classical economics
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Criminals Love Anarchy
CRIMINALS LOVE MARKET ANARCHY
By Wayne Jett
© April 25, 2008

    On April 23, 2008, the U. S. Department of Justice and the Federal Bureau of Investigation announced new strategy to fight “international organized crime” as a “growing threat to U. S. security and stability.” Among eight strategic threats to the U. S. from international organized crime, the DOJ/FBI tell us IOC exploits the U. S. financial system by sending billions in illicit funds through it, by “manipulating securities exchanges and engaging in sophisticated fraud schemes that rob U. S. investors, consumers, and government agencies of billions of dollars,” and by corrupting “successfully” officials in countries around the world as they seek “to influence – legally or illegally – U. S. officials.” The criminals use violence and threats of violence, as well as financial incentives, to achieve their objectives.
    The Department of Justice must have in its possession convincing evidence of crime in U. S. financial markets on a scale threatening U. S. security and stability. Why, then, have we seen no criminal prosecutions of those who have robbed billions from Americans by sophisticated fraud schemes? The dearth of perpetrators facing juries implies the need for more effective investigative and prosecutorial strategy, for certain. Worse than that, however, it implies that perhaps organized crime has succeeded in corrupting public officials in the U. S., as DOJ and FBI report is true in other countries.
“Phantom Shares” in U. S. Markets
    The Spring 2008 issue of Regulation magazine includes “The ‘Phantom Shares’ Menace” by John W. Welborn, who describes the significant risk overhanging U. S. financial markets in the form of undelivered shares that investors have bought and paid for without receiving them. The Supply Side Guide previously reported the exposure of NYSE member firms to undelivered securities on June 30, 2007, was $192 billion dollars. “The ‘Phantom Shares’ Menace” cites the same number and source.
    Welborn describes in comprehensive detail how the Securities & Exchange Commission has done more to aid this monstrous deception of U. S. investors than to inhibit it. The SEC staff buried the only significant investigation of a hedge fund for insider trading, wash sales and naked shorting – firing its own lead investigator. Yet the DOJ/FBI announcement of strategy for attacking organized crime stops short of admitting public officials in this country are corrupted.
The J. P. Morgan Chase Bank Recapitalization
    Also this week, we learned the SEC will not disclose why the agency’s investigation of heavy short-selling related to the demise of Bear Stearns was closed without reporting results, despite a letter inquiry from Senator Charles Grassley. Options expert John Olaques of Truth In Options then published his analysis on website Le Metropole reporting that far-out-of-the-money put options on Bear Stearns were created March 10 when the share price closed at 70. Heavy trading in those puts began the next day. Even-further-out-of-the-money puts were created on March 13 with only five days before expiration. Those put contracts, too, were bought heavily.     Olaques opines that this highly unusual options market activity means the deal involving the Federal Reserve, the SEC, Treasury, Bear Stearns and J. P. Morgan Chase must have been made before March 10 and probably finalized about March 7-8. This sequence of events would have enabled insiders to arrange for issuance of the highly leveraged options designed for their convenience in maximizing personal profits on the pending Bear Stearns takedown at a share price of $2.00.
    Olaques describes the Federal Reserve deal as funding a $25 billion loan to BSC plus a $30 billion loan to Morgan Chase, all secured by $55 billion of debt securities of BSC plus a guarantee of $1 billion by Morgan Chase. The collateral’s value was based upon BSC’s own appraisal.  The Fed offered the deal on condition that BSC agree to be acquired by Morgan Chase for $2 per share. Thus, for an exposure of $1 billion plus $2 per BSC share, Morgan Chase gets an infusion of $55 billion and gets to keep whatever business assets BSC had other than the collateralized $55 billion in debt securities. Why was this deal structured so sweetly for Morgan Chase (and the “put” buyers) and so sourly for BSC (and the “put” sellers)?
    Olaque notes the 100% loan-to-value loan advanced by the Federal Reserve secured only by BSC’s collateral and plus $1 billion promised by Morgan Chase and asks why the Fed didn’t simply make the $55 billion loan directly to BSC. BSC would have guaranteed repayment of the entire loan, its share price would have recovered and the firm’s failure would have been avoided. The deal, Olaque posits, must have been designed to pump $55 billion in additional funds into Morgan Chase from the Fed, and BSC was used as the vehicle for doing so. He also concludes that the Fed and/or Morgan Chase must have been in collusion with the put buyers, which would explain the SEC closing its investigation of the Bear Stearns takedown without reporting the results. The Federal Reserve’s funds, of course, came at the expense of other investors and all who use the dollar.
    Taken in context, the performance of the Federal Reserve, the SEC and the Commodities Futures Trading Commission (in its failure to monitor large trades in crude oil futures contracts), not to mention the self-regulatory and securities clearing organizations, raise serious concerns. Have these major institutions of U. S. financial markets been “successfully” corrupted somehow, if not by organized crime as DOJ/FBI report has occurred in other countries?
    The chairman and CEO of Morgan Chase is a member of the board of directors of the Federal Reserve Bank of New York, whose president was reportedly a player in the Federal Reserve’s deal with Morgan Chase. Major commercial and investment banks are principal shareholders of the Federal Reserve, so they are in positions of influence there. The same parties have influence at the SEC and the CFTC, although the influence is exerted in different ways.
    The U. S. financial system suffers from systemic rot at the highest levels. Without cures for ailments, symptoms can only worsen. If cures are undertaken, consequences for investors may be beneficial in the long term but volatile and damaging near term. If corrupt influences run to elective offices as well as appointive, as is surely the case, punishments may fall as heavily on the innocent as on the guilty. ~