The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

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By Ellen Brown / Original to ScheerPost
February 14, 2024

This is a sequel to a Jan. 15 article titled “Casino Capitalism and the Derivatives Market: Time for Another ‘Lehman Moment’?”, discussing the threat of a 2024 “black swan” event that could pop the derivatives bubble. That bubble is now over ten times the GDP of the world and is so interconnected and fragile that an unanticipated crisis could trigger the collapse not just of the bubble but of the economy. To avoid that result, in the event of the bankruptcy of a major financial institution, derivative claimants are put first in line to grab the assets — not just the deposits of customers but their stocks and bonds. This is made possible by the Uniform Commercial Code, under which all assets held by brokers, banks and “central clearing parties” have been “dematerialized” into fungible pools and are held in “street name.”

This article will consider several proposed alternatives for diffusing what Warren Buffett called a time bomb waiting to go off. That sort of bomb just detonated in the Chinese stock market, contributing to its fall; and the result could be much worse in the U.S., where the stock market plays a much larger role in the economy.

The Chinese Derivative Crisis

A January 30th article on Bloomberg News notes that “Chinese stocks’ brutal start to the year is being at least partly blamed on the impact of a relatively new financial derivative known as a snowball. The products are tied to indexes, and a key feature is that when the gauges fall below built-in levels, brokerages will sell their related futures positions.”

Further details are in a January 23^rd article titled “’Snowball’ Derivatives Feed China’s Stock Market Avalanche.” It states, “China’s plunging stock market is leading to losses on billions of dollars worth of derivatives linked to the country’s equity indexes, fueling further selling as retail investors offload their positions…. Snowball products are similar to the index-linked products sold in the 2008 financial crisis, with investors betting that U.S. equities would not fall more than 25% or 30%,” which they did.

Chinese shares rose on February 6, as officials took measures to prop up the ailing market, including imposing new “zero tolerance” curbs for malicious short selling.

The Greater U.S. Threat

The Chinese stock market is much younger and smaller than that in the U.S., with a much smaller role in the economy. Thus China’s economy remains relatively protected from disruptive ups and downs in the stock market. Not so in the U.S., where speculating in the derivatives casino brought down international insurer AIG and investment bank Lehman Brothers in 2008, triggering the global financial crisis of 2008-09. AIG had to be bailed out by the taxpayers to prevent collapse of the too-big-to-fail derivative banks, and Lehman Brothers went through a messy bankruptcy that took years to resolve.

In a December 2010 article on Seeking Alpha titled “Derivatives: The Big Banks’ Quadrillion-Dollar Financial Casino,” attorney Michael Snyder wrote, “derivatives were at the heart of the financial crisis of 2007 and 2008, and whenever the next financial crisis happens, derivatives will undoubtedly play a huge role once again…. Today, the world financial system has been turned into a giant casino where bets are made on just about anything you can possibly imagine, and the major Wall Street banks make a ton of money from it. The system … is totally dominated by the big international banks.”

The Speculators Dominate the Regulators

In a 2009 Cornell Law Faculty publication titled How Deregulating Derivatives Led to Disaster, and Why Re-Regulating Them Can Prevent Another, Prof. Lynn Stout proposed stabilizing the market by returning to 20^th century derivative rules. She noted that derivatives are basically wagers or bets, and that before 2000, the U.S. and U.K. regulated derivatives primarily by a common‐law rule known as the “rule against difference contracts.” She explained:

The rule against difference contracts did not stop you from wagering on anything you liked: sporting contests, wheat prices, interest rates. But if you wanted to go to a court to have your wager enforced, you had to demonstrate to a judge’s satisfaction that at least one of the parties to the wager had a real economic interest in the underlying and was using the derivative contract to hedge against a risk to that interest.… Using derivatives this way is truly hedging, and it serves a useful social purpose by reducing risk.

… Under the rule against difference contracts and its sister doctrine in insurance law (the requirement of “insurable interest”), derivative contracts that couldn’t be proved to hedge an economic interest in the underlying were deemed nothing more than legally unenforceable wagers.

Hedge funds, for example, should really call themselves “speculation funds,” as it is quite clear they are using derivatives to try to reap profits at the other traders’ expense.

The rule against difference contracts died in 2000, when the US embraced wholesale deregulation with the passage of the Commodity Futures Modernization Act (CFMA):

The CFMA not only declared financial derivatives exempt from CFTC or SEC oversight, it also declared all financial derivatives legally enforceable. The CFMA thus eliminated, in one fell swoop, a legal constraint on derivatives speculation that dated back not just decades, but centuries. It was this change in the law—not some flash of genius on Wall Street—that created today’s $600 trillion financial derivatives market.

The Casino Gets Special Privileges

Not only are speculative derivatives now legally enforceable, but under the Bankruptcy Act of 2005, derivative securities enjoy special protections. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Similarly, under the Dodd Frank Act of 2010, derivative claimants have “super-priority” in the bankruptcy of a financial institution. They are privileged to claim collateral immediately without judicial review, before bankruptcy proceedings even begin. Depositors become “unsecured creditors” who can recover their funds only after derivative, repo and other secured claims, assuming there is anything left to recover, which in the event of a major derivative crisis would be unlikely. 

That’s true not only of the deposits in a bankrupt bank but of stocks, bonds and money market funds held by a broker/dealer that goes bankrupt. Under the Bankruptcy Act of 2005 and Sections 8 and 9 of the Uniform Commercial Code (UCC), “safe harbor” is provided to entities described in court documents as “the protected class.” The customers who purchased the assets have only a “security entitlement,” a weak contractual claim to a pro rata share of a residual pool of fungible assets all held in the name of Cede & Co., the proxy of the Depository Trust and Clearing Corp. (DTCC). As Wall Street financial analyst John Rubino put it in a Jan. 27 podcast:

What we used to think of as a bank bail-in where they take your deposit in order to support a failing bank, that is now spread across the entire financial economy where whatever you have in an account anywhere can just disappear, because they’re going to transfer ownership of it to these big dominant entities out there in the financial system that need those assets in order to keep from blowing up.

Derivative speculators are considered “secured” because they post a portion of what they could wind up owing as “margin,” but why that partial security is superior to the 100% security posted by the depositor or purchaser is not explained. The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

The Solution of the Regulators

The fix of the G20 leaders following the global financial crisis, however, was to force banks to clear over-the-counter derivatives through central counterparties (CCPs), which stand between buyer and seller and protect either party if the other blows up. By March 2020, 60% of credit default swaps and 80% of interest rate swaps were centrally cleared. The problem, as noted in a December 2023 publication by the Bank for International Settlements, is that these measures taken to protect the system can actually amplify risk.

CCPs tend to ask for more collateral than banks did in the pre-crisis world; and when a CCP hikes its initial margin requirement to cover the risk of default, this applies to everyone in the market, meaning cash calls are synchronized. As explained in a May 2022 Reuters article:

It’s logical that CCPs ask for more collateral during a panic: that’s when defaults are most likely. The problem is that margin calls seem to have made things worse. In March 2020, for example, a so-called “dash for cash” saw investors liquidate even prime money-market funds and U.S. Treasury securities.

… [R]ampant margin calls have intensified a financial panic twice in as many years, with central banks effectively bailing out markets in 2020. That’s better than in 2008, when taxpayers had to step in. But the problem of margin calls remains unsolved.

… Central counterparty (CCP) clearing houses should consider asking clients for more collateral during good times to reduce the risk of destabilising margin calls during a financial panic, a Bank of England official said on May 19.

Yet all this, as Michael Snyder observes, is to allow the big international banks to run the largest derivatives casino that the world has ever seen. Why not just shut down the casino? Prof. Stout’s suggested solution is for Congress to return to the pre-2000 rule under which speculative derivative bets were not enforceable in court. That would include reversing the “superpriority” privileges in the Bankruptcy Act of 2005 and the Dodd-Frank Act. But it won’t be a quick fix, as Wall Street and our divided Congress can be expected to put up a protracted fight.

What If the DTCC Goes Bankrupt?

In a 2015 law review article titled “Failure of the Clearinghouse: Dodd-Frank’s Fatal Flaw?,” Prof. Stephen Lubben points to a more ominous risk from pushing all derivatives onto exchanges; and that concern is shared by former hedge fund manager David Rogers Webb in his 2024 book “The Great Taking.” The exchanges are supposed to be safer than private over-the-counter trades because the exchange steps in as market maker, accepting the risk for both sides of the trade. But in a general economic depression, the exchanges themselves could go bankrupt. No provision for that is made in the Dodd-Frank Act, which purports to decree “no more bailouts.” Still, reasons Prof. Lubben, the government would undoubtedly step in to save the market from collapse.

His proposed solution is for Congress to make legislative provision for nationalizing any bankrupt exchange, brokerage or Central Clearing Counterparty before it fails. This is something to which our gridlocked Congress might agree, since under current circumstances it would not involve any major changes, wealth confiscation or new tax burdens; and it could protect their own fortunes from confiscation if the DTCC were to go bankrupt.

Other Possible Federal Solutions

Another alternative that not only could work but could fix Congress’s budget problems at the same time is to impose a 0.1% tax on all financial transactions. See Scott Smith, A Tale of Two Economies: A New Financial Operating System, showing that U.S. financial transactions (the financialized economy) are over $7.6 quadrillion, more than 350 times the U.S. national income (the productive economy). See my earlier article summarizing all that here. On a financial transaction tax curbing speculation in derivatives, see also here, here and here.

There are other possible solutions to customer title concerns. There is no longer a need for the archaic practice of holding all securitized assets in the street name of Cede & Co. The digitization of stocks and bonds was a reasonable and efficient step in the 1970s, but today digital cryptography has gotten so sophisticated that “smart contracts” can be attached by blockchain-like distributed ledger technology (DLT) to digital assets, tracking participants, dates, terms and other contractual details. The states of Delaware and Wyoming have explored maintaining corporate lists of stockholders on a state-run blockchain; but predictably, the measures were opposed. The practice of holding assets in street name has proven very lucrative for the DTCC’s member brokers and banks, as it facilitates short selling and the “rehypothecation” of collateral.

In October 2023, the DTCC reported that it has been exploring adopting DLT; but the goal seems only to be speedier and safer trades. No mention was made of returning registered title to the purchasers of the traded assets, which could be done with distributed ledger technology.

South Dakota’s Innovative Solution

The most readily achievable solution is probably that in a South Dakota bill filed on Jan. 29.  The bill is detailed in a Feb. 2 article titled “You Could Lose Your Retirement Savings in the Next Financial Crash Unless Others Follow This State’s Lead”, which observes:

… [I]f your broker … were to go bankrupt, the broker’s secured creditors (the people to whom the broker owes money) would be empowered to take the investments that you paid for in order to settle outstanding debts….

To avoid a catastrophe in the future, a nationwide movement is desperately needed to alter the existing Uniform Commercial Code. Of course, that won’t be easy to accomplish, especially because bank lobbyists and other powerful financial interests will almost certainly fight kicking and screaming to stop policymakers from taking away their advantage over consumers.

The good news is, this “great taking” can be stopped at the state level. Americans don’t need to count on a divided Congress to get the job done. Because the UCC is state law, state lawmakers can take concrete steps to restore the property rights of their constituents and protect them in the event of a financial crisis.

On Monday, South Dakota legislators introduced a bill that would do just that. The legislation would ensure that individual investors have priority over securities held by brokerage firms and other intermediaries.

It would also alter jurisdictional provisions so that cases are determined in the state of the individual investor, rather than the state of the broker, custodian or clearing corporation. This would ensure that individual investors are able to rely on the laws of their local state.

Hopefully, other states will follow South Dakota’s lead. Tennessee, for one, is reported to have such a bill in the works.

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Ellen Brown is a regular contributor to ScheerPost. She is an attorney, founder of the Public Banking Institute, and author of thirteen books including the best-selling Web of Debt. Her latest book is Banking on the People: Democratizing Money in the Digital Age and her 400+ blog articles are at EllenBrown.com.

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By Ellen Brown / Original to ScheerPost

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Reading the tea leaves for the 2024 economy is challenging. On January 5^th, Treasury Secretary Janet Yellen said we have achieved a “soft landing,” with wages rising faster than prices in 2023. But critics are questioning the official figures, and prices are still high. Surveys show that consumers remain apprehensive.

There are other concerns. On Dec. 24, 2023, Catherine Herridge, a senior investigative correspondent for CBS News covering national security and intelligence, said on “Face the Nation,” “I just feel a lot of concern that 2024 may be the year of a black swan event. This is a national security event with high impact that’s very hard to predict.”

What sort of event she didn’t say, but speculations have included a major cyberattack; a banking crisis due to a wave of defaults from high interest rates, particularly in commercial real estate; an oil embargo due to war. Any major black swan could prick the massive derivatives bubble, which the Bank for International Settlements put at over one quadrillion (1,000 trillion) dollars as far back as 2008. With global GDP at only $100 trillion, there is not enough money in the world to satisfy all these derivative claims. A derivative crisis helped trigger the 2008 banking collapse, and that could happen again.

The dangers of derivatives have been known for decades. Warren Buffett wrote in 2002 that they were “financial weapons of mass destruction.” James Rickards wrote in U.S. News & World Report in 2012 that they should be banned. Yet Congress has not acted. This article looks at the current derivative threat, and at what might motivate our politicians to defuse it.

What Regulation Hath Wrought

Derivatives are basically just bets, which are sold as “insurance” — protection against changes in interest rates or exchange rates, defaults on loans and the like. When one of the parties to the wager has a real economic interest to be protected – e.g. a farmer ensuring the value of his autumn crops against loss — the wager is considered socially valuable “hedging.” But most derivative bets today are designed simply to make money from other traders, degenerating into what has been called “casino capitalism.”

In 2008, derivative trading brought down investment bank Bear Stearns and international insurer A.I.G. Both institutions could not be allowed to fail, because the trillions of dollars in credit default swaps on their books would have been wiped out, forcing their counterparty banks and financial institutions to write down the value of their own risky and now “unhedged” loans. Bear and A.I.G. were bailed out by the taxpayers; but the Treasury drew the line at Lehman Brothers, and the market crashed.

Under the rubric of “no more bailouts,” the Dodd Frank Act of 2010 purported to fix the problem by giving derivatives special privileges. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Counterparties owed collateral can grab it immediately without judicial review, before bankruptcy proceedings even begin. Depositors become “unsecured creditors” who can recover their funds only after derivative, repo and other secured claims, assuming there is anything left to recover, which in the event of a major derivative crisis would be unlikely. We saw this “bail-in” policy play out in Cyprus in 2013.

That’s true for deposits, but what of stocks, bonds and money market funds? Under the Uniform Commercial Code (UCC) and the Bankruptcy Act of 2005, derivative securities also enjoy special protections. “Safe harbor” is provided to privileged entities described in court documents as “the protected class.” Derivatives enjoy “netting” and “close-out” privileges on the theory that they are a major source of systemic risk, and that allowing claimants to jump ahead of other investors in order to net and close out their bets reduces that risk. However, critical analysis has shown that derivative “super-priority” in bankruptcy can actually increase risk and propel otherwise viable financial entities into insolvency.

It is also highly inequitable. The collateral grabbed to close out derivative claims may be yourstocks and bonds. In a 2016 American Banker article called “You Don’t Really Own Your Securities; Can Blockchains Fix That?”, journalist Brian Eha explained:

In the United States, publicly traded stock does not exist in private hands.

It is not owned by the ostensible owners, who, by virtue of having purchased shares in this or that company, are led to believe they actually own the shares. Technically, all they own are IOUs. The true ownership lies elsewhere.

While private-company stock is still directly owned by shareholders, nearly all publicly traded equities and a majority of bonds are owned by a little-known partnership, Cede & Co., which is the nominee of the Depository Trust Co., a depository that holds securities for some 600 broker-dealers and banks. For each security, Cede & Co. owns a master certificate known as the “global security,” which never leaves its vault. Transactions are recorded as debits and credits to DTC members’ securities accounts, but the registered owner of the securities — Cede & Co. — remains the same.

What shareholders have rather than direct ownership, then, “is a [contractual] right against their broker…. The broker then has a right against the depository institution where they have membership. Then the depository institution is beholden to the issuer. It’s [at least] a three-​step process before you get any rights to your stock.”This attenuation of property rights has made it impossible to keep perfect track of who owns what.

Fifty Years of “Dematerialization”

In a 2023 book called The Great Taking (available for free online), Wall Street veteran David Rogers Webb traces the legislative history of these developments. The rules go back 50 years, to when trading stocks and bonds was done by physical delivery – shuffling paper certificates bearing titles in the names of the purchasers from office to office. In the 1970s, this trading became so popular that the exchanges could not keep up, prompting them to turn to “dematerialization” or digitalization of the assets. The Depository Trust Company (DTC) was formed in 1973 to alleviate the rising volumes of paperwork. The DTCC was established in 1999 as a holding company to combine the DTC and the National Securities Clearing Corporation (NSCC).

The DTCC is a central clearing counterparty (CCP) sitting at the top of a pyramid of banks, brokers and exchanges. All have agreed to hold their customers’ assets in “street name,” collect those assets in a fungible pool, and forward that pool to the DTCC, which then trades pooled blocks of stock and bonds between brokers and banks in the name of its nominee Cede & Co. The DTCC, a private corporation, owns them all. This is not a mere technicality. Courts have upheld its legal ownership, even in a dispute with client purchasers. According to the DTCC website, it provides settlement services for virtually all equity, corporate and municipal debt trades and money market instruments in the U.S., and central safekeeping and asset servicing for securities issues from 131 countries and territories, valued at $37.2 trillion. In 2022 alone, the DTCC processed 2.5 quadrillion dollars in securities.

The governing regulations are set out in Uniform Commercial Code (UCC) sections 8 and 9, covering investment securities and secured transactions. The UCC is a set of rules produced by private organizations without an act of Congress. It is not itself the law but is only a recommendation of the laws that states should adopt; but the UCC has now been adopted by all 50 U.S. states and has been “harmonized” with the rules for trading securities in Europe and most other countries.

The Wikipedia summary of the relevant UCC provisions concludes:

The rights created through these links [up the collateral chain] are purely contractual claims ….  This decomposition of the rights organized by Article 8 of the UCC results in preventing the investor to revindicate [demand or take back] the security in case of bankruptcy of the account provider [the broker or bank], that is to say the possibility to claim the security as its own asset, without being obliged to share it at its prorate value with the other creditors of the account provider.

You, the investor, have only a contractual claim against your broker, who no longer holds title to your stock either, since title has been transferred up the chain to the DTCC. Your contractual claim is only to a pro rata share of a pool of the stock designated in street name, title to which is held by Cede & Co.

Rehypothecation: The Problem of Multiple Owners

The Wikipedia entry adds:

This re-characterization of the proprietary right into a simple contractual right may enable the account provider [the “intermediary” broker or bank] to “re-use” the security without having to ask for the authorization of the investor. This is especially possible within the framework of temporary operations such as security lending, option to repurchase, buy to sell back or repurchase agreement.

“Security lending” by your broker or other intermediary may include lending your stock to short sellers bent on bringing down the value of the stock against your own financial interests. Illegal naked short selling is also facilitated by the impenetrable shield of the DTCC, and so is lending to “shadow banks” for the re-use of collateral. As Caitlin Long, another Wall Street veteran, explains:

 [T]he shadow banking system’s lifeblood is collateral, and the issue is that market players re-use that same collateral over, and over, and over again, multiple times a day, to create credit. The process is called “rehypothecation.” Multiple parties’ financial statements therefore report that they own the very same asset at the same time. They have IOUs from each other to pay back that asset—hence, a chain of counterparty exposure that’s hard to track. Although improving, there’s still little visibility into how long these “collateral chains” are.

It is this reuse of the collateral to back multiple speculative bets that has facilitated the explosion of the derivatives bubble to ten times the GDP of the world. It should be the collateral of the actual purchaser, but you, the purchaser, are at the bottom of the collateral chain. Derivative claims have super priority in bankruptcy, ostensibly because the derivative edifice is so risky that their bets need to be cleared.

What About the “Customer Protection Rule”?

Broker-dealers argue that their customers’ assets are protected under the “Customer Protection Rule” of the Securities Investor Protection Corporation (SIPC). The SIPC provides insurance for stocks similar to FDIC insurance for bank deposits, maintaining a pool that can be tapped in the event of a member bankruptcy. But a 2008 memorandum on The Customer Protection Rule from the law firm Willkie Farr & Gallagher asserts:

With respect to cash and securities not registered in the name of the customer, but held by the broker- dealer for the customer’s benefit, the customer would receive a pro rata portion of the aggregate amount of the cash and securities actually held by the broker- dealer. If there is a remaining shortfall, SIPC would cover a maximum of $ 500,000, only $ 100,000 of which may be a recovery for cash held at the broker- dealer.

… [M]ost securities are held by broker-dealers in street name and would be available to satisfy other customers’ claims in the event of a broker- dealer’s insolvency.

If the member has a large derivatives book (JPMorgan holds $54.4 trillion in derivatives and a mere $3.4 trillion in assets), derivative customers with priority could wipe out the pool and the SIPC fund as well.

What Webb worries about, however, is the bankruptcy of the DTCC itself, which could wipe out the entire collateral chain. He says the DTCC is clearly under-capitalized, and that the startup of a new Central Clearing Counterparty is already planned and pre-funded. If the DTCC fails, certain protected creditors can take all the collateral, upon which they will have perfected legal control.

Defensive Measures

In the event of a cyberattack that destroys the records of banks and brokers, there could be no way for purchasers to prove title to their assets; and in the event of a second Great Depression, with a wave of 1930s-style bank bankruptcies, derivative claimants with super-priority can take the banks’ assets without going through bankruptcy proceedings. In today’s fragile economy, these are not remote hypotheticals but are real possibilities, which can wipe out not just the savings of middle class families but the fortunes of billionaires.

And there, argues Webb, is our opportunity. The system by which Cede & Co. holds title to all “dematerialized” securities is clearly vulnerable to being exploited by “the protected class,” and Congress could mitigate those concerns by legislation. If our representatives realized that they are not the owners of record of their assets but are merely creditors of their brokers and banks, they might be inspired to hold some hearings and take action.

The first step is to shine a light on the obscure hidden workings of the system and the threat they pose to our personal holdings. Popular pressure moves politicians, and the people are waking up to many issues globally, with protests on the rise everywhere — economic, political and social. Possible action that could be taken by Congress includes reversing the “special privileges” granted to the derivatives casino in the form of “super priority” in bankruptcy. A 0.1% Tobin tax or financial transaction tax is another possibility. For protecting title to assets, blockchain is a promising tool, as discussed by Brian Eha in the American Banker article quoted above. These and other federal possibilities, along with potential solutions at the local level, will be the subject of a followup article.

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Posted on October 3, 2023 by Ellen Brown

“’You’ll own nothing and be happy’? David Webb has gone through the 50-year history of all the legal constructs that have been put in place to technically enable that to happen.” [Oct 2 interview titled “The Great Taking: Who Really Owns Your Assets?”]

The derivatives bubble has been estimated to exceed one quadrillion dollars (a quadrillion is 1,000 trillion). The entire GDP of the world is estimated at $105 trillion, or 10% of one quadrillion; and the collective wealth of the world is an estimated $360 trillion. Clearly, there is not enough collateral anywhere to satisfy all the derivative claims. The majority of derivatives now involve interest rate swaps, and interest rates have shot up. The bubble looks ready to pop.

Who were the intrepid counterparties signing up to take the other side of these risky derivative bets? Initially, it seems, they were banks –led by four mega-banks, JP Morgan Chase, Citibank, Goldman Sachs and Bank of America. But according to a 2023 book called The Great Taking by veteran hedge fund manager David Rogers Webb, counterparty risk on all of these bets is ultimately assumed by an entity called the Depository Trust & Clearing Corporation (DTCC), through its nominee Cede & Co. (See also Greg Morse, “Who Owns America? Cede & DTCC,” and A. Freed, “Who Really Owns Your Money? Part I, The DTCC”).  Cede & Co. is now the owner of record of all of our stocks, bonds, digitized securities, mortgages, and more; and it is seriously under-capitalized, holding capital of only $3.5 billion, clearly not enough to satisfy all the potential derivative claims. Webb thinks this is intentional.

What happens if the DTCC goes bankrupt? Under The  Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, derivatives have “super-priority” in bankruptcy. (The BAPCPA actually protects the banks and derivative claimants rather than consumers; it was the same act that eliminated bankruptcy protection for students.) Derivative claimants don’t even need to go through the bankruptcy court but can simply nab the collateral from the bankrupt estate, leaving nothing for the other secured creditors (including state and local governments) or the banks’ unsecured creditors (including us, the depositors). And in this case the “bankrupt estate” – the holdings of the DTCC/Cede & Co. – includes all of our stocks, bonds, digitized securities, mortgages, and more.

It sounds like conspiracy theory, but it’s all laid out in the Uniform Commercial Code (UCC), tested in precedent, and validated by court rulings. The UCC is a privately-established set of standardized rules for transacting business, which has been ratified by all 50 states and includes key provisions that have been “harmonized” with the laws of other countries in the Western orbit. The UCC makes boring reading and is anything but clear, but Webb has diligently picked through the obscure legalese and demonstrates that the amorphous “they” have it all locked up. They can take everything in one fell swoop, without even going to court. Ideally, we need to get Congress to modify some laws, beginning with the super-priority provisions of the Bankruptcy Law of 2005. Even billionaires, notes Webb, are at risk of losing their holdings; and they have the clout to take action.

About The Great Taking and Its Author

As detailed in the introduction, “David Rogers Webb has deep experience with investigation and analysis within challenging and deceptive environments, including the mergers and acquisitions boom of the 80’s, venture investing, and the public financial markets. He managed hedge funds through the period spanning the extremes of the dot-com bubble and bust, producing a gross return of more than 320% while the S&P 500 and the NASDAQ indices had losses. His clients included some of the largest international institutional investors.”

A lengthy personal preface to the book not only establishes these bona fides but tells an interesting story concerning his family history and the rise and fall of his home city of Cleveland in the Great Depression.

As for what the book is about, Webb summarizes in the introduction:

“It is about the taking of collateral (all of it), the end game of the current globally synchronous debt accumulation super cycle. This scheme is being executed by long-planned, intelligent design, the audacity and scope of which is difficult for the mind to encompass. Included are all financial assets and bank deposits, all stocks and bonds; and hence, all underlying property of all public corporations, including all inventories, plant and equipment; land, mineral deposits, inventions and intellectual property. Privately owned personal and real property financed with any amount of debt will likewise be taken, as will the assets of privately owned businesses which have been financed with debt. If even partially successful, this will be the greatest conquest and subjugation in world history.”

You might have to read the book to be convinced, but it is not long, is available free on the Net, and is heavily referenced and footnoted. I will try to summarize his main points, but first a look at the derivatives problem and how it got out of hand.

The Derivative Mushroom Cloud

A “financial derivative” is defined as “a security whose value depends on, or is derived from, an underlying asset or assets. The derivative represents a contract between two or more parties and its price fluctuates according to the value of the asset from which it is derived.”

Warren Buffett famously described derivatives as “weapons of financial mass destruction,” but they did not start out that way. Initially they were a form of insurance for farmers to guarantee the price of their forthcoming crops. In a typical futures contract, the miller would pay a fixed price for wheat not yet harvested. The miller assumed the risk that the crops would fail or market prices would fall, while the farmer assumed the risk that prices would rise, limiting his potential profit.

In either case, the farmer actually delivered the product, or so much of it as he produced. The derivatives market exploded when speculators were allowed to bet on the rise or fall of prices, exchange rates, interest rates and other “underlying assets” without actually owning or delivering the “underlying.” Like at a race track, bets could be placed without owning the horse, so there was no limit to the potential number of bets. Speculators could “hedge their bets” by selling short — borrowing and selling stock or other assets they did not actually own. It was a form of counterfeiting that not only diluted the value of the “real” stock but drove down the stock’s price, in many cases driving the company into bankruptcy, so that the short sellers did not have to cover or “deliver” at all (called “naked shorting”). This form of gambling was allowed and encouraged due to a number of regulatory changes, including the Commodity Futures Modernization Act of 2000 (CFMA), repealing key portions of the Glass-Steagall Act separating commercial from investment banking; the Bankruptcy Law of 2005, guaranteeing recovery for derivative speculators; and the lifting of the uptick rule, which had allowed short selling only when a stock was going up.

Enter the DTC, the DTCC and Cede & Co.

In exchange-traded derivatives, a third party, called a clearinghouse, ensures that the bets are paid, a role played initially by the bank. And here’s where the UCC and the DTCC come in. The bank takes title in “street name” and pools it with other “fungible” shares. Under the UCC, the purchaser of the stock does not hold title; he has only a “security entitlement”, making him an unsecured creditor. He has a contractual claim to a portion of a pool of shares held in street name, assuming there are any shares left after the secured creditors have swept in. Webb writes:

In the late 1960’s, something called the Banking and Securities Industry Committee (BASIC) had been formed to find a solution to the “paperwork crisis.” It seemed the burdens of handling physical stock certificates had suddenly become too great, so much so, that the New York Stock exchange had suspended trading some days. “Lawmakers” then urged the government to step into the process. The BASIC report recommended changing from processing physical stock certificates to “book-entry” transfers of ownership via computerized entries in a trust company that would hold the underlying certificates “immobilized.”

Thus was established the Depository Trust Company (DTC), which began operations in 1973, after President Nixon decoupled the dollar from gold internationally. The DTC decoupled stock ownership from paper stock certificates. The purchasers who had put up the money became only “beneficial owners” entitled to interest, dividends and voting rights, leaving title of record in the DTC. The Depository Trust and Clearing Corporation(DTCC) was established in 1999 to combine the functions of the DTC and the National Securities Clearing Corporation (NSCC). The DTCC settles most securities transactions in the U.S. Title of record is with DTC’s nominee Cede & Co. Per Wikipedia:

Cede and Company (also known as Cede and Co. or Cede & Co.), shorthand for “certificate depository”, is a specialist United States financial institution that processes transfers of stock certificates on behalf of Depository Trust Company, the central securities depository used by the United States National Market System, which includes the New York Stock Exchange, and Nasdaq.

Cede technically owns most of the publicly issued stock in the United States. Thus, most investors do not themselves hold direct property rights in stock, but rather have contractual rights that are part of a chain of contractual rights involving Cede. Securities held at Depository Trust Company are registered in its nominee name, Cede & Co., and recorded on its books in the name of the brokerage firm through which they were purchased; on the brokerage firm’s books they are assigned to the accounts of their beneficial owners. [Emphasis added.]”

Greg Morse notes that the dictionary definition of “cede” is to “relinquish title.” For more on “beneficial ownership,” see the DTCC website here.

“Harmonizing” the Rules

The next step in the decoupling process was to establish “legal certainty” that the “anointed” creditors could take all, by amending the UCC in all 50 states. This was done quietly over many years, without an act of Congress. The key facts, notes Webb, are these:

• Ownership of securities as property has been replaced with a new legal concept of a “security entitlement”, which is a contractual claim assuring a very weak position if the account provider [bank/clearing agent] becomes insolvent.
• All securities are held in un-segregated pooled form. Securities used as collateral, and those restricted from such use, are held in the same pool.
• All account holders, including those who have prohibited use of their securities as collateral, must, by law, receive only a pro-rata share of residual assets.
• “Re-vindication,” i.e. the taking back of one’s own securities in the event of insolvency, is absolutely prohibited.
• Account providers may legally borrow pooled securities to collateralize proprietary trading and financing.
• “Safe Harbor” assures secured creditors priority claim to pooled securities ahead of account holders.
• The absolute priority claim of secured creditors to pooled client securities has been upheld by the courts.

The next step was to “harmonize” the laws internationally so that there would be no escape, at least in the Western orbit. Webb learned this by personal experience, having moved to Sweden to escape, only to have Swedish law subsequently “harmonized” with the “legal certainty” provisions of the UCC.

“Safe Harbor” in the Bankruptcy Code

The last step was to establish “safe harbor” in the 2005 Bankruptcy Code revisions – meaning “’safe harbor’ for secured creditors against the demands of customers to their own assets.” Webb quotes from law professor Stephen Lubben’s book The Bankruptcy Code Without Safe Harbors:

Following the 2005 amendments to the Code, it is hard to envision a derivative that is not subject to special treatment. The safe harbors cover a wide range of contracts that might be considered derivatives, including securities contracts, commodities contracts, forward contracts, repurchase agreements, and, most importantly, swap agreements. …

The safe harbors as currently enacted were promoted by the derivatives industry as necessary measures . . . The systemic risk argument for the safe harbors is based on the belief that the inability to close out a derivative position because of the automatic stay would cause a daisy chain of failure amongst financial institutions. The problem with this argument is that it fails to consider the risks created by the rush to close out positions and demand collateral from distressed firms. Not only does this contribute to the failure of an already weakened financial firm, by fostering a run on the firm, but it also has consequent effects on the markets generally . . . the Code will have to guard against attempts to grab massive amounts of collateral on the eve of a bankruptcy, in a way that is unrelated to the underlying value of the trades being collateralized.”

A number of researchers have found that super-priority in bankruptcy for derivatives actually increases rather than decreases risk. See e.g. a National Bureau of Economic Research paper called “Should Derivatives be Privileged in Bankruptcy?” Among other hazards, super-priority has contributed to the explosion in speculative derivatives, threatening the stability of national and global markets. For more on this issue, see my earlier articles here and here.

What to Do?

Webb does not say much about solutions; his goal seems to be to sound the alarm. What can we do to protect our assets? “Probably nothing,” he quoted a knowledgeable expert in a recent webinar. “We just have to stop them.” But he did point out that even the assets of the wealthy are threatened. If the issue can be brought to the attention of Congress, hopefully they can be motivated to revise the laws. Congressional action could include modifying the Bankruptcy Act of 2005 and the UCC, taxing windfall profits, imposing a financial transaction tax, and enforcing the antitrust laws and Constitutional property rights. As for timing, Webb says just the movement in interest rates, from 0.25% to 5.5%, should have collapsed the market already. He thinks it is being held up artificially, while “they” get the necessary systems in place.

Where to save your personal monies? Big derivative banks are risky, and Webb thinks credit unions and smaller banks will go down with the market if there is a general collapse, as happened in the Great Depression. Gold and silver are good but hard to spend on groceries. Keeping some emergency cash on hand is important, and so is growing your own food if you have space for a garden. Short-term Treasuries bought directly from the government at Treasury Direct might be the safest savings option, assuming the government doesn’t wind up in bankruptcy itself.

Meanwhile, we need to design an alternative financial system that is equitable and sustainable. Promising components might include publicly-owned banks, product-backed community cryptocurrencies, a land value tax, and a financial transaction tax.

A neoliberal, financialized economy of the sort we have today produces little and leaves the workers in debt. Goods and services are produced by the “real” economy; finance is just superstructure. Derivatives do not now produce even the security for which they were originally intended. A healthy, enduring economy must produce real things and exchange them fairly for the wages earned by labor.

First Published on Web of Debt by Ellen Brown.

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