9/8/08 (Epic Fail and Selling the Faith!)

Traders,

This weekend we saw an historical event take place – the biggest bailout in history. How did we get here and what does this really mean for the economy and the stock market? Freddie and Fannie were formed (one during the New Deal, the other during the late 60s when inflation was very high) to help American’s purchase homes with low cost mortgages. It has been for many economist – a hot topic – because while it was created by Congress (it’s regulation and rules) they were publicly traded companies. There was an IMPLIED belief that the government would bail them out, but our government continued to assure us that they would NOT be bailing out these two GSEs and the risk would fall squarely on the shoulders of the share holders.



Freddie and Fannie were also in a secondary business – that was selling bonds (obviously to raise money to cover the money they were lending out via mortgages). These preferred shares / bonds paid dividends. They were also rated AAA by the credit rating agencies (meaning they were as safe as US treasuries). Many mutual funds, investment firms, retirement funds, pension plans, and even foreign governments bought 100s of billions in these bonds and preferred offerings based on the implied safety of the AAA rating – coupled with the dividends (monthly payment). It was a supposed safe place to invest.

However many (that could do the math) have been saying for YEARS that these companies are bending under their own weight and are doomed to fail. But no one listened – why? Because of the blind faith and trust that the government KNOWS best. They told us that Fannie and Freddie were MORE than solvent and that was good enough for Congress and the American people – and also investors – who continued to buy shares and those preferred assets. Warren Buffet’s company (Berkshire) was a huge investor in Freddie and Fannie – but he too began to see the pending doom and failure coming. They could not continue to mount the massive amount of debt and expect nothing bad to happen. In 1999 he pulled ALL investments out of Freddie and Fannie and issued a warning to those few that listened.


When the housing market began to collapse last year – Congress lead a charge to help save the housing market from collapsing. Barney Frank, Pelosi, and Dodd proposed that Freddie and Fannie could help and formed a bailout plan of that many believed would help keep the housing market. They allowed Freddie and Fannie to increase their debt ratio (leverage). They were warned that the risk of increasing already a very massive position could create an EPIC FAILURE and cause a major collapse. Congressional testimony including Paulson (Sec. Treasury) said the balance sheets were fine, however asked for unprecedented power to take over the GSEs if necessary.



Paulson’s Bazooka line will go down in history, “If you have a bazooka in your pocket and people know it, you probably won't have to use it!” He implied that giving power and the threat would bring confidence to these companies and the housing market. It worked – for a while.
However, the housing market continues to fall, billions of write downs continue, and at the end of the day talk is cheap. These companies are (as Buffet, Ron Paul, and several economist pointed out) doomed to fail if they are allowed to continue to take on more debt. The breaking point was reached and a series of concerns that the GSEs were on brink of failure began to surface over the last couple of weeks. Several high ranking investors and foreigners had released memos, made phone calls, and began voicing their concerned that Freddie and Fannie are going to fail – something that could not be allowed to happen – not just because of the mortgages and selling them for pennies on the dollar, or the common share holders – what really concerned China, big investment funds, etc – was the 100s of billions in bonds/preferred shares. Freddie and Fannie had turned into an alternative to treasury investments for very big money and the concern that they could not meet their payment obligations on the debt was surfacing everywhere.


Again – the government stepped in over a weekend (Sunday morning) before the Asian market opened with the S&P back down in the 1250 range – and announced the biggest bailout in history. Paulson pulled the trigger on the Bazooka! They made a 2 billion investment, have warrants to buy out 80% of the outstanding, will be investing (loaning) $200-$600 billion more (depending on who you ask) to keep these companies from failing. Paulson said that common share holders would lose FIRST and also eliminated the payment of all dividends (including the preferred shares – this is causing some concern). Paulson in an interview this morning said it would be hard to say how much is it going to cost the tax payer. The reality is this – they are taking on $5 trillion plus in illiquid mortgage paper – not to mention the tons of bonds. Just like the mortgage companies, the government does NOT consider the $5 trillion actual liabilities. Why? Because people are paying their mortgages. That’s true until it’s not. Paulson is right, there is no way to tell how much this will cost tax payers – it all depends on how much of that $5 trillion in mortgages fail. Some have indicated as much as $1.5 trillion are non-performing at some level.

The sad thing is this is a bailout of a bailout. Freddie and Fannie were suppose to bailout the housing mess and now we are bailing them out. Is this good news? Absolutely not – even Paulson in the interview this morning said “It’s not good news, but better than the alternative. I am not going to second guess the decision.”

What does this mean for the economy, the dollar, and the market. Well truth be told it paints a very bleak picture – the government has taken on more debt and it will require the “printing” of more money. An economist said over the weekend – that you can only make bailouts like Bear Stearns, Freddie, Fannie so many times before you the faith and confidence begins to fail.

At this point it is FAITH that Paulson is selling – just like Bear Stearns was an isolated event and faith that it other banks are fine – then IndyMac. The “worst is behind us” talk is getting old and the well is running dry.

The market is getting a HUGE rebound at the opening, however remember Fannie and Freddie are halted (It was felt that it was better that we let it sink in – as not to create a panic). The spin doctors are in full swing – already saying the worse is behind us and this was a good thing. For those that can do the math – it doesn’t look good all.

The rally, just like after Bear Stearns – is based on euphoric optimism – not fundamental solvency. The market is rallying because it has now proven that it will not let anything fail – in comes economic socialism – but at the end of the day what does this mean about the dollar (our FIAT FAITH BACKED currency). The faith is starting to falter – inflation is real – secondary treasury auctions are failing. The dollar has recently rallied – but there are some interesting forces coming into play. The short positions in inflation hedges is becoming massive, but in Silver for instance – while it is very easy to buy silver (paper) you can’t get any quantity in the physical asset. The US MINT has also halted minting and issuing 1 oz rounds. The huge short interest, the shortage of physical, the mints halts issuing 1oz rounds – is another huge hidden bubble about to blow. These events are leaving many to come to the conclusion that the US government wants to keep the interest rates low (needs to keep them low) but at the same time trying to support the dollar. That’s called a prop up – not fundamental solvency.

This take-over has injected a HUGE amount of hidden volatility into the market. This rally is a gift – nothing more!

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Boeing Strike costing 100 million per day.

The strike at Boeing is costing about 100 million per day in revenue. The stock has seen some negative pressure since last Friday – the question is how long will the strike last – this is not the economic landscape to be striking companies that are tight on revenue and are looking for cost savings.










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Futures Pre-open

The ARB traders are loving it – the spreads are massive. Expect a HUGE pop in the market at the opening.

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Support / Resistance

We are getting a good pop – but it’s based on the biggest bailout in history – bad news is good news!

INDU 11250 / 11500 (We will no doubt hit the 11500 area – and we could break that an continue to head higher – even make it up to 12000 in the near future. However, nothing has changed – bailing out the GSEs is still cloudy as to what the bond and preferred holders will get – the dividend payments have already been halted.)

NDX 1750 / 1800 (1800 is close to where we may open. But don’t get to excited. This is a massive knee jerk.)

SPX 1225 / 1275 (Go figure – the economy looks bad and the S&P gets back down to the 1250 range and the government steps in AGAIN and makes a huge bailout. I guess 1250 range is the support range based on government intervention?)

RUT 700 (720/740) 760 (Talk about a massive range for this index. Today’s move will again be a hyper move based on euphoria and short covering).

We are going to have MASSIVE short covering at the opening that will fuel the rally even further.

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Conclusion

I mentally puked this weekend as I listened to Paulson, not like there was anything else he could do. But my faith in our Congress, Fed, and Treasury has been fading. This is not about Republicans or Democrats, this is not about Bush, Obama, McCain, this is about one thing – government in business and having their hand on a printing press. Printing their way out of problems. Mark my words – even if this market rallies and the dollar in the short term rebounds – we have just put the government seriously behind the eight-ball. The fiat currency is being tested like never before. It only takes ONE big player to say – I don’t want that paper anymore – I need INTRINSIC value. China already made overt hints at getting the GSEs in control.



100s of billions of loans at the Discount Window, $5 trillion in liabilities now added to the government balance sheet. I am not sure what the answer is. Of course you can bet that they will NOT add the liabilities to the balance sheet. Clinton did that to great effect to make it look like we had a surplus, removing liabilities to off-balance sheets and not including them in the Budget. I bet that whoever the next president is – they too will remove the $5 trillion (even the non-performing) off the balance sheet as well.





Math is math – no matter how you label it.