How Short-Sellers Almost Destroyed U.S. Banking

Forget Bernard Madoff’s $50 billion fraud. The SEC, and the press, should be focused on short-sellers’ attempts to destroy the U.S. banking system, Cramer said.

Don’t believe him? Here are the hard numbers, courtesy of a source inside the New York Stock Exchange:

Just in the 12 days leading up to the Nov. 24 Citigroup bailout, short selling accounted for over 49% of the total trading volume in that company’s stock. For JPMorgan Chase, it was 41%. Bank of America: 35%. Goldman Sachs: 40%. Morgan Stanley: 37%. Wachovia: 42%. Wells Fargo: 42%.

As a result, these stocks tumbled anywhere between 69% and 27% over that time period – all because of huge volumes of short selling.

You have to remember that banking is a business built entirely on trust. When shareholders and customers see these stocks plummeting virtually without a bottom, then they pull their money, further exacerbating the problem. And you can see that play out in these financials right up to the Friday before the Citigroup bailout.

On four days in November – the 6th, 10th, 12th and 19th – the shorts accounted for at least 50% of Citi’s trading volume. On one day it was as high as 71%. In that time, the stock cut in half to $6.40. By then panic had set it, and regular investors started selling Citi en masse. In just one day – Nov. 20 to Nov. 21 – the amount of shares sold jumped 1.5 million and the stock finished its near month-long decline at $3.77.

See the pattern? Lack of proper regulation allows short-sellers to hammer down a stock, causing fear among regular investors and customers. These regular investors then continue the selling, further damaging the stock and making the short-sellers a lot of money. Citigroup wasn’t alone, either. This same game played out with JPMorgan, Bank of America and almost all the other big banks. Imagine what would have happened if the government didn’t step in on Monday, Nov. 24.

Cramer didn’t hesitate to point fingers at SEC Chairman Christopher Cox. It was Cox who repealed the uptick rule, which his exactly what’s allowed bear raiders to annihilate stocks. Until there’s a return to regulation on Wall Street, this kind of thing will continue to happen.

If Congress got a hold of these numbers, there’d be an immediate investigation, Cramer said. Because “this is a true scandal, and it came close to wrecking our financial system.”

Jim's charitable trust owns Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wachovia.

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