I think we can all agree that the middle of last September was as strange a time as our financial markets have ever experienced.

In case you’ve forgotten, let me remind you with a simple timeline. As you read it, keep in mind that following the demise of Bear Stearns, the strictest interpretation of the so-called investment bank “Bulge Bracket” included just four entities: Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley.

• September 9: The short attack on Lehman Brothers begins in earnest.
• September 14: The New York Times reports Lehman will file bankruptcy.
• September 15: Goldman Sachs share price begins to wilt. Merrill Lynch announces it will be sold to Bank of America.
• September 17: Goldman Sachs’ share price continues to plummet. The SEC announces “new rules to protect investors against naked short selling abuses”.
• September 18: Goldman Sachs’ share price continues to plummet.
• September 19: The SEC “halts short selling of financial stocks to protect investors and markets”.  Goldman Sachs’ share price posts a strong gain.
• September 22: Goldman Sachs and Morgan Stanley, the two remaining members of the “Bulge Bracket” announce their intentions to transition to bank holding companies, giving them access to lending facilities of the US Federal Reserve (an organization with which Goldman has an uncommonly tight relationship).

As I see it, the most interesting event to come of that most eventful period was the SEC’s September 19 ban on legitimate short selling. What makes it so enigmatic is the fact that not even the most vocal opponents of illegal naked short selling have ever even hinted at the need to restrict legitimate shorting. In fact, Patrick Byrne himself compared the ban to limiting motorists to making only right-hand turns.

However, I have a theory that might explain what was going on.

An examination of the volume of both naked and legitimate shorting of Goldman Sachs in September of 2008 reveals something very interesting: while there was an enormous amount of short selling taking place, there was essentially no naked shorting of Goldman shares. Indeed, short selling accounted for a third of total volume on September 15 and 16, while failed trades accounted for less than 0.07%, suggesting shortable Goldman shares were in abundant supply.

This conclusion is supported by an analysis of the stock loan rebate rate that prevailed for Goldman shares during the period in question: a very reliable indicator of the scarcity of shares available for short sellers to borrow, where a lower rebate rate indicates a more limited supply.

In the case of Goldman, from May through August 29 of 2008, the rebate rate averaged 1.80%. And, between September 1st and the September 19th short selling ban, Goldman’s average rebate rate remained exactly the same: 1.80%.

By way of comparison, the average rebate rates for Lehman Brothers shares over the same periods were 1.18% and 0.16% (bottoming out at -0.25% during Lehman’s last week), respectively.

By contrast, Goldman shares appear to have been easy to borrow right up to and in the midst of its stock price free-fall.

This scenario is consistent with the levels of naked short selling of Lehman and Goldman during the same period: extremely high in the case of Lehman, and almost non-existent in the case of Goldman; furthermore, this suggests that, given abusive naked shorting does not tend to occur until after short sellers have exhausted the supply of borrowable shares, it was legitimate shorting that pushed Goldman’s share price over the edge.

With that in mind, let’s revisit the above timeline, focusing on Goldman, with my interpretation appended.

• September 15: Lehman declares bankruptcy. Goldman Sachs share price begins to fall. Following the destruction of Lehman Brothers at the hands of short selling hedge funds, the financial world is keenly aware of the capacity of naked shorting to decimate the share prices of financial firms. Furthermore, given the role Goldman undoubtedly played as broker in the criminal short selling hedge funds’ attack Lehman, the firm is justifiably concerned that the karma train is heading its way.
• September 16: Goldman lobbies its extremely well-placed (and well-documented) federal government contacts for a temporary ban on naked short selling.
• September 17: The SEC temporarily bans naked short selling.
• September 18: Despite the ban on naked shorting, Goldman Sachs’ share price continues to fall, suggesting legitimate short selling, not illegal naked short selling, is the cause of Goldman’s problems. Goldman lobbies for the SEC to temporarily ban legitimate shorting.
• September 19: The SEC temporarily bans legitimate shorting of all financial stocks. Goldman’s share price rises.

Might the SEC have been acting in the best interest of the market when it issued both emergency orders? I suppose that’s possible. But given the utter disinterest – even contempt – that organization has demonstrated toward investors and small public companies that have complained about the issue, I find it very difficult to believe.

Meanwhile, the SEC stood by and watched as naked short selling destroyed Bear Stearns and Lehman Brothers. Merrill Lynch then took itself out of the game, leaving a Bulge Bracket consisting of only Goldman Sachs and Morgan Stanley.

Of those two, which has uncommon influence over the federal government?

Goldman Sachs, of course.

And if this is true, does it leave any doubt as to the lengths the SEC might have gone to preserve a corrupt system when it benefited the company?