Monday, September 22, 2008


The head of the SEC has asked every passenger on the boat to move to the starboard side. He knows the risks of operation have increased, he knows that the boat will list, but, politically, he did the right thing!

In the midst of a financial crisis, there are all sorts of calls going out for the government to steer the boats to safety. The congress suddenly knows the market seas better than the boat captains. Hank Paulson says a large number of boats have run aground, but a flood of liquidity from the government will allow most to recover.

The features of the proposed buy-out are anxiously awaited. The rational for banks to hold-on to all the deeply discounted mortgages they can has increased. Soon after the government starts buying mortgages, the value of all the rest should rise. The bank that gets by without selling any of its "junk" to the government, will make the highest returns. Banks are leveraged at only around 12 to 1 while investment banks and hedge funds are typically leveraged to at least 20 to 1.

The good news is that the market is punishing the meddling in the markets by the congress and the excessive leverage. It was the congress that pushed the market to lend to non qualified buyers. It was the investment banks and hedge funds that could not resist the temptation to leverage these mortgages to the hilt. It took both to create the super housing bubble.


Morgan Stanley and Goldman Sachs will end their long history as independent investment banks. They will join others who have become "regular deposit taking banks". By taking deposits, these banks will become regulated by the FOMC. They will no longer borrow at 20 to 1 leverage and the huge bonus payments for making big deals will end. (When Barclay buys Lehman, executives of this failed institution will share in a multi-billion dollar bonus pool.) Never-the-less, the risk of a future total collapse in the banking system will have increased due to the consolidation; a future mistake by the FOMC will put all banks at risk.

Congress and "news commentators" do not want to stop with the regulation of investment banks; they want to hang "evil" speculators (financial shoppers). I am very thankful for "shoppers". When I buy a car or anything else, careful shoppers have made the transaction less risky. The vendor who asks too much for his goods is likely to disappear from the market place. Another way to think of short sellers and speculators is that they are much like the "no pass" betters on the crap table; who bet against the dice, reducing the risk to the house. Speculators are like fire and water on a steam engine, you have to have both fire and water to make a steam engine work, you have to have a cooling system on a car engine.

Should a casino ban betting against the dice, it would dramatically increase its risk of loss. In the perfect casino, every single bet on the pass line or come bar would be matched by a bet against the dice. The casino would never lose a bet. It would take its small transaction fee, each time there was a roll of a 36 (on average, the house gets paid on one of 36 rolls).

Of course, casinos do not mind taking the gamble on the center table bets, where the foolish go against long odds. Professional gamblers avoid the long odds; the big money bets, including short sales in financial markets and "no pass" bets on the crap table are made by big money pros. Amateur gamblers need not bet against the dice and small investors need not sell short. Small investors can let the pros keep the market fair whild avoiding the "high fees" on the center table bets at the crap table and on the high fee strategies offered by Wall Street brokers.

However, the timing of the removal of short selling was perfect. The SEC, the FOMC, the Treasury Department and the Congress will all take as much credit as they can for the turn in the markets. The fact that this turn was due is of little consequence; the public is counting on government to save the day. The congress will "negotiate" with the administration this week but Paulson holds a full house against the inside straight draw of congress. Paulson will get 90% of what he wants. The congress will likely leave town this Friday after having passed the Nuclear 123 bill with India, a continuing resolution that does not include a drilling moratorium and the Paulson financial bail-out bill.

Before passing the "clean" CR, the senate will fail to pass four energy bills. Democrats will run on the platform that if they had a few more votes they could save the planet from ourselves. They will suggest that with a few more democratic votes all will be made well in the next session of congress. The major remaining questions are, "Will congress be running against the headwind of $4 gasoline?" and "Will the Iran--Russia--Middle East 'problem' be fixed?"

If the Iran--Russia--Middle East "problem" is not fixed, it will be left up to the next president? Clearly, all the bad guys in places like Pakistan, Afghanistan and Somalia are not going to be converted or eliminated in the next month. Tense times help John McCain's bid for the presidency. The USS Iwo Jima just concluded another "show off" stop in Greece. The technology apparent in this sophisticated battle group has received steady praise during its "pleasure cruise". The next destination is the mouth of the Persian Gulf. The gold and oil markets have already bounced, in anticipation for what might come next. Should the matter be resolved peacefully, just as the congress decides to get out of town by passing a clean CR, crude oil should quickly test $85 support. Four Dollar gasoline would give republican congressional campaigns a strong boost because democrats have demonstrated that they want higher fuel prices in exchange for more money to throw at clean but inefficient energy. An escalation in the conflict with Iran would give McCain's bid for president a strong boost. Tense times create a win-win situation for republicans. Republicans and all Americans need the banking crisis to be solved.


It is worth repeating that real estate recessions only come around every 18.3 years on average. Almost like clockwork, our last real estate recessions were in 1973-74 and in 1990-91. Furthermore, financial stocks make V bottoms during real estate recessions and move up strong long before the real estate recession is over. For example, the financial V made in the fall of 1990 was so strong that many bank stocks were up 100% by the fall of 1991, bank stocks had doubled in value while most people hunkered down to fend off Armageddon.

The market is showing evidence that it may be jerked down today; financial shares in London are down about 2%. There is uncertainty in regard to the bailout bill. Chris Dodd, Chairman of the Senate Banking Committee, is barking about alternatives as is Pelosi, Frank and others. Again, Paulson holds a full-house. He has the power to put another bank out of business if congress does not play along. He will get his bill this week and return to Wall Street in January. Are you taking full advantage of the financial turn?