The Real AIG Scandal: How the Game Is Rigged at Wall Street's Casino

By Lucy Komisar, AlterNet. Posted March 26, 2009.

A newly released report from the Office of Inspector General revealed that the SEC received 5,000 complaints regarding naked short selling of stocks in 2007 and 2008, which led to zero enforcement actions by the SEC.

A Market Ripe for Fraud and Manipulation

Here’s how naked short selling relates to manipulation of CDSes. The face value of CDS contracts at one time was $60 trillion. Even Christopher Cox, who took no meaningful action on the matter as SEC chairman, got worried and acknowledged in testimony, "Holding a credit default swap is effectively, or nearly effectively, taking a short position in the underlying ... and because CDS buyers don’t have to own the bond or the debt instrument upon which the contract is based, they can effectively naked short the debt of companies without any restriction, potentially causing market disruption and destabilizing the companies themselves. This market is ripe for fraud and manipulation.

"This is a problem we have been dealing with, with our international regulatory counterparts around the world with straight equities (stock), and it’s a big problem in a market that has no transparency and people don’t know where the risk lies."

The most profit from these types of contracts is obtained if the security that is the asset for the contract declines to a price of zero. Derivative trades are often sham transactions between cooperating dealers designed solely for the purpose of creating shares to sell into the public market. Securities prices can be manipulated downward through naked short selling. Even though derivatives are unregulated transactions, the stock manipulation occurring from the sham transactions that create the naked short shares is regulated and is illegal under U.S. securities laws.

If the derivatives contracts were hedged with a short sale by the casino operators, they have already received profit from the sale of the securities they did not own.

Where Does the Money go?

Derivatives trades are generally accounted for by the big broker dealers (now getting taxpayer money) as "off balance sheet" transactions. They are hidden from regulators and investors, via special purpose entities (SPEs), which can be offshore and presumably are for the profit of elite special partners or clients of these same firms.

More Transparency Needed

So, we need to know about the claims AIG and others on Wall Street are paying out from taxpayer funds. Who made these derivative trades? Did they own the underlying assets or not? Did the parties that received money from the taxpayers write sham contracts to create shares to sell and then naked short sell securities they didn't own into the U.S. markets? Is AIG paying on "losses" for which no claims have yet been made?

Shouldn't Congress, the Fed -- which is overseeing AIG -- and law enforcement agencies be investigating these SPEs and the money they received? Shouldn't they investigate whether it was obtained illegally?

What if there are trillions of dollars in the special purpose entities that have been hidden for the benefit of a powerful few? Should the U.S. taxpayer come to the aid of the largest U.S. banks and brokerages that created these fancy off-balance-sheet financial instruments without full disclosure to at least one government agency of the monies in SPE accounts?  

How can Congress make intelligent regulation without understanding the scope of the problem and the trading techniques they are trying to regulate, which took down AIG and are destroying the economy -- especially the sham transactions designed for the purpose of creating shares of publicly traded companies?

Since Congress is so focused on Wall Street salaries and bonuses that compensate obscenely paid Wall Street executives, shouldn't it be asking if these titans of business have reaped financial rewards through the use of SPEs? Beyond that, were offshore SPEs used to avoid taxes or hide improper gains?

Why should we pay anything for the casino gambling debt? If there were illegal profits made on derivatives transactions that created sham shares sold into the marketplace, we should claw back that money, which could amount to a lot more than the bonuses paid to AIG officials.

See more stories tagged with: deregulation, financial crisis, aig, derivitaves

Lucy Komisar is an investigative journalist who focuses on offshore and financial corruption. Her articles are posted at the Komisar Scoop.

Liked this story? Get top stories in your inbox each week from AlterNet! Sign up now »