Wall Street creates 'phantom shares' through naked short selling -- selling shares that don't exist to crush stock prices

The financial system has mechanisms built into it that most people will never fully understand. That opacity, it turns out, may be by design—and it may have allowed banks to profit from creating shares of stock that don't actually exist.

The claim sounds almost too outlandish to be real: major Wall Street institutions like Goldman Sachs were selling shares they never bothered to borrow, effectively manufacturing counterfeit stock in companies like Bear Stearns and Lehman Brothers during the financial crisis. For years, this was dismissed by mainstream financial commentators as the paranoid fantasy of conspiracy theorists and activist investors with an axe to grind.

But Rolling Stone's investigation into accidentally released documents told a different story. The reporting revealed that Goldman Sachs and other major banks had engaged in naked short selling—the practice of selling shares without first locating and borrowing them from someone who actually owns them. When you sell shares that don't exist, you're flooding the market with counterfeit securities that dilute the holdings of actual shareholders and artificially depress stock prices. It's roughly equivalent to counterfeiting currency, except it happens in markets with the implicit cooperation of financial institutions.

The financial industry's official response was predictable: this wasn't a real problem, or if it was, it was isolated and insignificant. Regulators seemed content to look the other way, even as these practices contributed to the destruction of major financial institutions during 2008.

Then the SEC effectively admitted the problem existed. Rather than prosecute the banks engaging in the practice, the agency simply banned certain types of naked short sales during the crisis. The timing is noteworthy—the SEC didn't ban the practice because it wasn't happening. It banned it because it was happening and it was destabilizing financial markets. You don't ban something that doesn't exist.