connections, contributed to the 2008 financial cataclysm that nearly brought the United States to its knees.

This is hyperventilated melodrama. You can't drive a company out of business by manipulating its share price. If the company is healthy, all you can do is produce a transient blip in its market cap. If a company is a hollow shell that's ready to die anyway (as Bear Stearns was) you can kill it off, but the cause of that is the underlying condition of the company, not the share price manipulation.

Short sellers are the vultures and jackals of the financial world. They kill off the sick and dying, they don't bring down the healthy. It's entirely possible - indeed likely - that people with inside knowledge of how badly Bear Stearns and others were overextended decided to make some money by pushing them over the edge. That's illegal, but it happens. These companies didn't fall because of short sellers, though, they fell because they were badly managed.

It all has a strong whiff of the standard conspiracy-theory tactic: start with a theory, find a bunch of factoids that ae consistent with the theory, ignore all facts that aren't consistent with the theory. You convince those predisposed to believe, but not many others.

[bourbon]

You can't drive a company out of business by manipulating its share price. If the company is healthy, all you can do is produce a transient blip in its market cap.

You mean according to efficient market hypothesis; which, if you are one of the people who still subscribe to this theory – I couldn’t convince you otherwise with a car battery and a strobe light. Needless to say, EHM completely ignores the reality of market panics.

You are also presupposing a classical bear raid, and ignore the use of ETFs, phantom shares, and option strategies. Not to mention credit default swaps, that can be easily manipulated.

Short sellers are the vultures and jackals of the financial world.

That’s great, but again (and you have done this before) we are not talking about regular short selling, which is legal and generally good for markets.

We are talking about market manipulation and naked short selling, which is an abuse of the clearing and settlement system. It creates phantom shares which massively dilute supply, thereby driving down price.

It is apples and oranges, as has been explained before. Yet you continue to fail to understand the distinction.

It all has a strong whiff of the standard conspiracy-theory tactic: start with a theory, find a bunch of factoids that ae consistent with the theory, ignore all facts that aren't consistent with the theory. You convince those predisposed to believe, but not many others.

Except the difference between conspiracy theory and scientific theory is the ability to make predictions; and the things DeepCapture and its principles were saying about the slop in clearing & settlement mechanisms has borne out over the past two years in scandals involving stocks, CDS, MBS, ETFs, and commodities. That intellectual debate has been settled; they were right.

The rest that is reported is actions – many of which can be easily confirmed; and actors – who would be suing the hell out of these guys if any of this wasn't true (they haven’t).

[bourbon]

The Miscreants’ Global Bust Out (Chapter Two): The “Money Weapon” and a Jihad Bigger than Bin Laden, by Mark Mitchell. Deep Capture, 03 May 2011.

Three years later, a lot of people still thought it was “remarkable” that Sheikh DeLorenzo and an Al Qaeda operative had managed to insert spies into the U.S. military. But that didn’t stop Sheikh DeLorenzo (a sophisticated financier who looks the part in his pin-striped suits) from seeking permission from the Securities and Exchange Commission to set up a trading platform called Al Safi Trust, the ostensible purpose of which was to enable Muslim traders to engage in short selling without violating shariah law.

In 2007, the SEC granted permission, which is pretty “remarkable” because Al Safi Trust creates precisely the sort of crack in the financial system that would likely be exploited by people looking to crash the markets. Traders who engage in legal short selling (as opposed to illegal naked short selling) first borrow stock, then sell it, hoping the price will fall. This is a perfectly legitimate practice because it does not manipulate the markets. The stock that is borrowed and then sold is real stock; it is not phantom stock that artificially increases supply and drives down prices.

The Miscreants’ Global Bust Out (Chapter 3): Michael Milken and the BCCI Criminal Enterprise, by Mark Mitchell. Deep Capture, 05 May 2011.

But, of course, this scheme eventually collapsed – and it must be stressed, the vast majority of the companies that Milken financed ultimately disappeared.

In later years, the “bust out” concept was refined into such schemes as the “death spiral” PIPEs finance that was pioneered with help from Al Qaeda Golden Chain member Shiekh Yamani’s Investcorp and other outfits. Always, the basic idea is to finance a company, load it with debt, and then take it down.

In the 1980s, Milken and his cronies orchestrated a number of bust outs in league with BCCI and its proprietors, including future Al Qaeda Golden Chain member Shiekh Mahfouz, who remained one of Milken’s closest associates until Sheikh Mahfouz’s death in 2009.

[Dayuhan]

That’s great, but again (and you have done this before) we are not talking about regular short selling, which is legal and generally good for markets.

We are talking about market manipulation and naked short selling, which is an abuse of the clearing and settlement system. It creates phantom shares which massively dilute supply, thereby driving down price.

It is apples and oranges, as has been explained before. Yet you continue to fail to understand the distinction.

I am aware of the distinction. I'm also aware that it doesn't matter. Either way, all you're doing is driving down the share price, which has no impact at all on the fundamental viability or core strength of the company. If the company is strong, all you do by depressing the share price is open a buying opportunity for somebody else. You might as well try to dig a hole in the ocean. If the company is already on the edge, or is too small or too far out on the fringe for investors to notice the price dropping below what fundamentals can support, that's a different story. That's why short sellers seek out the weak and the isolated.

Naked or otherwise, short sellers don't bring down healthy companies and they don't bring down economies. Naked shorting is abusive and can do damage, but it's not a cause of major economic dislocation. If you see a long line of dominos falling and want to know why, don't ask what knocked down the first domino: dominos fall all the time. Ask why so many others were stacked in a neat vulnerable line.

Except the difference between conspiracy theory and scientific theory is the ability to make predictions; and the things DeepCapture and its principles were saying about the slop in clearing & settlement mechanisms has borne out over the past two years in scandals involving stocks, CDS, MBS, ETFs, and commodities. That intellectual debate has been settled; they were right.

The rest that is reported is actions – many of which can be easily confirmed; and actors – who would be suing the hell out of these guys if any of this wasn't true (they haven’t).

Of course they were right. They were predicting things that were already going on, and have been for ages in various forms. There re always scandals in financial markets; predicting that is like predicting sunrise in the east. When the economy is strong, nobody notices outside the community. When the economy is weak, people come to the conclusion that the scandals caused the weakness. They're wrong. The scandals are always there and always will be. They are actually a good sign. Given the amount of money to be made, somebody will always break the rules. If there are scandals it means people are being caught, which provides at least some control. If there are no scandals it means nobody's getting caught, which means everybody is breaking the rules. Never invest in a market where there are no scandals.

I see no evidence that "economic warfare" or sinister malign influences were the cause of the recent crash. I see a long chain of mutually reinforcing bad decisions, from Wall Street, Main Street, and most of all Government, reaching back to the mid 90s... arguably before, but that's when it started going out of control. That chain could have been broken at several points, but it wasn't. Lots of lessons to be learned, but they really don't involve the Dark Arts, though people who really want to see it that way will always find reasons to do so, and will always suppose that the majority who don't see it that way are naive or deluded.

We too easily miss the forest for the trees. Any of us can point to a hundred abuses of the derivatives markets since 2002, and propose regulations, describe effects, etc. Or we could just note that if the derivatives markets had been allowed to fully crash in 2001/2002 when they needed to, instead of having the risk sucked out of them by an inappropriate countercyclic intervention, all that discussion would be unnecessary. Macro incentive management often achieves more than attempts at specific regulation.

[bourbon]

I am aware of the distinction. I'm also aware that it doesn't matter. Either way, all you're doing is driving down the share price, which has no impact at all on the fundamental viability or core strength of the company. If the company is strong, all you do by depressing the share price is open a buying opportunity for somebody else. You might as well try to dig a hole in the ocean. If the company is already on the edge, or is too small or too far out on the fringe for investors to notice the price dropping below what fundamentals can support, that's a different story. That's why short sellers seek out the weak and the isolated.

Again, you mean according to efficient market hypothesis.

There are at least three flaws with this argument:

- As mentioned before, it ignores the reality of market panics;
- It violates the principle of one vs. many;
- And it ignores the factors time and speed.

Taken in isolation, a naked short sale of a single or small number of shares will function like a traditional short. But in the case of many shares sold short there is a critical difference:

- A traditional short is constrained by the number of shares available to borrow, which is limited by the number of shares in the public float – which is based on the on number of shares issued. This is a finite number.

- In a naked short the limit has nothing to do with the ability to barrow. The only limit becomes the amount of capital put up against the position, and that capital requirement diminishes as the price of the stock falls. It can create an unlimited amount of shares short to drive the price down through the basic supply/demand equation.

When you consider that Lehman fell in one week of market panic, your point about depressing the price to point of opening buying opportunities is moot. Speed kills. Nobody had time to think, much less the ability think or act rationally.

Naked or otherwise, short sellers don't bring down healthy companies and they don't bring down economies.

Once again, this is according to efficient market hypothesis.

You have also not bothered to address the use of CDS, leveraged ETFs, and rumor/media which is likely to be used in conjunction with NSS in a bear raid. And which the evidence suggests is the case with Bear and Lehman.

Naked shorting is abusive and can do damage, but it's not a cause of major economic dislocation.

The collapse of Lehman caused a stock market collapse and the immediate freezing of credit markets; it is also universally accepted as a key trigger of this current economic catastrophe. So in this case, it looks like it may have.

If you see a long line of dominos falling and want to know why, don't ask what knocked down the first domino: dominos fall all the time. Ask why so many others were stacked in a neat vulnerable line.

No, I’m going to want to beat the hell out of the person who intentionally pushed the first domino. Then beat the hell out of his friends.

Yes, dominos fall all of the time. Newborn babies also die all of the time, but that doesn’t mean you can go into a nursery and snuff-out infants.

[Dayuhan]

Again, you completely miss the point. Short selling, naked or clothed, no matter who is involved, only manipulates share price. It has no influence on the fundamental viability of the company, which is determined not by share price, but by revenues and earnings, debt, returns on equity and investment, and a whole bunch of other boring stuff.

All of what you say about naked shorting is true. It's also irrelevant, because you can't drive a healthy company out of business by manipulating the share price.

An example: suppose you, AQ, the Russian Mafia and the Saudi Royal Family decided to drive Google out of business by short selling. You could certainly depress the share price for a short while, but that would have no impact at all on Google's health or business. Google doesn't live on selling stock, it lives on selling services, and short selling will not do anything to the core revenue stream that Google thrives on. You wouldn't even be able to depress the share price for very long, because once you depress it you'll trigger a whole bunch of buying action. It's like digging a hole in water: if the shares are worth money and you force the price down, others will buy in and force the price back up. A naked short position will protect you from losing money, but it won't drive Google out of business no matter how large it is.

On the other hand, if a company is in a huge amount of debt, has made all kinds of unprofitable hugely leveraged acquisitions, if it earns less than it spends, if it's balance sheets and profit/loss statements are pig-ugly... if you short that company down, you won't bring in buying action because people will look at the numbers and run away. The share price tumbles, and instead of a green light flashing a red flag goes up, the bond ratings dive, the creditors stop lending and call in their notes, and pretty soon you don't make payroll, among many other awful things. When that happens the Company is gone, but it wasn't the short sellers that killed it. The ex-CEO may stagger down the Bowery mumbling into his bottle that if the short sellers hadn't jumped he could have squeezed through. The shareholders who were holding your stock without looking at the numbers will blame the short sellers to avoid taking responsibility for their own bad decision. At the end of the day, though, a company in this position isn't brought down by short sellers, it's brought down by the bad decisions that left it vulnerable to short sellers. All the short sellers did was run up the red flag.

Short selling manipulates share price. It has no impact on the actual business.

As long as the actual business is strong and the company is well managed, you cannot drive the company out of business by manipulating the share price.

Even if you shorted Exxon Mobil's share price to zero, they'd still sell oil and they'd still stay in business... and with $6 billion or so a year in earnings, long before you got the share price to zero there would be more buyers than you could short against. You wouldn't keep the Russian Mafia or the Saudis on board either, because they'd see more to earn on the buy side.

When you consider that Lehman fell in one week of market panic, your point about depressing the price to point of opening buying opportunities is moot. Speed kills. Nobody had time to think, much less the ability think or act rationally.

What fell? The share price? The share price isn't what keeps a company alive, if that company has a strong underlying business. And a week is a long time in the market world. If you dropped XOM below $50 you'd see buyers in a whole lot less than 7 days. Probably less than 7 minutes.

The collapse of Lehman caused a stock market collapse and the immediate freezing of credit markets; it is also universally accepted as a key trigger of this current economic catastrophe. So in this case, it looks like it may have.

The collapse of Lehman didn't cause the stock market collapse. The stock market collapsed because its valuations were riding on thin air and it deserved to collapse. Lehman was just the first to drop. If Lehman had gone down in a healthy economy they'd have been bought out by a healthier competitor and buried in peace, and nobody would have noticed. Lehman was not the cause or the trigger, it was just the first of the walking dead to keel over. The cause was the long chain of events that drove the bubble in the first place.

No, I’m going to want to beat the hell out of the person who intentionally pushed the first domino. Then beat the hell out of his friends.

Yes, dominos fall all of the time. Newborn babies also die all of the time, but that doesn’t mean you can go into a nursery and snuff-out infants.

That would be a silly response. An economy is by nature Darwinian: the weak must die, or they drag down the whole. Neither is it much of a big deal when the weak die, if the whole is healthy.

If there's a herd of sick, weak, dying buffalo staggering down the Serengeti, the jackals will come round. The sickest weakest buffalo will get pulled down first, and the jackals will play as dirty as they can.

Instead of blaming the jackals, ask why that herd was so damned sick in the first place.

[slapout9]

Watch this video to truly understand how Banking works and how Money really works. As John Kenneth Galbraith said it truly boggles most peoples minds at the simplicity of it.


http://www.youtube.com/watch?v=wDHSU...eature=feedlik

[tequila]

Even if you shorted Exxon Mobil's share price to zero, they'd still sell oil and they'd still stay in business... and with $6 billion or so a year in earnings, long before you got the share price to zero there would be more buyers than you could short against. You wouldn't keep the Russian Mafia or the Saudis on board either, because they'd see more to earn on the buy side.

I think you're conflating industrial firms with financial firms a bit too much here. Lehman didn't have oil stocks or refineries to liquidate or fall back on. It churned digital paper and depended on short term financing to survive because it was leveraged, like all the major investment banks including Goldman Sachs, up to its eyeballs.

Once investor confidence in Lehman, as evidenced by share price, evaporated, Lehman could not find anyone willing to lend to it or counterparties to do deals with to generate revenue.

I'm not a big believer in the stuff that Deep Capture is selling, but all financial firms depend on confidence, more than anything else, to generate profits and to survive.

[slapout9]

HBO releases the movie version of the best seller "To Big To Fail"

A lot of Lehman Brothers stuff will be in the movie. Link to some nice clips especially the guy they picked to play Ben Berneke.....almost pass for a double.


http://www.hbo.com/movies/too-big-to-fail/index.html

[Dayuhan]

I think you're conflating industrial firms with financial firms a bit too much here. Lehman didn't have oil stocks or refineries to liquidate or fall back on. It churned digital paper and depended on short term financing to survive because it was leveraged, like all the major investment banks including Goldman Sachs, up to its eyeballs.

A financial firm's assets are in its investment portfolio. If the financial firm is stupid and has a portfolio full of hot air, it will deflate at the slightest puncture. The cause of the deflation is not the puncture, it's the gaseous nature of the portfolio. If the portfolio is solid, a puncture won't matter.

It is true that most US financial firms had pumped up their books with volumes of hot air, which left them insanely vulnerable. The eventual explosion has to be blamed on the decision chain that produced that vulnerability, not on the specific events that caused the deflation. Anyone running a financial firm should know there's a $#!tload of nails and needles out there and you will sooner or later brush up against them. If they pop your balloon, it's not the fault of the nails and needles, it's your fault for overinflating your company into a hot air balloon just to make it bigger.

Why do you figure short sellers targeted Lehman and Bear Stearns, and not, say, Wells Fargo?

Jackals prey on the weak. They aren't the cause of the weakness.

[motorfirebox]

A financial firm's assets are in its investment portfolio. If the financial firm is stupid and has a portfolio full of hot air, it will deflate at the slightest puncture. The cause of the deflation is not the puncture, it's the gaseous nature of the portfolio. If the portfolio is solid, a puncture won't matter.

It is true that most US financial firms had pumped up their books with volumes of hot air, which left them insanely vulnerable. The eventual explosion has to be blamed on the decision chain that produced that vulnerability, not on the specific events that caused the deflation. Anyone running a financial firm should know there's a $#!tload of nails and needles out there and you will sooner or later brush up against them. If they pop your balloon, it's not the fault of the nails and needles, it's your fault for overinflating your company into a hot air balloon just to make it bigger.

Why do you figure short sellers targeted Lehman and Bear Stearns, and not, say, Wells Fargo?

Jackals prey on the weak. They aren't the cause of the weakness.

While that's accurate in one sense, I think reality is that any serious portfolio--any Goldman Sachs, any Lehman Bros, any amount of real investment--is, nowadays, largely 'gaseous'. It's leveraged on leverages which are leveraged on leveraged leverages, just as a matter of course. It stops being a minor point of failure when it becomes the systemic basis. And even businesses rooted in goods and services are vulnerable because they've all got gigantic financial wings. A famous instance is GE's financial wing being significantly larger--and significantly riskier--than its manufacturing business.

[Dayuhan]

While that's accurate in one sense, I think reality is that any serious portfolio--any Goldman Sachs, any Lehman Bros, any amount of real investment--is, nowadays, largely 'gaseous'. It's leveraged on leverages which are leveraged on leveraged leverages, just as a matter of course. It stops being a minor point of failure when it becomes the systemic basis. And even businesses rooted in goods and services are vulnerable because they've all got gigantic financial wings. A famous instance is GE's financial wing being significantly larger--and significantly riskier--than its manufacturing business.

It's certainly true that all of the financial industry carries some amount of risk - it pretty much has to - and that by 2007-2008 that amount had, across the board, become largely unsustainable. It wasn't evenly distributed by any means, though. Companies like Barclay's Wells Fargo, JP Morgan Chase, came out of it rather well, and were able to acquire productive assets from other companies at minimal prices. Others, especially those who had overindulged in mortgage-backed Kool-Aid, didn't do as well.

My point in the above was simply that a company in any industry that has managed its risks effectively and, effectively, paid as much attention to defense as offense, is not going to be driven out of business by short selling, even in a recession. It may see its share value reduced, but that won't force it to close up shop.

Lehman and Bear Stearns werre attractive to short sellers and vulnerable to short sellers because they grotesquely mismanaged risk. They didn't fall because of short sellers, they fell because they had taken on an unmanageable amount of risk. Short sellers saw that - possibly due to inside information (illegal but common), possibly just from watching carefully (legal and common) and moved in to pick off the low hanging fruit. Ugly, yes, but the crisis would have happened anyway. Too many companies were way too far out on way too skinny limbs, somebody was gonna tumble and set the dominos going. It was just a question of when and how. A situation like that is made to order for short selling, and somebody will take advantage. If you leave food scraps on your kitchen floor the rats and roaches will come around. Don't blame the rats and roaches, blame whoever's been leaving the food scraps on the kitchen floor.

I personally think that the recent crisis was inextricably rooted in the late 90's equity bubble and what I consider to be a highly inappropriate response to that bubble, before and after it burst, Analysis that focuses excessively on the events of 2005-2008 is going to miss a lot of essential points.

[motorfirebox]

It's certainly true that all of the financial industry carries some amount of risk - it pretty much has to - and that by 2007-2008 that amount had, across the board, become largely unsustainable. It wasn't evenly distributed by any means, though. Companies like Barclay's Wells Fargo, JP Morgan Chase, came out of it rather well, and were able to acquire productive assets from other companies at minimal prices. Others, especially those who had overindulged in mortgage-backed Kool-Aid, didn't do as well.

My point in the above was simply that a company in any industry that has managed its risks effectively and, effectively, paid as much attention to defense as offense, is not going to be driven out of business by short selling, even in a recession. It may see its share value reduced, but that won't force it to close up shop.

Lehman and Bear Stearns werre attractive to short sellers and vulnerable to short sellers because they grotesquely mismanaged risk. They didn't fall because of short sellers, they fell because they had taken on an unmanageable amount of risk. Short sellers saw that - possibly due to inside information (illegal but common), possibly just from watching carefully (legal and common) and moved in to pick off the low hanging fruit. Ugly, yes, but the crisis would have happened anyway. Too many companies were way too far out on way too skinny limbs, somebody was gonna tumble and set the dominos going. It was just a question of when and how. A situation like that is made to order for short selling, and somebody will take advantage. If you leave food scraps on your kitchen floor the rats and roaches will come around. Don't blame the rats and roaches, blame whoever's been leaving the food scraps on the kitchen floor.

I personally think that the recent crisis was inextricably rooted in the late 90's equity bubble and what I consider to be a highly inappropriate response to that bubble, before and after it burst, Analysis that focuses excessively on the events of 2005-2008 is going to miss a lot of essential points.

If there's a hundred dollar bill stuck to the end of a tree branch, and a bunch of guys die falling off the branch trying to get it, yeah, they were stupid--but the fact remains that there was an arguably good reason to go crawling out on that branch.

Yes, if a company leaves itself so exposed that it can be severely damaged or taken down completely with a campaign of short sales, CDSs, and the like, that company was stupid. But they're only stupid if it doesn't work--if their vulnerability is never exploited, they can make a buttload of money. It's not like Lehman Bros went out and exposed itself to massive risk on a dare; they had strong financial motive to do so, and they were hardly the only firm doing it. Our financial regulation allows and encourages risky behavior by financial giants who can crush us if they trip and fall. I don't completely buy the idea that the crash was a deliberate act by teh terrars, but I don't see it as out of the realm of possibility.

[Dayuhan]

If there's a hundred dollar bill stuck to the end of a tree branch, and a bunch of guys die falling off the branch trying to get it, yeah, they were stupid--but the fact remains that there was an arguably good reason to go crawling out on that branch.

There's arguably a much better reason to stay underneath, wait for the whole lot to fall, pick up the bill and walk away... which is, effectively, what the short sellers did.

Yes, if a company leaves itself so exposed that it can be severely damaged or taken down completely with a campaign of short sales, CDSs, and the like, that company was stupid. But they're only stupid if it doesn't work--if their vulnerability is never exploited, they can make a buttload of money. It's not like Lehman Bros went out and exposed itself to massive risk on a dare; they had strong financial motive to do so, and they were hardly the only firm doing it.

Gain is always an incentive to take risks. That incentive is counterbalanced by fear the disincentive to risk is fear of the consequence of getting caught out. That's why it's called risk. The question in this case is why so many people simultaneously focused on the incentive and disregarded the balancing disincentive. i would argue that government's response to the late 90s equity bubble created a general perception that risk had been largely taken off the table, thus removing the controlling counterincentive. The traders were no longer afraid... and ultimately it's fear, not regulation, that controls how much risk a trader is willing to take.

If the derivatives market had been allowed to crash and burn in 2001/2002, which it should have done and undoubtedly would have done without intervention, I doubt very much whether derivative traders would have pursued risk as aggressively as they did from 2005-2008. Look at the whole world of penny tech stocks. They still trade, but very few people take interest. That's not because of regulation, it's because traders had an object lesson in how easy it is to get burned.

Look up the total amount of derivatives exposure in 2001 and 2008, and you'll see what I mean.

Our financial regulation allows and encourages risky behavior by financial giants who can crush us if they trip and fall. I don't completely buy the idea that the crash was a deliberate act by teh terrars, but I don't see it as out of the realm of possibility.

I personally think regulation is very much overrated. It's easy to look back and say regulation could have prevented this, this, or that, but in fact the speculators are always one and a half steps ahead of the regulators. Intelligent management of macro incentives achieves much more. Unfortunately, intelligent management of macro incentives is often politically inexpedient.

Every politician loves a bubble, and wants to ride it as far as possible before it pops. Bill Clinton got away with that quite triumphantly, leaving poor dumb George to reap his whirlwind. Every politician hates a recession, and tries to end it as soon as possible. Sometimes, though, a bubble needs to be deliberately popped before it goes critical, and sometimes a recession needs to be able to do its job and run its course.

[motorfirebox]

I largely agree, though I think there's some value in regulation--certainly some value in tighter regulation than we currently enjoy. Deregulation can't fully be blamed for, say, the housing crisis, but it seems to me that it facilitates rapid wealth extraction in the form of foreclosures on homes to which proper standing cannot be reliably produced.

To get back to the topic of economic warfare, the existence of that bubble presents a vulnerability that seems exploitable to the right group under the right conditions. That, for instance, short selling only affects share price doesn't strike me as a reason it can't be used as a weapon. People and companies make money off of share prices. If the right share price or set of prices changes dramatically at the right time, traders end up with losses they may or may not be able to cover; enough uncovered debt will trigger a downturn.

If it can occur via pursuit of money, why can't it occur via pursuit of ideology?

[Dayuhan]

I largely agree, though I think there's some value in regulation--certainly some value in tighter regulation than we currently enjoy. Deregulation can't fully be blamed for, say, the housing crisis, but it seems to me that it facilitates rapid wealth extraction in the form of foreclosures on homes to which proper standing cannot be reliably produced.

I wouldn't suggest that regulation has no value, just that's it's overrated as both a cause of and a solution to problems. It has a place, but it needs to be used intelligently, and it rarely is. There is a very real regulatory burden on business. It's not because regulation is too tight, though, it's just too chaotic: there's a huge, overlapping, and often contradictory web of federal, state, and local regulation, and the confusion makes compliance a real burden. If you ask people in the business world, many would gladly accept tighter regulation if it was simpler and more coherent.

Above all, especially where financial regulation is concerned, it has to be recognized that creating an incentive and then trying to regulate against it is like trying to carry water in a strainer. We can and do prohibit certain types of high-risk behaviour, but ultimately the primary factor regulating risk-taking is fear of adverse consequence. Take away that fear and risk-taking will get out of hand no matter how you regulate. Regulation supports, but cannot replace, effective management of incentives.

To get back to the topic of economic warfare, the existence of that bubble presents a vulnerability that seems exploitable to the right group under the right conditions. That, for instance, short selling only affects share price doesn't strike me as a reason it can't be used as a weapon. People and companies make money off of share prices. If the right share price or set of prices changes dramatically at the right time, traders end up with losses they may or may not be able to cover; enough uncovered debt will trigger a downturn.

If it can occur via pursuit of money, why can't it occur via pursuit of ideology?

It could, but I'm not convinced that it did, and it would only be an effective weapon in very limited and unusual circumstances. Short selling is primarily a way of making money. It's a rather shady way of making money, but that's not unusual. Sometimes it can have second-order effects, but to be useful as a weapon those effects would have to be predictable and to some extent reliable to make it worth the effort. I doubt very much whether the people who shorted Lehman or Bear Stearns had any idea what the subsequent chain of events would be: a coherent plot aimed at achieving the results that occurred would require far more prescience than I'm prepared to assign to any of those involved.

The most likely scenario to me is that some shady actors (likely acting on inside information) spotted some low hanging fruit, in the form of companies with market valuations grossly out of proportion to the actual state of their business, and decided to pluck it. I suspect that they were as surprised as everyone else when the whole tree came down.

Never attribute to malice, conspiracy, etc that which can be adequately explained by stupidity, clumsiness, greed, casual venality, etc, etc, ad infinitum, ad nauseam.