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Failure To Deliver (FTD) - Where are the stocks? (Kor sub) - YouTube
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how do stocks trade grandma on the left
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has savings the fellow on the right has
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stock grandma's going to buy the stock
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but her savings the money in stock has
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to change hands that's called settlement
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in most countries they change hands two
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or three days after the trade that's
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called t plus two or t plus three
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and importantly
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the
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money and stock change hands
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simultaneously
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in the u.s however while we operate on a
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t plus three system the mechanisms for
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exchanging money and stock have become
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divorced so it's possible for money to
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settle whether or not the stock settles
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in reality grandmas aren't calling
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strangers making stock deals we have
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stock brokers stock brokers work uh in
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places called broker dealers or bds
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merrill lynch goldman sachs bear stearns
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e-trade they're all bds
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all represent them as blue circles
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there are about 2 000 of them in this
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country arranged in a hub and spoke
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system around a central organization
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called the depository trust and clearing
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corporation also called the dtcc the
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dtcc acts as a central back office for
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wall street where three days after trade
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uh when it's time for money and stock to
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settle that it settles at the dtcc
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how does it settle trades can be settled
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through the dtcc
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in reality however settlement usually
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occurs within the dtcc grandma's talking
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to her broker the fellow on the right
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talked to his these brokerage houses
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have accounts at the dtcc and when their
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customers are trading out at the spokes
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what really happens is the money in
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stock shift around within accounts at
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the dtcc
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there is also something called x
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clearing that's when two broker dealers
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settle directly with each other external
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to the dtcc
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2.5 billion shares per day trade on a
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new york stock exchange and nasdaq these
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trades settle through the dtcc within
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the dtcc and back and forth directly
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among broker dealers by x clearing
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let's get back to our simplified system
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of grandma on a stock seller and see how
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the system handles delays suppose they
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do a trade when it's time to settle
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grandma's money settles through the
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system but something comes up that
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blocks the fellow from settling his
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shares through the system there could be
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all kinds of legitimate problems he
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might be using paper stock and it's
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stuck in a bank vault or it's at home
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lost in the closet or something maybe he
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signed the wrong piece of paper on some
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form for one reason another he can't
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settle the trade and you don't want the
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system to just grind to a halt so the
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system creates an iou but note it's not
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an iou for money it's an iou for stock
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it gets sent through the system
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grandma doesn't see that as anything
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other than normal stock her brokerage
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account says that
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she holds stock not an iou for stock in
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most respects the whole system just sees
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this as normal stock it's only in the
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back offices that keep track of what's a
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iou and what is
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assuming that on day t plus four t plus
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five the blockage clears up the fellow
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is able to send his stock through the
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system and he wipes out his iou
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great
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imagine however that a guy shows up who
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wants to game the system taking
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advantage of this loophole i just
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described he's a villain or a miss grant
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i paint his desk red to remind to remind
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you he's a miss grant he performs a
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trade with grandma three days later her
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money comes through the system but he
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says you know what something's blocking
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me from sending my share she creates an
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iou and sends it through the system
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does it again
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and again
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and again
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but imagine he doesn't really have a
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blockage keeping him from settling his
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shares like maybe he doesn't have any
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stock
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what he's doing is gaming the settlement
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system so that he ends up with grandma's
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money and all he's done is issue some
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stock i used to grandma
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he's failed to deliver the stock that he
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sold that's a strategic failure to
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deliver it's strategic in the sense of
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deliberate
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it's not an honest error he just
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exploded loophole
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and in 2006 people are saying naked
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short selling and they're saying
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fraudulent stock transfer
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there's subtle differences but the
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common denominator is that the ious are
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not sincere ious they were strategically
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created i'm going to mark them as ftds
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for failure to deliver and paint them as
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red just to make them easier to trap
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how does this look at our hub and spoke
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system notice the miss grin on the right
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has the red desk i'm going to paint the
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his bd red 2 to signify that the bd
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might be a crook like his clan or maybe
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the bd is the crook maybe the bd's
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honest
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but it's a broker who turns a blind eye
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to his miss grant client because the
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client is a big hedge fund that gives
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him millions of dollars a month in
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commission
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so
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uh he starts trading with grandma the
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ftds flow through the dtcc and bounced
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around within the dtcc
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uh if say for every hundred legitimate
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shares there's one ftd the system is
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going to keep on working it's not going
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to ground to a hole but if we ever reach
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the point where for every 100 legitimate
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shares there's 50 or 100 or 200 of these
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ftd's it'll become like sand and the
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economic and the bearings of the
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economic engine
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now look at the effect on a company i'll
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show you
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basic supply and demand curves imagine
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there's a stock with a certain amount of
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demand out there certain amount of
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supply and the point where they meet is
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forty dollars the miss grant shows up
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and starts gaming the system
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he sends out ftds since the system sees
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these fpd's as normal stock he's
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increasing the supply of stock of a
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parent stock and when you increase
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supply you shift the supply curve to the
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right
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he does it again generating ftds
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shifting the supply line to the right as
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he goes
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eventually he shifts the supply line far
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to the right
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now notice where
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the supply and demand lines cross
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of course the price collapses the 40
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stock turns into a penny stock most
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investors think penny stocks are the
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wild west they stay away so demand dries
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up as demand dries up the ceiling forms
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over the stock the ftds in the upper
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right
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started off life as stock ious and
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sincere stock ius but i used just the
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same now that it's a penny stock these
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ftds become penny ious penny stock penny
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ious
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the fellow at the right has the money
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the firm's a penny stock a vicious cycle
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ensues where the company collapses other
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businesses stay
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away from the firm they say geez penny
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stock is it going to be around they
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stopped doing business capital markets
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shun the firm
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if you're a penny stock you can't go
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into the world and raise capital
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so as it loses customers and can't
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access the market it can't recover
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society loses the products and
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technologies that were offered and
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because the companies that come under
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these kinds of attacks are often
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software and small pharmaceutical
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companies and high-tech companies
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because it's possible to create the most
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confusion about them
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so
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when the next microsoft or genentech is
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destroyed society loses those
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technologies
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shareholder value is wiped out jobs are
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destroyed not just those today but those
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that the company would have created over
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its life cycle had it not been strangled
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in its crib
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and ironically the miscreant keeps his
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cash and often does not even pay taxes
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for an arcane reason i won't go into
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here but he generally gets away without
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paying taxes
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now consider a scarier question what
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does the situation look like if there's
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not just shorting but naked shorting
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remember our miscrit
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let's assume he generated millions of
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ftds into the system what does his
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squeeze look like
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if shooting his gun on this not just the
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normal borrowing and then shorting of
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stock but naked shorting it's been
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scattering these ftd's all over the
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system when the fellow goes to cover
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there are more ftds in the system than
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there is real stock to be bought
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so she tries to buy stock to deliver
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against his short he gets in trouble
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the supply and demand lines shift so far
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that they don't meet anymore there is no
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market price the market snaps that's
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volatility that's what the sec wants to
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avoid
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why
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remember that a lot of this money isn't
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in the system anymore because as the
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price went down the miss grant was able
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to withdraw his money out of his short
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position
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so that money's been turned into
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mansions and ferraris in the hamptons
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and in greenwich connecticut
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and in any case perhaps enough ftds have
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been issued that the squeeze would take
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the price far beyond where the price was
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when the shorting occurred so that it
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will take more money to cover than was
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taken out of the short position
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if this fellow is forced to cover he'll
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use all his money covering a fraction of
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the failures
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but he's going to run out of money
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before he runs out of irus to cover so
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he's gone
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the broker dealer could be in the same
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situation
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in fact if a buy-in really occurs the
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price could high enough that there'd be
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more ftds in the system than liquidity
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in the system
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in which case you would see a wave of
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failures move through the system like
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this
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i know that sounds crazy systemic
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failures like that don't happen right
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well they did with the snl's 15 years
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ago but this couldn't happen with wall
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street right
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