9/22/08 (Bailout USA!)

Traders,

Last Friday Wall-Street changed, with only two large investment banks left, Goldman and Morgan. Then over the weekend the final chapter of Wall Street concludes – with both Goldman and Morgan now being regulated by the Fed and leaving the investment bank realm. But what does that mean, it means they now have ACCESS to Federal Reserve and all its lending powers. Many people don’t realize this really doesn’t change much at Goldman or Morgan – you could always gone to Goldman or Morgan an open a account, get checks, get loans. They always offered banking services, this just brings them under the Fed Reserve (wing of protection) and different structure.

Over the week-end I listen to a European Economist that made an interesting observation – which we are seeing take place. He said that massive bailout package and the taking over of Freddie, Fannie, AIG – the US government is taking on huge debt. This is not just a US bailout – but a global bailout. It does lend some security and stability to the overseas market (temporarily) – enough time to unwind US dollar risk positions. The problem, worldwide, is the US Dollar (as a world reserve currency). The bailout and the massive credit lines extended by the US government – is bringing serious stress to the dollar and foreign nations are quickly losing faith.

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Goldman/Morgan Banks

As I mentioned Goldman and Morgan were always banks, you could get a checking account and get a loan from them, however they were not under federal guidelines and did not have access to federal funds (until recently and temporarily). The massive deleveraging that is happening – both in the traditionally banking side and massively on the investment banking side has put tremendous pressure on the firms to gather as much assets to keep the capital reserves up as they deleverage.

Allowing Goldman and Morgan are now in the same game as BofA, Wachovia, Citi, and others. They are going after deposits and will be offering inducements to bank with them. Why, because it is not over yet – they still have massive leverage and continue to need capital.

Is it really a big deal that Goldman and Morgan are now banks? Not as big as the talking heads are making it out to be, we already knew they were unwinding leveraged positions – this just gets them to Fed Funds the easier way and restructures the rules (which seem to be ever changing anyway) to become members of the Fed.

Think about his for a second and then ask yourself why they opted to become banks, rather than investment banks.

The Discount Window (the ability to borrow directly from the Federal Reserve) is only available to member banks (not investment banks). The Discount Window is a (traditionally) 30-day short-term loan that needs to be paid back in full, the lender of last resort. When Bear Stearns failed the Discount Window (in a emergency measure) was made available to a list of non-members, including Goldman and Morgan – both who have borrowed from the Discount Window. The window was to be closed to non-members in Sept, but it was extended to Jan 2009. The terms of the loan have been changed from 30 days to 84 days. I have previously mentioned that I was concerned that these firms will not be able to pay back the loans, hence the extension of the window and the terms of the loans being changed. I expected that many of these firms would merge with a member bank (JP Morgan/Bear and BofA/Merrill) – there was rumors last week that Morgan Stanley would be merging with Wachovia. It made sense more deposits and full access to the Fed.

Remember, these investment banks borrow money short-term to leverage themselves – if money is tight and there is nowhere to go – they need a lender of last resort – the Fed.

So, think about that for a second.
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The Bailout

On Friday it was $500 billion (1/2 trillion) over the weekend they tacked on another $200 billion with the possibility of adding even more. Just two days after the revealed plan, the new bigger (is better) plan includes other types of debt, including (but not limited to) car loans and credit card debt. It even goes as far as to imply that 700 billion could be just for starters.

The problem is that many are now questioning the Fed and Treasuries honesty and transparency of the problems in this country. Several analyst are already voicing their concerns as to the health of the economy. ``The costs of the bailout will be significantly higher than originally considered or acknowledged,'' said Josh Rosner, an analyst with Graham Fisher & Co. in New York. ``How, given these changes, can the administration and Federal Reserve believe they are being forthright in their unrevised expectation of future losses?''

Clearly the problems of the US Economy should not escape you, the recent actions of the Treasury and Fed are getting very lofty and taking the time to think about their proposals and actions should leave us all concerned. Congress is giving both the Fed and Treasury sweeping powers beyond their traditional mandates – they are becoming the most powerful arm (as per the economy) as we see power transfer from Congress to these two entities.

What is alarming is that many complain (rightly so) that banks and financial firms are not very transparent, but now shifting those losses to the Federal Government makes it even less transparent. Many analyst and economist are trying to figure out the impact to the Federal Government, we know its big the question is how well they are able to sell the FAITH. I guess at some level we could say we have moved to a Economic Socialist System were the risk is shifted to the government and its now more about faith that the government can absorb these losses. Those that don’t think through the problem and believe the government can wipe clean that debt, simply by absorbing it, could be in for a big surprise.

The NEW risk factor is now the dollar and buying power. These decisions by the government to bailout everyone and anyone has shifted the problem from the deleveraging (which is still continuing) to the debasing of the currency. Clearly the “Safe Haven” is NOT the US dollar anymore, China mentioned two weeks ago they are moving into gold and the Euro. Several other countries are moving into hard assets and also foreign currencies. We saw this happen on Thursday and Friday – Gold and other commodities rocketed higher.

Jimmy Rogers made an interesting point, he stated smart money will want some credible backing behind paper – and the only paper with hard deliverable assets behind them is commodities (futures). If the currency is devaluing (something that Rogers has claimed has been a risk for some time – now becoming a reality) the safe haven is commodities – which are quickly converted to buying power of any kind.

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Where is the money?

If the government is pouring money into the system, then where is the money. It is simply being absorbed by the losses in the defaulting debt instruments (write downs). The problem expands as banks are losing deposits (capital) and on investments. Last week you might of heard that the dollar broke, that meant that money markets dropped below 1 (dollar parity) – several banks FROZE money markets (from redemptions) to make sure they had enough capital. That created a panic – many people no longer could get access to their funds.

Paulson has stepped in with $50 billion to secure money markets – but that may not be enough, hence the 700 billion in purchasing all kinds of debt. However, that too may not be enough and will have to expand.

The problem is simple – it is massive leverage being unwound. When you have $100 dollars, but you borrow $500 (by posting your $100 as collateral) and then lend out that $500 at a higher interest rate (to profit) – when that $500 loan fails – your $100 capital is quickly used up. Now the lender who loaned YOU the $500 wants to be paid, you don’t have any money. So you now borrow MORE money to make up the difference.

The catalyst was the failure in the mortgage market, when 1 millions of home loans defaulted and people began to foreclosed – it spurred a secondary lending cycle as banks and institutions were borrowing money to keep their capital current and within Fed Regulations. The banks could NOT write down the loans to zero, because that would wipe them out. They would write down as much as they can to remain solvent, borrow some more for the next quarter and write down some more. The bank was assuming losses by shifting the losses of the loans they made by borrowing from the government. They are now in debt to the government for these mortgage losses.

Now that problem is being repeated in the credit card and car loan arenas – as well as other lending areas.

We are a nation of consumers – regardless of government regulation, under-regulation, over regulation, at the end of the day – this is not about Bush, Republicans, Democrats, - it is about the citizens of this country borrowing more than they could ever afford. Sure companies, banks, and mortgage companies are to blame for not managing their risk, same is true for the government agencies and Congress not being on top of this. However, it was the citizens of this country that borrowed trillions of dollars (home loans, equity lines, credit cards, car loans, etc) – a nation of consumers that have, for the most part, defaulted. We, the citizens, have been instrumental in bankrupting this country.

The best we can hope for now is Stagflation – consumers are tapped out, banks are tapped out, the government is bailing everyone out. Consumers barely have enough money to spend and their credit lines are gone. Three quarters of the GDP is consumer spending – that is expected to shrink considerably.

So far the money the government is pouring into the system is just paying down losses, they haven’t injected enough to cover that yet – which will take some time.

Some of you may be happy about the bailout – the reality (IMHO) this is a very dark time for this country and this time in our history could mark the Zenith of the US being the Economic world leader, I believe we have passed that baton, probably to China. It will take years to get out of this hole and I doubt the government will ever be able to repay the debt – two things are coming MORE taxes (a lot more) – just to pay down debt. At some point we must remind ourselves about a little tea party in Boston, at what point does taxation without representation become apparent? How much more can we bleed the citizens of this nation for other people’s (and companies) fault?

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Commodities Bottom?

If Rogers is correct, the dollar will continue to devalue (get weaker) as the government assumes more and more debt (doubling our national debt and liabilities). We saw the money markets freeze and also the 30 day treasuries trade for negative interest – as people rushed for safety and not knowing where to go. At the end of the day the dollar is a FIAT currency, meaning that it is used to REPRESENT the transaction goods and services. The dollar, itself, has no intrinsic value. So it’s those goods and services that actually has value. Energy, Food, hard commodities, are all things – that we the people need to survive. Rogers and others are calling last week a recent bottom in commodities, not just based on supply/demand (as they have historically pointed out) – but now even more so as the dollar continues to weaken.

Expect commodities to rally.

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Futures Pre-Market

The futures have been down in the pre-market but are drifting higher. The news about the massive bailout is twofold – on one hand there seems to be some relief that the government is bailing everyone out, on the other hand what does that mean about the health of the economy or the dollar. I think the Arb traders will be on the sideline – until more resolution as to what is actually going on.
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Support /Resistance

The market rallied Thursday and Friday as the government takes on all the bad debt (mortgages, credit cards, car loans, etc.) – as the market rallies, the dollar is sliding.

INDU 11,000 / 11,500 (We rallied massively – on the largest short-covering in history. We pulled off some from the 11,500 line. Remember, shorts are still handcuffed until Oct 2nd – so there is probably still upside pressure.)

NDX 1700 (1750) 1800 (I say that 1750 is the pivot point – either direction is in the cards – 800 issues are non-shorts – which could give some upside bias. However, there are many that are looking at the dollar sliding.)

SPX 1200 (1250) 1300 (1250 is the pivot point – again just like everything else – this rally was technical (short-covering) – don’t expect this market to move on fundamentals.)

RUT 720-740 / 760 (760 is the previous top – we are right there. Again – not sure what to make as long as the market is getting propped by the government.)
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Conclusion

The economic world is changing right in front of our eyes, policies are changing in hours not months. I got a look at the Paulson Plan $700 billion, it’s a 3 page piece of legislation that was drafted in hours. It’s absurd and very concerning. It is amazing that people are feeling confident and optimistic – the government is pouring 100s of billions into the market if not trillions – I don’t know what is so great about that.

In the last two trading sessions we have seen the dollar slide, gold, oil, silver, and other commodities move higher. The rest of the world does NOT seem to have the confidence that our government dumping money into the system is going to bring stability to the economic landscape.

Stagflation, inflation, recession, depression – the economy is drawing dead, any of those cards suck and means things are not going to resolve themselves until at the earliest maybe 2010.

Right now it is the Tax Payers taking on trillions in liabilities and we don’t see any ending to the debt loan in sight. I don’t think the $700 billion is even close to being enough.

First they came for the Naked Short-Sellers.

Then they came for ANY Short-Sellers.

Then the IRS strapped on their Jack-boots and came for Tax Payers.