9/26/08 (Looking over the edge!)

Traders,


We face an edge of a cliff and I believe with or without the bailout package we are going over - why? The bailout package may keep us falling for now, but it does not solve the unwind of leverage and it will spur stress of the dollar. This is not a tax payer story, a wall street story, a housing bubble story - this is a Dollar Story - which no one is talking about. That IS the real problem.

The bailout plan needs to be paid by someone, we here Congress say this is a Tax Payer issue. They are right, but NOT today - that's WAY down the road. The Fed needs money TODAY for this bailout plan - so WHERE is that going to come from? It is going to come from selling treasuries, but WHO buys the treasuries? It's foreign money. Our government, our corporations, our citizens all spend on a credit line which has been granted to us by China, South Korea, UK, Saudi Arabia, etc. These and many other countries buy treasuries for several reasons. It is THESE countries we are going to for money, but will they come to buy MORE treasuries?

Let's look at this from THEIR eyes as a sound investment. The yield (return on investment) in treasuries is between .5% - 3% (depending on maturity date) we will uses 2.25% - target rate. However, the inflation rate measured by the government (CPI - which you know I already think is too low - but we will use it in this exercise because it is the "Official" number) is 5.4% (unadjusted). That means if you buy a treasury at 2.25% and CPI is saying inflation is 5.4% you are actually losing money (buying power) of 3%. Remember, buying treasuries is lending money to the government, who are paying you back with interest. Now let’s look at the second factor these foreign investors are concerned about and that is the exchange rate of the dollar (back to their currency). That measures the strength of the currency vs. domestic currency, now the dollar has been sliding (abet we did get a slight rebound) against foreign currency. Let's say they expect the dollar to slide another 2% against their currency. When their treasury investment matures and they repatriate from USD back to their local currency they lose more money. Now there are some NEW concerns - if this bailout plan is passed the government is just increased their debt (lowered its credit rating). These foreign investors are wondering who else is going to buy this increase in treasuries? Why, because with an increase of a $1 trillion in debt (700 billion from the plan and 300 billion from the other bailouts) - they don't want to be the FIRST large investor or the last large investor. They KNOW if the treasury auctions FAIL (even a little bit) that inflation will ramp. Inflation comes in all forms (price stability, printing more than is coming in, leverage, etc.) = in this case it's direct inflation, meaning they are "printing" more than they are taking in (treasuries). And lastly - looking at the Fed Fund future prices - they are indicating a 92% chance of another rate cut by Oct's FOMC meeting. In conclusion - it is a very BAD investment for foreign nations to purchase USD treasuries. It is a losing trade. At this point they either do it (toss money away) because they believe they NEED to help - or they stand on the sidelines not wanting to be first. Our nation is begging for money - and that is the sad truth.

At the end of day - we are putting are HOPE and FAITH in governments like China that will come to the rescue to extend us a massive line of credit. Do they, and that leads me to my first story.

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China Closes the Door

Last night a Reuters Wire reported from the South China Morning Post, that stated that the Chinese Banking Regulatory Commission (CBRC) had told banks to STOP lending to the U.S. Banks. Shortly after, they came out with a story DENYING that story, but in my humble opinion only to defused a true story because they didn't want to cause any MORE market panic. Remember, this is a communist controlled paper - you know they would not print anything without heavy editing and approval of the government. Or are we REALLY seeing Free Press in China? Take it for what you will. The ONE fact in this story is that Chinese Banks (regardless if told by the government) have shut the door to lending.

NANNING, China, Sept 25 (Reuters) - China's banking regulator sought to
reassure jittery financial markets on Thursday, denying a report it had told
local banks to stop lending to U.S. banks and stressing that foreign bank
operations in China were healthy.

"The CBRC has never, through any channel, issued a statement or told domestic commercial banks not to lend to or borrow from U.S. financial institutions," the China Banking Regulatory Commission said in a statement on its website. CBRC Vice Chairman Wang Zhaoxing told Reuters that a report in the South China Morning Post, which said the agency had told Chinese banks to stop lending to U.S. banks in the interbank market, was not correct.

"If they are not willing to lend, this is the normal practice of risk control," said Wang, speaking on the sidelines of a major banking conference. The CBRC later said the SCMP report was irresponsible.

Dealers at some Chinese and foreign institutions, who declined to be identified because of the sensitivity of the issue, said U.S. and some other foreign banks were finding it harder to borrow from the market.

Some Chinese banks have temporarily stopped offering new lending to U.S. banks, in yuan and other currencies, because of uncertainty about risk, three traders said. Similar caution in lending has been seen in markets around the world.

http://www.reuters.com/article/asiaIpoNews/idUSSHA17536520080925

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WAMU implodes - now FDIC has a problem

As Washington is playing Hot Potato with the bailout plan - another bank FAILS. This time it's a WHOPPER - not some local regional bank but a massive one. FDIC went in a lock the doors and JP Morgan is "buying" deposits. WAMU was a long time coming as I had been reporting their odds of failure were mounting fast. WAMU faced $19 billion in losses, not to mention a massive book of failing mortgages.

FDIC is already trying to curb panic and are opening their doors to allow (INSURED) depositors access to their money. They are quickly doing the best they can, but the FDIC is running into its own problems. First, they kept VERY low balances against insurance (1.19% as of July 2008). That is VERY poor risk management - heading into this credit crisis - they should of boned up their balance sheets getting it up to 5-10%, yeah that's a lot more - but probably still not enough. Their stupid assumption that only 1.19% of all insured deposits will fail - means the FDIC will SOON be visiting the treasury - along with everyone else - for handouts. That's right the FDIC could also be out of money very soon.

Their mandate states they need to maintain 1.15% capital on balance, they were running very close to that. Several small banks failed brining them right to that threshold. If they fall below it they HAVE to actively raise money. They generate capital by charging a premium for insurance, just like any insurance company. Then INDYMAC failed and took them below that 1.15% threshold - they now had to raise money (either borrow money from the Treasury OR raise premiums) - they announced they would be raising premiums, but (IMHO) that is too little too late. WAMU is going to suck out a big part of that remaining balance, which is only about $40 billion now.

I constantly hear people say - this isn't as bad as SnL Crisis which saw 1000 banks fail. True, a 1000 banks failed - but NONE of them were a INDYMAC or WAMU, they were all small savings and loans. That net crisis cost $150 billion, guess what we spent TWICE that much already on Freddie, Fannie, AIG, and Bear Stearns - and they are just the early birds. I am just miffed that FDIC, knowing last year (because they have inside view to the bank’s balance sheets) KNEW there was increased risk did NOT bone up their balances and start charging HIGHER premiums a year or two ago. Coming into a crisis that continues to unfold and carrying balances at lows not seen for over decade just above their minimum threshold is just another example of Government sleeping at the wheel.

Expectations - after WAMU - FDIC is now in serious trouble, they don't have enough money to insure many more failures. They will be going to the Treasury (the Bailout Plan will now have to cover the FDIC as well).

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Bailout Plan - a Political Blow Out!

Now it's a government cluster f###. The Democrats are blaming the Republicans for not coming on board, but that is just Horse Shit - if they want to pass it they control BOTH houses and they could pass it. What they are REALLY saying is that we don't even have all our Democrats on board and don't want to take heat from the voters that we "DEMOCRATS" just blew $700 billion of tax payers money. You could say the Republicans put the Democrats in the Dog House, the Democrats have BLAMED the Republicans for this - but it is THEM that control both houses. This is now a political vote going into the election. If the Democrats past this in a party-line vote and it fails (which it WILL) then the Republicans can point their finger at the Democrats and they will take the blame.

This is beyond silly and stupid - they are playing political games. Dems could pass it without the Republicans, even Bush has sided with the Dems, but I don't think the Dems are ALL on board with it. This is just a total cluster f###.

The 3 page document turned into 6 page and is now over 40 pages. However, they are trying to pass legislation on the FLY - which is difficult to begin with. Doing it going into an election, economic crisis, and energy crisis. Whatever the plan is - I DON'T HAVE FAITH.

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Credit Lines being tapped - last ditch run

JP Morgan (that just bought Bear Stearns and now WAMU's deposits) is seeing massive strain, along with Citigroup and Bank of America. Several large companies are tapping their credit lines in a last ditch run to get capital on the books as capital becomes harder to come by. Goodyear, GM, and others are drawing on their (revolving loans) - banks had over $1.4 trillion in untapped loan commitments and now these companies want to borrow the money - NOW!

This is putting unbelievable stress on the already stressed out credit lines. Several of these companies tapping money already have stressed credit ratings and now borrowing this money puts them further behind the eight-ball. The problem is that many of these banks do NOT have the money to lend and will have to go to out to borrow it and those spreads are widening as NO ONE wants to lend.

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Futures Pre-market

The bailout plan has turned into a mudslinging event and WAMU goes bust, so don't expect the futures to rally in the opening. They are getting hit pretty hard. The ARB spread is very wide, but since Arb traders can NOT short stocks - we are not going to see them rush in to BUY futures into the opening - since they can't short the basket. Expect a lower opening.

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Support / Resistance

We are very close to the YTD support levels - if these don't hold we could have a vacuum to the downside. I don't think many firms will want to go home today holding any paper - unless something changes.

INDU 10,500 (11,000) 11,500 (We are at that MASSIVE pivot point and looking lower going into the opening. 10,500 is in the cards, but we could also get a shocker and the Bailout plan COULD be announced sending us into an upward spike. Smart money is going home with no delta positions - that is something you CAN bet on.)

NDX 1650 (1700) 1750 (1700 is the pivot point, we are right below that - if 1650 doesn't hold we can see a suck out and head lower fast.)

SPX 1150 (1200) 1250 (1200 is the pivot point - we are headed lower at the opening.)

RUT 680 (700) 720 (700 is the pivot point)


The last time I saw a intra-day halt in trading was in 97 during the Asia Flu credit crisis - it is NOT impossible to see that today - if panic sets in. We could also see a last minute vote and a bailout package which could inject a huge rally (but that would be a knee jerk) - today is ANYTHING goes. Smart money does NOT want to go home naked long (without hedges) - so expect longs to unload into the close unless something changes. Could Monday be a revisit of Black Monday in 1987. Back then Friday was a big down day, followed by Monday which was a down 22% day. That will probably NOT happen because of trading curbs (which we didn't have then) - also we have all these PROPS to keep the market from crashing. But we could continue to head lower.

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Conclusion

I have little faith in this government and have lost confidence, even if they manage to put a bailout package together. The problem is not Democrats or Republicans - it’s there lost of focus. I keep saying this is a Dollar problem, but everyone is focused on Wall Street, Main Street, and the Tax Payer. But it doesn't matter if you are Wealthy, Middle Class, Poor, if you are a Corporation or Small Business - commerce works because we have FAITH in the Dollar and we RELY on FAITH in the Dollar from other countries. Once the dollar starts to devalue - nothing else really matters. Bailouts, credit lines, etc - it is all based on the Dollar, which is a FIAT currency and not backed by ANYTHING. It simply works because we have FAITH that our Treasury, Federal Reserve, and Government is competent to maintain a strong dollar by keeping inflation in check, budget deficits in check, and paying down any debt.

We, domestically, have lost faith in our Government - but more importantly the WORLD is losing faith very quickly. That means the bigger problem - the Dollar!


You may get sick of hearing this quote, but I am going to repeat it until it sticks in your head!

"Paper money eventually returns to its intrinsic value --- zero."Voltaire (1694-1778)

Two MUST reads if you WANT to UNDERSTAND what is going on and how this all works (or fails). Not reading these books means that you wish to remain IGNORANT. Sorry for hammering on it - but we need to take an active role in UNDERSTANDING what is going on and not HOPE that our Politician’s know better.

Tug of War (by Paul Erdman) - little dry - but fast read on how the currency crisis happened in the past and how the whole thing works.

Vandal's Crown (by Millman) - a fun read - the history of futures and currency.

Read these two and you will KNOW more than anyone in Congress and will help you understand why this is all happening. Vandal's is a better read, but Tug of War is textbook necessary.