Global financial speculation: the short-selling of America

Part 1 of 2 - The Problem

In 2008, hedge fund speculator John Paulson entered into a series of futures contracts to short sell billions of dollars worth of U.S. mortgage bonds and mortgage-backed securities.

This did not mean that he then actually owned what he contracted to sell at a future date. No, he was gambling on the assumption the real estate market was weakening, and in the interim the values of mortgage bonds and securities would decline, so that when the due date came to deliver billions worth of securities he would be able to buy those billions in the current spot market at a lower price. The price differential would be sheer profit to him — and it was, to the tune of several billion dollars of personal profit for Paulson. He could smile all the way to the bank.

This was the opposite of investment in the mortgage market. It was betting against that market. Meanwhile, no home-owner benefited from Paulson’s actions, which were perfectly legal. The weakened mortgage industry did not benefit. Nor did the U.S. government benefit.

Other investors in mortgage instruments lost billions. There was no discernible benefit to the market, to the real estate industry or to the nation. Paulson’s actions amounted to a short selling of America that led directly to the bursting of the real estate bubble and the launching of the global great recession which haunts us today.

It is generally recognized by economic experts that the great recession was essentially caused by three prior decades of (a) de-regulation, (b) excessive risk-taking and (c) questionable trading practices by the global financial investment community, notably the self-styled elites of what we euphemistically call Wall Street and the hedge fund industry.

What’s the problem? Well, malpractice is part of the problem, but truth in labeling is a major issue that goes essentially unregulated.

Other than Elizabeth Warren, few legal and economic experts have focused on the abusive, misleading and sometimes fraudulent nature of the actual products being traded back and forth by the global financial investment industry.

These products include everything from usurious credit cards to bundled mortgage-backed securities and various forms of so-called derivatives, including so-called credit default swaps, which are so convoluted that senior executives of banks and businesses that deal in these instruments, when called to testify before Congress, are totally incapable of defining, explaining or justifying the products.

Prior to 1949, hedge funds and derivatives didn’t even exist, yet America’s financial markets and industry boomed without them. Then Alfred Winslow Jones supposedly invented the hedge fund.

The twin hallmarks of the hedge fund were: (1) the creation of investments based on borrowing leverage and purchases on margin, often many times what the investor is worth, coupled with (2) short selling tantamount to betting against the investment item, be it stock, bond, currency or commodity, as a hedge against future failing value.

The truth is that most short sales are not hedges at all. Short sale betting against an investment contributes to weakening the investment item, so the investor can profit from everyone else’s loss in a down market.

Today some 10,000 hedge funds control about $2 trillion of such hedge investments with virtually no government regulation or oversight. In truth, the hedge-funders are engaged in a middle-man’s zero sum game, in the sense that every investment win is necessarily someone else’s loss (obviously, plus 1 minus 1 equals 0).

These transactions produce no jobs, no products and no services of social value, but they do generate tremendous risks for American taxpayers, other investors and working citizens. They create what could be called Ponzi piles of paper leading to bubbles that eventually, necessarily burst. Short selling actually contributes to the bust. Hedge funders make money betting against the economy, not only here in the United States but in foreign countries as well.

George Soros achieved both wealth and fame in 1992 when he bet the house and sold short some $10 billion worth of pounds sterling, which he didn’t actually own at the time. Soros correctly guessed that the British pound was weakening, so he calculated that he could enter a contract today to sell pounds ahead and tomorrow buy sterling in the spot market to meet that obligation, but at a lower price.

The price differential would be sheer profit for him — and it was. Everything Soros did was perfectly legal. In doing so, however, Soros’ gigantic bet against the pound helped further weaken that currency — a sort of self-fulfilling prophecy. So, he contributed still further to his own profit.

But this did not help banks and businesses that actually needed British pounds for commercial and other real purposes, and it temporarily destabilized the global currency exchange market.

Sharon resident Anthony Piel is a former director and general legal counsel of the World Health Organization.