7/14/08 (The Bailout!)

Traders,

Today will be marked down in history as the beginning of the Government Bailout. The weekend saw two huge events that started the ball rolling as to a massive government bailout. First it was after the close on Friday the California bank INDYMAC becomes the 3rd largest bank in history to go bust. The FED is now manning the bank as FDIC insurance kicks in. Those with over $100k on deposit, well game over. Then on Sunday, Treasury Sec. Paulson, has introduced his plan for a government bailout of the two largest mortgage companies, Freddie and Fannie. But is this just a bailout or are we entering the next NEW NEW DEAL?

These are historic times no doubt - but what does this all mean? The U.S. government is now becoming a commercial bank (via the failure of INDYMAC), they even changed the name. The bailout PLAN does reflect the possibility of the U.S. government actually taking over the two largest mortgage companies. This train is heading down the Socialism fast track - and these promises of money both the bailout of the bank (probably more to come) and now to take on the risks of Freddie and Fannie - well has anyone forgotten our coffers are dry? This government have over 40 TRILLION in debt - at this point we don't have any money to bail it out anyone. So while you might be for or against the bailout the real question you should be asking yourselves - where is the money going to come from? Expect more inflation not less. I would argue this is the beginning of the story - not the end.

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Freddie and Fannie - the Bailout

Sec. Treasury Paulson on Sunday publicly introduced his bailout plan (which needs approval from the House) - however - I think they'll give it the nod. The problems DWARF the Countrywide and other mortgage companies problems - these WERE the backstop for all mortgages - now they have failed!

The plan is simply this:

1. Increase Freddie and Fannies government line of credit - (est. to $300 billion - which will probably not be enough - but they will just up it more - wait and see)

2. Government invest DIRECTLY in companies (they would become THE stock holders)

3. Give the FED regulatory oversight - (expanding the roll, power, and mandates of the FED)

4. Open the DISCOUNT WINDOW to Freddie and Fannie - (of course - it's open to investment banks already - let's just make open to everyone)

Is this necessary? Well - I don't know what would happen if we let Freddie and Fannie fail? What would happen - I don't think anyone really knows. This plan could very well turn these into FULLY government run companies. Venezuela Part Two?

How did Freddie and Fannie get to this point you ask? Freddie and Fanny had all the benefits of being a private company without any of the risk. They had never been considered a problem when the housing implosion happened. In fact it was suggested that they HELP with the housing crisis. Barney Frank (and his followers) lead the charge to expand the credit lines to Freddie and Fannie to buy down MORE bad paper to help kept the system running. Many argued against Barney (and supporters) when he introduce his FIRST bailout plan of giving Freddie and Fannie MORE leverage and MORE money - that it would NOT solve the problem (doesn't matter who owns the loans - they are still bad). However - I remember Barney arguing his point back in February and in March he got his way and Freddie and Fannie were able to increase their leverage. Now - we are bailing out the bail out! Thanks Barney!

It reminds me of a conversation I had with a local politician in town back in February this year. I was concerned about both the huge short-fall in tax revenue for the county (because of home sales), the weakening dollar, and the looming debt the county was facing. I said, "The county could go bankrupt!" - he laughed in my face as if I was ignorant. He said "I have been in politics all my life and let me assure you that the government can't go bankrupt!". Boy, is he fully living the lie! His paycheck has been coming from the tax payer all his life and he believes in the SYSTEM. It was no use making my point of how Fiat currencies and Treasuries work - he obviously didn't understand or care.

Well - it's those kind of people that believe that - which help create the problems this nation is in. It doesn't matter if you are Republican or Democrat, the disease has spread to many politicians - the Democrats just where their colors more publicly. Many Republicans are supporting these programs as well.

I will leave the Freddie and Fannie story with this quote by Milton Friedman, which rings so true today!

"There are four ways in which you can spend money:

You can spend your own money on yourself. When you do that, you try to get the most value for your money.

You can spend your own money on someone else. For example, purchasing a gift, you may not be so careful about the contents, but you're very careful about the cost.

You can spend other people's money on yourself. Which means you'll probably be having a great lunch.

Finally you can spend other people's money on other people. When this happens you're never concerned about cost or value. And that's government and how tax payer's money is spent."

- Milton Friedman

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INDYMAC - the first bank to fall?

INDYMAC has new ownership, it's called the U.S. Government. The second largest bank failure in the U.S. happened when over $1 billion was withdrawn in less than two weeks by investors. Rumors abound there was a problem and those rumors spurred a run on deposits. Within 11 days the bank had lost too much on deposit to even keep the doors open and they closed - LOCKED.

The FED has now stepped in and those with $100k or less may feel safe - but expect them to withdraw their money regardless. Yeah - some would say "Well now it is not only backed by the FED, but also owned, it is SAFE!" - well that is the spin the CEO is giving to the new INDYMAC FEDERAL BANK <- note the name change.

The NY Times story indicated that more than 150 banks will probably fail over the next 18 months as the housing and credit problem spreads. INDYMAC was only the first, if this is to be believed. Federal Deposit Insurance Corp. lists another 90 banks that are currently at the tipping point. The FDIC has $53 billion available to reimburse depositors at failed institutions already, of which $4 billion to $8 billion will be needed for IndyMac. Expect that $53 billion to break the $100 billion mark by the end of 2008.

The interesting history of this bank, it was founded by David Loeb and Angelo Mozilo, who founded Countrywide (which was on the brink of failure and taken over by Bank of America).

Unfortunately this story is being overshadowed by the Freddie/Fannie bailout! Which, while more important, this story is the first crack in the banking system - thus being overlooked.

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Citi - what about that $1 Trillion on the off-balance sheets?

CEO Pandit (the new CEO that sold his hedge fund to Citi, only later to see it fail) had his investor presentation about Citi's $2 trillion balance sheet. He has been cutting costs and trying to sell off $300-400 billion of higher risk paper (to whom?). However, which was NOT mentioned was the $1 trillion on OFF BOOK balance sheets. This is causing concern, since the clarity of the risk or liquidity is well foggy at best.

Questions are already starting to rise after the investor presentation - which was (IMHO) a marketing tool prior to the earnings being reported on the 18th. What everyone is starting to complain about is what IS that $1 trillion and what is really going on. While Pandit and his marketing people are stating that it is FULLY disclosed - many are saying yeah if you can read Esperanto!

Some have said that Pandit was just trying to quite the voices as he introduces MORE write-downs - trying to calm the investors so the shock of the looming write-down doesn’t hit them that hard. As Richard Bove (of Ladenburg Thalmaan & Co.) states, “You will rapidly realize what a farce these off-balance-sheet things are, you could pick up a lot of loan losses with the stuff you’re putting back on.”

It is impossible to predict what risk and losses loom in these off-balance-sheet positions. All we know now is that there is a $1 trillion dollar “shadow account” at Citi and we really don’t know what it contains. That being said – regardless of write-downs – how accurate are those earnings going to be or for that matter the write downs. After seeing CEOs being fired left and write and even CFOs get the axe (or demoted) – skepticism is high.

Wonder if David Enihorn will be talking about Citi any time soon – no doubt he is or will be reviewing the books shortly.

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This InBev’s for you?

The Anhesurer-Busch member’s agree to the $52 billion takeover by InBev (a Belgium based Beer conglomerate). The $70 a share transaction ends bitter fighting and bad press that the Europeans have been taken from the attempted take-over of Bud, the supposed King of Beers. Locals believe that it will cost jobs and InBev will close business, and now the Unions will have to deal with a new boss.

The transaction will be the largest cash takeover on record and some anti-globalization advocates are blaming our government for allowing foreigners to buy up U.S. businesses – and thus calling for MORE regulation and protectionism. No doubt we may see Obama surrounded by Union members of this once St. Louis based company speak about MORE jobs and Protectionism. It will definitely add fuel to the Socialist fire.

There is no doubt that the weaker dollar will enhance U.S. takeover targets by foreign assets. Who knows what is in store – with a new administration and the recent Freddie and Fannie bailout – protectionism may not be too far off.

It is amazing how people, so in love with their beers, are willing to protest and fight for their brand – maybe if we could get that kind of passion out of people for the economy and more important issues – well dare to dream.

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Futures Pre-Open

The futures are getting a HUGE boost from the Freddie and Fannie story, I guess bad news is good news, right? Well – don’t hold your breath. The futures are seriously front running the cash at this point, expect ARB traders to short the futures into the opening and buy the cash basket if the spread remains. I am seeing (30mins before the opening) about 10 points right now. That is a spoonful by anyone’s measure – expect that to close into the opening.

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Support / Resistance

While the RUT has remained strong and held the 650 level, the other indices have fully failed for the most part. The VIX almost broke through 30 (and from a statistical measure should). This morning future’s are rallying hard – but don’t buy the hype!

INDU 11200 (We will probably open on or above this level – but it would be nice to see it close above here.)

NDX 1800 / 1900 (We are still above the 1800 level of support and with the massive amount of new IPhones that sold over the weekend the hype might push this index up again.)

SPX 1250 (We will most certainly be above the 1250 line – if the futures hold true. The question is how we close.)

RUT 650 (We have held this level for now and so far it has been the best indicator of money flow and there has NOT been a panic in the market yet – as the broadest of market continues to hold support.)

We could see a massive follow through euphoric rally this morning and some follow through into the late session. We are trying to find a support area – some indices are holding, most importantly the RUT. However the S&P and INDU have both failed. This is still a volatile time. Additionally – the shorts have loomed large – so expectations are high for a good short-covering today – if that happens that INDU could be up over 250 points!

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Conclusion

Bad news is good news? Whatever – just like with the “Strong Dollar People” and “The worst is behind us” – this is seriously bad news. To have a massive rally into the opening because the 2nd largest failure in U.S. history of a major bank (INDYMAC) and now the biggest possible bailout in the history of the world (Freddie and Fannie) are in the cards – people are getting LONG? Again – euphoric optimism. I heard that Jack guy (a trader guest on CNBC that Joe Kernan dubs “Mr. Bull”) infer AGAIN that the worst is behind us and we will see a rally – just like when we saw the Bear Stearns bailout. This guy can spin anything into gold.

Economic history is being shaped daily – these are the times that the future of our country will look back on as a major step forward (or backward) as to the fundamentals of Democracy. Several foreign nations (mostly non-allies) are pointing to the merits of Democracy by the recent failures. While our allies are alarmingly (rightly so) about the fundamental value of the dollar – if more is needed to be “printed” for the conveyor belt of bailouts with more to come.

I am sure the House will pass the Paulson Bailout package and I am positive that we will see at some level the Government taken on a bigger role at Fannie and Freddie. I am also sure we will see MORE overnight loans at the Discount Window (now that Freddie and Fannie can tap that too). The economic system is being defined by WHO can go to the Discount and borrow money.
While Bernanke stated in the Congressional hearings that the Discount Window is NOT purchasing these debts, but rather just lending money and further stated not one has failed – the reality is that they have already FAILED. Look – let’s just keep it simple shall we – if a LOAN FAILS – just because I am able to borrow from the Government to keep that bad loan on my books – doesn’t mean that the loan is now good. The failure exists – the only difference is that the bank no longer is covering the risk (because they are out of money) but rather the U.S. government is.

The rally today (and possibly the continued rally going forward – if we see some massive short-covering) is a GIFT. We are not rallying because we have a fundamentally solvent nation – it’s rallying because the Government (in 40 trillion dollars of debt) is riding to the rescue to take on more debt. For me – any rally means:

1. Long positions – roll up those insurance policies and push them out to November Expiration – for those that didn’t get them on – get them on NOW!

2. Get MORE gamma on your sheets.

Make sure to send thank-you cards out to all those people (the same people that rallied this market after the Bear Stearns collapse) for a second change to unwind your long assets or ability to rehedge. You are all getting a second chance – those don’t come often!