Solving the problem

Either the world deflates as in 1929, or the world infltes like 1923 Germany. I suspect 1923 will be the choice .

The Day After

Mkts cratered yesterday as the spineless and undercapitalized/over leveraged mkt participants were all leaning on the bailout going through. Call it a rescue package or whatever, but it does not help the average US citizen. In fact, the homeowner up to his eyeballs in debt is in the drivers seat. They can just stop paying their mortgage and and then wait for the bank to try and foreclose-good luck as the bank probably has no paperwork regarding the titile to the property. The mortgage has been packaged and re packaged and probably repackaged again. It will take months if not years to put all the pieces back together. Wait unitl the majority of subprime borrowers and then Alt-A borrowers and then credit card borrowers and then Auto borrowers go through the same process and then realize that if they stop paying, the banks/financial institutions have recourse only to the pledged asset. Given that the pledged asset is upside down, highly unlikely the banks are in a rush to take the asset back.

Fireworks

Listening to the Financial News on the MSM, one would think the world is coming to an end. Maybe the financial world, but not the real world. In a capitalist society, bankruptcy is necessary to reign in excessive risks. Thw wise and strong will survive, while the ignorant and weak wither. For the last 8 yrs, risk control has taken a back seat to greed. Now the opposite is happening as risk control has shifted to the other side and fear reigns supreme. How long this lasts is anybody's guess. The 'Free' Market will sort it out eventually, but the markets have been anyhting but free in the last 12 months. Heavy PPT intervention, followed by excessive rule changing has completely screwed the system up. Let the Mkts work-set the interest rate, provide liquidity and then help the players build a solid base to continue business. The fact is that when the retail investor has been duped into buying stocks that are supported by a 25-1 leverage ratio-bad things happen. There are some great investments out their right now, but with capital short and tied up in illiquid and junky assets, it can not migrate to the better investments. The Paulsen plan would help free up some of that capital, but it is being bogged down in Congress as the cost of the plan is being difficult to sell. The US gov't has abandoned the middle class in the last 8 yrs while pandering to the rich. The gall to ask for taxpayer funds to support the Fat Cats is ridiculous. Let the mkt work it out-sure there will be bankruptcies, but that is life. The sun will rise in the East and Set in the West-life will go on, but it will not be as nice as it was when money and credit were cheap and esy to get.

Fed Losing Influence

One thing to note that is being downplayed by the MSM is that the Treasury had to go to the market for more money to initiate some of its programs. The US FED is raising NEW MONEY to pay for these bailouts. In the past the FED was able to use its existing balance sheet to bailout financial institutions or influence the mkts. More fund raising required.

An early morning Saturday note is the Pres. Bush has just requested Congress to raise the National Debt limit to 11.3 trillion from 10.6 trillion. This is after Paulsen and Bernanke had the debt limit raised form 9.8 trillion to 10.6 trillion for their rescue plan for Frediie and Fannie (also AIG). The ink is not even dry on the proposals and the price tag is rising (just like oilsands projects). In the last 2 months, the National debt limit has been raised from 9.8 T to 11.3 T or 15% (1.5 T total). If it was not so sad, it would be funny. To put it into context, each and every US citizen has just gone $5,000 deeper into debt.

Saturday Notes

Capital markets rally huge on Friday as the World Gov'ts intervene in the mkts. Banning short selling in the finacials resulted in a massive short squeeze. Other events-guaranteeing MMKT funds, creating a RTC and/or RFC type gov't agency to take the bad debts off the banks balance sheet. What has become clear in the last month is that US Financial Institutions are a protected species. They are also an endangered species are on the protected list-NO HUNTING US BANKS.

Interesting timeline. IN 2004 the SEC granted 5 US Broker Dealers with the ability to leverage themselves up from 10-12X to 30-40 X. Who were they-Bear Stearns, Lehman, Merrill Lynch, Morgan Stanley, and Goldman.
3 of the 5 have blown up or been married off. If that was not bad enough, the top talent from these firms went off to set up hedge funds which in turn were levered 20 to 40X. So the capital pyramind not only get bigger, but it almost got more unstable. NOTICE the SEC created this mess and the greed on Wall Street amplified the mess. Was this a plan by the NEOCONS to finance the US economy. This entire leveraging experience is going to unwind. The process is 1/3 to 1/2 way through.

The FEDS are taking the inflation way out. Instead of letting asset prices fall to a clearing level-DEFLATION, they are going to maintain asset prices by deflating the value of the USD. All of these plans by the government are going to require new debt to be issued and new money to be created to pay for this. The US TAXPAYER is going to get creamed in the next decade. The US is going to muddle along for years as the excesses are unwound. The fraud is coming out and it is just like ENRON and Worldcom-only larger. Interest rates are going a lot higher as they full faith of the US GOV'T has been compromised. Foreign investors are skeptical of the US Gov't actions. The theory it will never happen due to mutual economic destruction (similiar to the Nuclear arms race) is now toast. The Chinese, Middle East, and Europeans are going to build their domestic economies up and stop relying on the US for there products. The Chinese have 1.2 Trillion of reserves and part of that is going to be used to maintain a positive domestic economy.

Hang on-my fearless forecast: Interest rates, Precious Metals up, oil prices flat at 80-120, copper up (due to the electrification of global economies), base metals down to flat, food crops up as the third world wants to eat, stocks down as the higher interest rates will decrease the multiple investors are willing to pay. In addition as the demographics swing to a retiring population, the asset mix is going to favor fixed income/dividend products. Corporate bonds are trading at wide spreads as default rates rise. If 5 yr corporate bonds are yield 6%+, why buy equities?

Is anything safe?

The US government is confiscating companies left and right. What is next after Fannie and Freddie go down. AIG is bailed out, Lehman obliterated, and Merrill forced to marry Bank of America. When the smoke clears in a year or two, the strong will be stronger and the weak will be dead.

GOLD vs OIL

Here is the quandry, which asset goes up the most in a reflationary cycle. I thought it would be oil, but have been switching back to gold as oil is more economically sensitive. Storing gold is infinitely cheaper than storing oil.

The ratio has been swinging in gold's favor the last week so it bears watching.

THE United Socialist States of America

The US Government is out of control. Banning Short Sales of 799 Financials for 10 days (over qtr end funny enough) is another act of desparation. The unwinding of trillions of OTC CDS contracts is causing massive balance sheet distortions. Insurance companies thought they had is not necessarily there-hence forcing asset right downs. What a CON JOB.

The reflation trade is taking place. Printing money to buy garbage assets-bailing out banks and bank execs. With no shorting of financials, it gives the remaining executives a chance to unload their shares before they get the Bear Stearns and Lehman treatment. Gold is going to soar after the Exchange Stabilization Fund has shot its last bullet.

The US Government finally acknowledged the existance of the ESF as it will lend 50 bln to insure money market funds. The LIBOR rate has yet to drop below 3%. That is key as it should trade 20-30 bps over funds. It has been trading around 2.80 over the last 2 weeks, so things are still uncertain in financial circles.

China cuts rates

In what maybe the start of looser financing in the overheated kingdom, the BOC dropped interest rate 27 bps last night to 7.20%. Also they lowered the reserve requirements by 1% for the smaller banks-larger banks get no break.
Fed meeting tomorrow-rumors of a 25-50 bp rate cut-I think unlikely, but I suspect DOVISH talk and another liquidity injection.

Is there enough blood yet?

The bankruptcy of Lehman, followed by Merrill being acquired by Bank of America, and AIG desparately seeking capital. All equities are for sale as the realization that they actually do go to zero is resulting in a repricing of risk. Good, BAd and purely awful stocks are for sale-no buyers of substance. Expect more selling tomorrow as the mutual fund redemptions get exercised.
Some of the losses are truly amazing as the lack of capital across the spectrum is hampering any buying. The Hedge Funds-especially the undercapitalized ones are getting squeezed.

SEC is making comments about short selling -tightening the standards for short selling-trying to curb the abuse. Nothing like trying to influence the markets after the cow has left the barn. Unless there are serious consequences for 'illegal' shorts, they will continue.

Gold up, but not by much-only 2%. Oil crushed as the reality of a prolonged economic slump takes hold. Waiting for a supply response to the demand drop. Already hearing chatter about some oil sand projects being shelved. Treasury bonds are getting bid to the moon as the flight to safety continues. USDX is up as the USD benefits from the return of capital to the US-all the emerging mkts are under pressure as deleveraging continues. Not sure about property rights in emerging markets.

Stay tuned, the beginning of the end is near as the panic level is rising. Maintain capital.

Killing the Golden Goose

In what amounts to a huge amount of irony, the hedge fund mavericks have killed their golden goose. By attacking the Wall Street IB and the weaker financial institutions (small regional banks), they have effectively shut off the flow of blood to their brains-ie cheap financing. These funds have put short term gains ahead of long term plans. Now they are being forced to reduce their positions, take losses and hence be below the high water mark and hence no bonus payments. What a bunch of 2 qtr mgrs. The hedge fund community has cut off their noses to spite their face. Good bye multi million $ penthouses, hello to 2 bedroom apartments in Brooklyn. Wall Street is going to feel the pain for yrs to come.

Dr. Copper

A bottom -temporary or not-may be forming in the commodity sector. Copper is holding the 3$ level and oil is hovering around 100. Gasoline and Heating Oil are rallying sharply. This engineered selloff by the authorities to blast the overleveraged hedge funds out of the market has had the desired result of reducing the froth in the hard asset camp. Now the return of demand will provide a fundamental floor for some of these commodites. The big scare of slowing Chindian economies is not really happening-the law of large numbers is taking hold. .

Dr. Copper is indicating that global growth is not going to go negative, but it will slow down to more sustainable levels. Brazil is raising rates, while New Zealand and Australia are chopping rates. The Baltic Freight Index has dropped as the supply of ships is overwhelming the amount of goods to be transported. US Retail sales are weak-no surprise since no one can get financing. US is in recession and the slow growth and credit contraction period has a long way to go.

As a side note-whenever the mains stream media (MSM) run articles making predictions about future price levels from secand and third tier fund managers-perk up your early warning indicators. Who cares what a 50-100m $ fund thinks-there are 3000 of them around. Watch the charts and look for divergences-that will tell the true trend.

Brazil's Central Bank

What are they thinking raising rates 75 bps to 13.75 %. They will be cutting rates to 11% within 12 months.

As for China, the Hang Seng continues to be pressured-it needs help also. Global equity markets are deleveraging and investors are realizing that stocks sometimes go to ZERO. Risk is being repriced. Leverage is disappearing. The Central Banks are going to respond, maybe next week. Shock factor will be required to have maximum impact. Probably coordinated action.
China's central bank will soon drop reserve requirements from 17.5%-probably all the way to 12.5% in the next 12-24 months.

The Central banks have been resisting the Nuclear Option of dropping interest rates to re inflate the system since that would hurt their Masters the most-the Banks. The Banks in a hyper inflationary environment get paid back in deflated $. Debt holders get to pay back with deflated $.

Baltic Freight Index

Many rock star hedge fund mgrs are pointing to the plunge inthe Baltic Freight index as a sign of slowing economic growth. That is only partly true. The index is not a measure of tonnage moved, it is a index of prices paid to move that tonnage. There is going to be an oversupply of ships on the high seas as the total tonnage of ships available has outgrown the the total tonnage of goods to be moved. Stay tuned as shipping rates will continue to plunge as the number of new builds oversupply the mkt. The classic value trap is being built in the shipping stocks.

There is no doubt he rapid growth rates in CHINDIA are moderating, but moving from 11 % to 8% is partly due to unsustainable growth rates and partly due to the law of large numbers. Growing from 100 to 110 is 10% growth, but gowing from 110 to 120 is 9%. Growing from 120 to 130 is 8.3%. Of course the growth seekers view this as negative, but the value managers see this as a positive.

Copper

Despite the drop in commodites across the board, copper is hanging rather well. WHY? Because the world is going to electrify and that requires massive amounts of copper. Copper is becoming the new oil.

Are we going to see the BIG ONE

Lehman is on the ropes. WaMu is on the ropes. Will they get bailed out, or will the gov't see how their damage control plans works?.

Lehman is a prime broker and it is no doubt reducing financing to the hedge fund crowd. As is every other prime broker reducing financing to the hedge fund crowd. The bankers are saving their own skin once again, not helping their clients. The strong banks are sitting back and waiting for the plunge-hoarding cash waiting for even better prices. Why buy LEH at 10-13, when u can buy it for 2?

Asset sales are global, the pain is starting to bite which means the downtrend is probably half over. I expect a policy shift at the next FED meeting to move some of this hoarded cash off the balance sheet. The PPT is busy trying to help the US consumer out-dumping crude contracts as well as a host of grain contracts. No problem here with that process, but how long will it go for. OPEC has already announced a supply response. THe grain crops are going to be massive in Australia this year, but if prices drop too far, the North American crops will be reduced next yr. The government should get out of the price adjusting game and let free market mechanisms work.

Good Bye Hedge Funds

Hedge Funds are going the way of the Dodo bird. Not all hedge funds or alternative investment vehicles, but the days of 27yr old math whizzes raising 500mm and then levering 20X are over. The 2 plus 20 payout is going to be an endangered species. When Blackstone went public last yr, no one was contemplating the peak of hedge fund importance. Now they are in survival mode as prime brokers pull back their lending lines and the system goes through a deleveraging. Everything is for sale and if it has a bid, then short it. Money is being created hand over fist, but credit is contracting at a much faster pace. The power of deflation in credit vs inflation in cash.
The bailout of Fannie and Freddie delay the collapse of some financial institutions, but the US consumer is still retrenching after yrs of sub par wage increases.
The concept of the global economy picking up the slack of a weak US and European economy have been dealt a cold dose of reality. Time will tell if the Chinese shut down for the Olympics and Para Olympics has longer running ramifications. The Asian growth stroy has been put to rest for the time being.
The USD is rallying partly due to a re patriation of dollars from foreign markets which have been crushed this year. China down 50% for example. Qtr end in 3 weeks is also resulting in a deleveraging of positions across the financial spectrum. In addition, the problems of Spain and Italy are putting pressure on the Euro. The Euro is a currency with no country, but speculation has surfaced regarding the Club Med Countries running into trouble fiscally and thus put pressure to reduce the value of the Euro.

Buyers are on strike in the equity markets. As equity holders recently found out-sometimes equities go to zero (FNM, FRE) With corporate debt trading close to 10%, equities are no bargain. Against treasuries, stocks look reasonable, but comparing a AAA to a BBB corp credit is not a fair comparison.

Fannie and Freddie BAILOUT

It has finally happened. The gov't of the USA has nationalized FNM and FRE. They had to do it. Quote of the day goes to Treasury Secretary Hank Paulson (and I paraphrase): 'I did not want to do this, but this action is sooo much better than the next best alternative.'

Winners and losers in the aftemath; common shareholders are losers-massive dilution and last in line for any profits-likely decades into the future if at all. Preferred shareholders are losers-dividend toasted and again they stand below the equity holders-ie the gov't. Subordinated debt holders and above-Winners. The new financing is below existing debt holders. Most vocal action plan man Bill Gross wins has 61% of his portfolio is in agency paper-Nice Gamble Mr. Card Counter. Now lets see what you do-does PIMCO pony up more capital to go in with the Treasury's capital infusion.

Major Losers-US Taxpayers. Once again the Wall Cheaters take care of their own. A slap on the wrist for the total disregard of risk management. The taxpayer is getting the bill while Wall Cheaters take their multi million/billion payouts to the bank. No downside risk results in ridiculous risk taking. The system is broke and needs to change to get on better footing.

Will this fix the system. NO. US consumers are bloated with debt and that is going to require time and real wage growth to correct. As William Ackerman states: 'This is a Band Aid." The banks and financial institutions are getting some breathing space to recapitalize and again that will take time. Until the banks rebuild their balance sheets, lending will be tight.

Uptick rule

The bottom of the mkt will occur when the SEC reinstitutes the up tick rule. WHY? Because the need for levered money to relentlessly pound on securities will drive the gov't to stop the process and it is good for the country. As John McCain says-change is coming and the death of hedge funds is soon to be upon us. The Gov't has already stopped large funds from taking positions in commodities since that exposed the amount of capital that is floating around the system. Too much money/credit has been created in the last 10 yrs-that credit is shrinking in the US and is not being created in other global mkts.

Banks saving themselves

Have not posted for a while, but now that I am back from summer vacation only to watch the markets melt down , my brain is on full crash alert. The mkt lacks leadership in both stocks and institutions. The banks are trying to save themselves from insolvency. Global financial institutions are sticking it to their clients as they refuse to lend capital. If you want money-too bad. They are going to save themselves first and then maybe help their clients. This is extremely bad for the economy and the long term inflation implications. The Greenspan doctrine was to lend money to everyone and create competition -thus keeping a cap on prices. If competition declines-watch prices rise or at a minimum not cecline. Look at the auto and airline industry-price cuts after price cuts as an industry inmassive oversupply tries to survive.
Investors have their hand on their wallets as there appears to be little appetitie for additonal risk taking. Bill Gross's commentary basically calling for a bailout of the financial system indicates 'things' are bad. Hedge funds, banks, and brokers are deleveraging in a massive way-everything is for sale. Good, bad and ugly assets are for sale-no bid is a bad bid. P/E multiples are inaccurate as are EV/EBITDA, P/BV and any metric. This survival of the fittest.
This mornings employment report drive home the point that US workers are losing jobs-more to come as the full effect of auto shutdowns and financial lay offs filter through the system.

Capital preservation followed by dividend/interest income are the two priorities. Capital gains are not in the cards for 95% of financial assets.
As a side note-the credit mkt spreads are wide and remaining wide-indicating capital is scarce. We have the FED plowing money into the banks, and the banks hoarding it because their balance sheets are a disaster.