9/15/08 (Lehman, AIG, B of A, You B.S., Fed Runs Amok!)

Traders,

This weekend we hoped for a take-over of Lehman before the Asian markets open, but that didn't happen and the Government didn't step in to be the loan player (yet). However, B of A was in a takeover mood and purchased Merrill Lynch ($50 bill) over the weekend. Lehman is left out to dry and has filed for Bankruptcy protection.
The futures market were down hard overnight (-300 INDU, -40 NDX, -40 SPX), the dollar also started falling, as metals started to rally. I guess the worst was not really behind us like we are continued to be told. The problem is that this may not be the last of the problems - more losses are seen on the horizon - a lot more.

_______________________________________
Lehman - beating the dead horse

As I continue to beat this dead horse, and have been wondering if it is dinner time YET. Well - we finally find out this weekend that the meat is BURNT - and no one wants to bite this poison apple for desert. The talks with the Fed failed and Lehman is left to sink - they are now filing bankruptcy protection. However, it doesn't mean it is over yet - the Fed may have no choice to step in. Bank of America and Barclays said No Thanks - unless the Fed could guarantee a bigger part of the credit risk. The Fed balked at the increased squeeze.

I am sure it looked like a high stakes poker game, and the Fed blinked. I didn't think the Fed expected the players to walk away from the table and now their bluff was called. It was in the Fed's best interest to have a bailout solution, remember Lehman is borrowing at the Discount Window and this could create a series of failures. The Fed will clearly lose that short-term loan at the Discount Window. Remember, when Bernanke told Congress - they are NOT investments, but rather Short-Term loans, they have NEVER failed. I got news for Congress - you now have your third Discount Window failure (Freddie, Fannie, Lehman), and now it HAS become an investment. Whether the government likes it or not - they are in the game and more so then they ever thought.

The real problem is NOT Lehman - but a clear sign that this credit crisis may have to play out and there is NOTHING the Fed can do. At some point cranking on the printing press and taking on more debt could be catastrophic for the government (and the US Dollar). Some of these companies will have to fail. That leaves just Morgan Stanley and Goldman Sachs as the last two large investment banks left.

But is Lehman the first domino that will start a chain of failures? Have we let the cat out of the bag? Well the following stories may just be that...

_______________________________________
Merrill Lynch avoids the dog house

Bank of America couldn't go home this weekend empty handed, and made an all in bet for Merrill Lynch. Now Bank of America has Countrywide and Merrill Lynch. Talk about pushing heavy - they are all in on these firms (both have more risk and write-downs as well.) It wasn't like these firms were any GREAT deal - they are not. Sure Countrywide has a fairly decent loan business, but this is not the kind of market that you want to be loaning money in, further more the debt on Countrywide's books is massive (GSE type massive) - I don't think B of A really had a clue as to what they were buying (it was more of a save-face game, as they had already dumped a big amount of cash on Countrywide, now they have to show everyone that it wasn't through-away money - I say good money after bad). As per Merrill Lynch, well they do have a pretty massive brokerage business, but they also have some massive debt issues and prior to the take-over were looking to take down some more write-downs.

The question is - does this bode well for B of A? Probably not any time in the short-term, both these companies have lots of debt weight on their books. One thing IS for sure - B of A is getting seriously bloated with illquid debt positions - I hope they don't pop!Merrill does bring something to the table, and that is deposits (that does help). I am not sure how secure Bank of America's credit and capital are, maybe the takeover of Merrill was less about making an acquisition and more about picking up more NEEDED capital (deposits) willing to risk it all on taking on the additional debt as well. One thing is for sure - they are living up to their name sake! Could Bank of America, literally be the Bank of America in the future? One thing alarming to think about, if Bank of America has a problem - who could bail them out? Only one - and they ARE the Bank of America (The Fed / Treasury).

_______________________________________
UBS - You B.S. ?

UBS is expected to write-down MORE, not just a few 100 million, but more than another $5 billion going into the second half. Their credit is not looking rosy and it seems to be a very rough ride ahead for UBS. Unlike the FED, the ECB is NOT taking an active role in bail-out deals of the banks in Europe. There is NO big mommy to run too. UBS has a large presence in the U.S., the question do they split the company? Yeah, split the company in two - UBS U.S / UBS Europe (currently they ARE split - but not enough). Since the U.S. seems to be the land of bailouts and debt - why not rotate the debt off the UBS Europe books onto the UBS U.S. books and let UBS U.S. go to the Discount Window and look for the Fed to broker another deal? Hey if U.S. consumers can just walk away from their homes and let the bank eat the losses, why can't banks? OK - I am sure I will get some feed back with that crazy idea - but is it really all that crazy?

_______________________________________
AIG - Sick Bag Needed

AIG is sick, very sick. They are looking for $20 billion in financing and investments as well as a $40 billion bridge loan from the Fed. American International Group (AIG), the largest U.S. insurer by assets - is in bad shape and on the brink of failure. The company has lost nearly $20 billion in 3 consecutive quarters. Debt obligations have been exercised, sucking out more much needed capital.

AIG has been in talks with the Fed, and rumors are that the Fed may OPEN the Discount Window to AIG, didn't they open that window to Lehman? Oh yeah - how'd that work out?

The lender of last resort for Federal Reserve Banks has now become the lender of last resort for any firm with their hand out - and now three of those have failed (Freddie, Fannie, Lehman) - but the Fed is not about learning lessons, they are about printing money. I am still wondering where the big recent dollar rally came from?

_______________________________________
The Fed - run AMOK!

Remember, the Fed does NOT want lend money, because really - it's doesn't have money to lend. It is considered the lender of last resort, when banks can no longer borrow from each other or raise capital on their own. The Discount Rate (borrowing directly from the government) usually is set to a higher rate, as much a 100 - 200 bps (1-2%) higher - to discourage banks to borrow from them. Banks also NEVER like going to the Discount Window, traditionally if they ever do, they like to keep quiet about it, since it means there is trouble a foot.

The Fed has loaned money in the past, small quantities to be sure. When you borrow from the Fed at the Discount Window, it's a 30 day loan that needs to be paid in full. Bernanke was correct, when he told Congress a few months ago - that a loan at the Discount Window has never failed - but then again, they never loaned 100s of billions, only millions. Bernanke has been living on the "hope" model. So how did we get here?

First the FED lowered the spread on the Discount Window to the Target Rate, making it less costly to borrow from the Fed. The spread between the Discount Window (borrowing from the Fed) and the Target Rate (the target where they borrow from each other - if they can) - is only 25 bps. The problem is that while "officially" the Fed has set the Target Rate to 2.00 - (remember it is just a target where the Fed would LIKE the banks to loan each other) - the banks don't have any money left to loan each other. Banks as early as last year started going to the Discount Window - a clear indication that money was getting tight and losses (write-downs) were ramping. They needed more capital - time to run to mommy (the Fed).

Bear Stearns, the weekend that the Fed brokered the deal of Bear Stearns, they did something else, something that not many people were talking about, since all eyes were on Bear Stearns. The Fed OPEN the Discount Window (for the first time) to NON-members. In order to borrow from the Fed you need to be part of the club, to be a part of the club you need to pony up a large chunk of change (into the reserve pool). You also have lots of rules and guidelines to follow. It's just like a private club with rules, membership dues, etc. But now the Fed opened the door to a NEW list - these non-members, included companies similar to Bear Stearns, other investment banks, Lehman, Merrill, Goldman, etc. It also included Freddie Mac and Fannie Mae. When the door OPENED to the Fed's Discount Window - the flood gates opened. We have never seen anything like it, even during the S&L crisis - we are not talking 10s of millions or 100s of million, we are talking billions. This really caused some serious concern, the lender of last resort is now lending, not just their members, but a bunch of new members that didn't even pay their dues or even HAVE the same guide lines.

Congressional hearings - Bernanke and Paulson told Congress that they acted using a rarely used power to help broker the Bear Stearns deal and also OPEN the Discount Window to these Non-members ONLY for a very SHORT time, September. They assured Congress that these WERE short-term loans, NOT investments. The window WOULD be closed in September to NON-members. These 30-day loans had NEVER failed. There was also the implied "wink-wink" by the Fed to Congress, "Hey we let your two friends into the club, Freddie and Fannie! So don't be so hard on us from bringing in a few of our own buddies!" - Paulson asked for the Bazooka (NUKE option) to have the power to buy out the GSEs, Congress granted it. Bernanke asked if he could keep his new found powers (the emergency powers), Congress granted it. Yeah a few distained - Ron Paul made it clear - we are headed down a very long and dark road. He voted against the extended leverage of the GSEs, voted against the new Treasury Power, and voted against the extend Super Fed Powers - but Barney Frank who leads Congress on financial matters said otherwise. Some said they could see Paulson and Bernanke "high-fiving" each other as they left Congress.

Extend the window / extend the loan date. As September approached and the money being lent by the Fed was getting bigger, not smaller - there was ALSO writing on the wall that there is NO WAY IN HELL that these loans could be paid back in 30 days and also if these NON-members are to survive we are going to need to continue to lend them money. Bernanke extended the opening to Non-members to January 2009 and also the loans are no longer 30-day loans, but are now 84-day loans. Clearly the health of the market was still in question - you don't extend the window and the loan dates if everything is getting better. But the talking heads would have us believe "The Worst Is behind us!" - Yeah right.

Lehman is next on deck, and this time the government is unable to broker a deal. Lehman files for bankruptcy - but that's not all. The Fed does something even crazier. Previously members and the new non-members had to pledge equity (good credit equity) to borrow money from the Fed. But now the Fed is accepting everything and anything. The Fed widened the collateral it accepts for loans to securities firms to include stocks and ALL grades of debt instruments. And they said it with a straight face, as if nothing is wrong. What? They are willing to take STOCK in failing companies as well as failed debt obligations as equity to borrow money from the Fed? Are they F'n kidding me!

Forget the lipstick, this is just one seriously f'ugly Pig. This is getting out of control. Regardless of what ANY talking head says - this is clearly a very bad sign that the credit crisis is getting a lot worse. You don't start taking stock in companies, including ALL grades of debt obligations - unless these companies are seriously ready to fail and you don't want any more failing. Sure Paulson and Bernanke are going to spin it this way, "With Lehman, an isolated incident, we just want to make sure that other investment firms have access to funding in case we do see some unwarranted panicking by investors. This is ONLY a precautionary measure!" - That's what they told us about Paulson's Bazooka, the GSEs would not fail - yeah right. That is what they told us about Discount Window would only be open until Sept. to non-members IF they needed it. That is what they told us when these are LOANS not investments, and none of them have failed. So - they just did this as a precautionary measure and they are SURE it will not be utilized. Of course they didn't say that - but if cornered they will.

I wished more people would of (and currently should) listen to Ron Paul, I also wish he would have been the GOP candidate. He has been calling this pig a pig for some time.

So here we are, 100s of billions being borrowed at the Fed, the Fed has extended the window to January, they now have 84 days to pay it back, instead of 30 days, and finally they'll take ANY form of collateral (all GRADES of debt and now actual stock) - it's starting to look like a garage sale. The sad thing is this is on the back of the American Tax payer. I don't seriously think that they are going to get back some of this money they have loaned and if a company who borrowed a couple of billion, pledged their stock and some of their CDO and SIV paper (probably some D rated) - well where does that leave the Fed? Not only a busted loan but now they are share holders in a failed company.

If I thought writing your Congressman, especially Barney Frank, who leads the financial committees and along with Dodd that had lead the charge to turn Freddie and Fannie into the Mt. Everest of debt. Or even Nancy Pelosi who running the show over there, or even Paulson and Bernanke - I would say go for it. This isn’t just a Democrat or Republican issue – this is a big stupid government issue. Our Fed, Treasury, and Congress are out of control. I hope that McCain or Obama will get Congress in line and also strip the Fed and Treasury of this ridiculous power which they are flushing the country into a massive debt toilet. You think the War cost money (it did and a lot), I have news for you - we just doubled our national liabilities by taking Freddie and Fannie - the Discount window (loaning money on pledged assets that are probably worthless) is just MORE losses. I wish more people were as passionate about the US economic system and its looming failure as they are about the Iraq war!

The dollar will not hold this recent rally (we saw it drop last Friday) - I am no longer expecting any good things for 2008. I had a glimmer of hope of a bottoming in the 4th quarter, but with Discount Window lending being extended into Jan 2009 on the back of worthless collateral - I think there is more bad news to come. My bet - the Fed will push out the Discount Window again and will start to accepting promissory notes written on cocktail napkins.

Now they are setting up a NEW $70 billion dollar fund to take on more problems - yeah - and who is funding that?

_______________________________________________________
Futures Pre-market

The futures are getting hit solidly in the pre-market, the news of Lehman and AIG is creating significant pressure. Also we are seeing OIL come off hard, oil is not coming off because of Ike or less demand – it is coming off (like other good companies) – firms need money and liquidation of equities, bonds, and commodities is used to keep capital ON the books.

The ARB traders WILL be buying futures going into the opening – the spreads are pretty fat an hour before the opening. That also means more pressure on the cash. Expect to see a big sell pressure at the opening.

_______________________________________________________
Support / Resistance

I don't know if these supports will hold - we WILL visit them, but they are not a place to get long. Sure we could see a knee jerk rally off of them - but do you really want to bet on that?

INDU 11,000 (11,100) / 11,500 (The futures show that we will probably open around the 11,100 level – this is an initial supporting area. Also 11,000 is a key support area. We need to close above that. But expect ANYTHING we could just as easily rally during the day and close unchanged if the spin doctors come out and the investors believe (yet again) that the worse is behind us. For now keep an eye on the 11,000 level. Closing at 11,100 is a good supporting area.)

NDX 1700 (1725) / 1800 (We are seeing a sharp sell-off in the futures it looks like 1725 is going to be the opening area. There is too much volatility to call this one way or another. 1725 is a good supporting area, but we also need to hold about 1700 to see any support.)

SPX 1200 (1225) / 1250 (It looks like the 1200-1225 range is where we are going to open. Again 1200 is a key support area. There is panic at the opening, yet we may hold and could even bounce off those levels. However – watch the close – that will dictate everything going forward.)

RUT 700 (720) 740 (We will open slightly below 700, but we need to close above it to see support. If we slide and start moving down towards the 680 level, expect the rest of the market not hold those levels. We could see big pressure in the broader market as firms unwind even good positions to bring in fresh capital to the books.)

____________________________________________________
Conclusion

I got up early (1 am) to check the news and foreign markets opening. When I started seeing the futures and then European markets open - I just shook my head. The VIX had not seen the panic yet, nether had the market. Investors were digesting bad news well and the market had not seen any panicking YET. However, I think that is going the change.

Asian markets don't seem to be doing badly, mainly because they are, unlike Europe, not in the same debt game. They also have a growing (while slowing) economy story. Sure their markets have come down, but the consumption and growth continue.

The question now - is what happens next. Any rally will be based on optimistic euphoria and not fundamental resolve - we can only find a bottom when the government stops intervening and we let these firms stand or fall on their own balance sheets. However, the extended ridiculous lending at the Discount Window (now to include AIG and to accept all forms of collateral) means that things are a lot worse than they had lead us to believe.

I also haven't touched on some other alarming things, Russia flexing their muscle in Georgia and now in the Caribbean, Hurricane Ike which took refineries off-line and sent gas prices higher, and election year where the mudslinging has just started.

The year of volatility is far from over. Sure we may hit some support levels, see a rally off of them, and hear a few talking heads assure us (AGAIN) that the worst is behind us. However, I say only - expect MORE volatility!