October 13, 2005
Jim Sinclair
Refco's position as the largest independent derivative dealer with billions of dollars in customers' money, declared a moratorium on withdrawing assets or funds today. That's analogous to a run on the bank with your once friendly banker slamming the front door in your face.
This is a very serious situation, not so much because of the run but rather because the missing money has been replaced. What makes this aspect of the situation so serious - and why Refco must be rescued - is because it is the principle of many over-the-counter, unregulated, unfunded, unlisted and non-Clearing House guaranteed derivatives. If Refco folds up its tent, then the financial world folds. You can take that to a real bank.
Every time you rescue a financial entity, you pour more fuel on the fire that will ultimately consume the dollar. We are so battered by economic misconduct and flagrant abuses in the business world these days that there are few if any rescue options for what is approaching in the financial world.
Even with "stabilization" activities in world dollar markets today, the US dollar did not make the desired technical breakout but in fact closed on its low ˆ portending perhaps what's in store for tomorrow.
Larceny 102 (Of course Not Related to Today's Drama)
In Larceny 101 I have already discussed:
- How you would start an OTC derivative market for widgets or electricity futures.
- How you create false profits in Widgets Inc.
- Then using those false earnings, how you attract major Wall Street brokers to issue equity and debt to bring in billions to your company.
- Again utilizing the miracle of OTC derivatives, you back the majority of that money to 2000 straw partnerships of rented names, then to Pakistan and Middle East accounts controlled by the perpetrators.
- When the auditor catches on, you incinerate all your OTC derivative records.
- The public company then declares bankruptcy.
Larceny 102
Larceny 102 is a lesson in how to extract funds from a controlled fund into another account and then hide the act for years until somebody drops a dime on the Fed because they do not like you. This method is known as "Rolling Forward" by the means of "Switch Trading."
Because you can unethically write the OTC derivative at any price you want (since there are no regulations) it is easy to construct a balanced trade both long and short of the same item as an offsetting loss and gain maturing in the present year and a future year constructed at the exact same time. The more exotic the OTC derivatives are, the more difficult if not impossible it is for an auditor to put it all together.
Step #1: The trade is initiated both on the buy and the sell by the same source at the same moment.
Step #2: When you put in a transaction, the result is a loss into the account of the captured hedge fund and a profit into your own (camouflaged) account.
Step #3: Since you have established the profit in your account with the offsetting loss in the captured hedge fund account, you could now extract say $500 million from the fund and direct it to yourself. If the fund was doing quite well, you might simply give yourself a bonus of the fund's profit. However, let's assume the fund activity, profit or loss, is no factor. You now have a $500 million profit in your account and a loss for the fund of the same amount.
Step #4: You now set up another trade but for the fund itself. You arrange this by writing the OTC derivative, offsetting long and short so that you create a simultaneous $500 million profit in the fund account, say for 2003, and the loss side matures in 2004. You do the same thing again for 2005 and 2006. This is how you "Forward Roll" the loss in the fund, breaking it even on a continuing basis maybe forever or until you tick someone off who knows what you're doing. Clearly, you don't just do this in one transaction but perhaps for 10,000 transactions, with some winning and some losing, but the balance accomplishing what you want to do. The end result of these shenanigans is to take $500 million out of one pot and put it into your own pot, hiding the loss forever.
The more exotic you construct the derivative, the less chance there is that anyone can detect the evil deed.
Step #5: This cannot be accomplished by one person but requires others to assist in the construction. Step five is when you make someone in the transaction chain very angry. That person then trades immunity in exchange for blowing the whistle on you.
Step #6: You hire the best attorneys on the planet to get you out of trouble, having stolen enough to afford them.
Step #7: You now have a religious awakening, praying reverently that other similar transactions remain unnoticed.
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