Friday, October 3, 2008

Bailout Passes/Market Drops! Ooops!

Good late afternoon!

Lets all give The Fed's a big round of applause for saving the market! Nothing like a 500 point reversal into the RED after passing the largest bailout in the history of the US.

Does anyone feel like their 401k should be renamed a 201k? I actually am surprised the reversal was so violent today. I thought we would at least get a 1 day rally out of this.

Anyone notice how each Bailout rally is getting smaller and smaller. Bear Stearns stoked a two month rally. The Fannie/Freddie nationalization gave us a couple day bounce. The AIG "bailout" lasted about one day. The Paulson plan monster rally was what? A few hours? Yikes!

I thought this bailout was going to stabilize the markets and help restore investor confidence? Hank, you promised us this would settle things down! NOT! The bailout seemed to have the exact opposite effect. This plan will create more intervention into the markets which will do nothing for confidence in the markets. The Treasury will be buying securities without having a clue as to what their true value is.

I can't see any distressed buyers stepping up to the plate and buying mortgage debt right now as the economy implodes. I mean look at the jobs report today. Who on earth wants to buy any bad debt right now unless its sold at distressed prices? The whole economy is tanking!

This will continue to lower the value of houses. No distressed buyer is going to stick their toes in the water right now until things stabilize, or the price is right which means pennies on the dollar!

The problem for the taxpayer is we all know the Treasury has announced they plan on overpaying for these subprime sandwiches. Thanks guys! Enjoy pissing my taxdollars down the drain!

They have really backed themselves into a corner here. Why? IMO, the Treasury will have to give these securities away in order to set true market prices, and we will know about it based on the on the plan was written.

Let me explain:

The problem the Fed has with this particular plan is they must announce what they paid for these crap sandwiches within I believe its 48 hours. This was written into the bill.

So for example, lets say the Treasury goes to a bank and buys $50 billion of subprime sandwiches at .65 on the dollar. They will be forced to tell us exactly what they paid for them within a couple days.

Now lets suppose they hold an auction and receive no bids for the paper at .65 on the dollar. Lets say the best offer they receive is .30. What in the heck does the Treasury then do?

Do they tell the banks "no deal" and risk holding onto these securities as the economy continues to spiral downward, or do they sell them at a huge loss? If the the Treasury decides to sell them at .30 and take a huge loss, they will see torches and pitchforks outside their windows because the taxpayer will know they got bent over.

If they decide to hold onto the securities thinking they can get a better price, we are right back where we were with zero transparency and no clue what their value is except with one exception: The Treasury(US taxpayers) now owns the bad debt. So my question is how does this solve anything in the long run?

The way I see it its a lose/lose proposition for the Treasury. Either they take the loss and Americans start rioting in the streets, or they hold onto them which does nothing to solve the transparency problem and potentially end up taking huge losses down the road as the economy worsens.

This is why this plan was plain stupid. Now of course we all know why this was done. China and Europe basically threatened to stop buying treasuries unless they got some of their money back for the sh*t sandwiches that we packaged up and sold to them by the pigs on Wall St.

Take a look at this article from The USA Today:

"BEIJING — Wang Jun has been reading up on the U.S. financial crisis. Books on the subprime mortgage meltdown are hot sellers here in the Chinese capital.

But until recently, Wang, 33, had seen the debacle as a long-distance drama. Now, out house-shopping with his wife, he's worried that Wall Street's woes will force the Chinese government to impose new mortgage regulations and possibly drive the cost of a home beyond his reach. "The crisis seemed so far away," says Wang, who works for a Beijing publishing house. "But sometimes it's so near."

Despite his worries, Wang is sure about one thing: China shouldn't help bail out flailing U.S. banks and investment firms. "I don't think China has the financial power to help America," he says. "We have our own problems. To look after our own business first is the best policy."

Brimming with cash — a world-leading $1.8 trillion in foreign exchange reserves — China looks like a potential white knight for Wall Street's distress. But the Chinese are wary, burned over the past year on investments in U.S. financial firms and caught in the quicksand of a sinking dollar. Few analysts expect China to be a leader rescuing the U.S. financial system.

The value of Chinese acquisitions in the U.S. is down 73% so far this year — to $914 million from $3.4 billion in the first nine months of 2007, according to Thomson Reuters. The 2007 figure was inflated by the Blackstone deal.

China could play another role in Wall Street's rescue: buying the Treasury securities the U.S. government will auction off to pay for the $700 billion bailout.

China is already a big investor in the Treasury market. China owned $518.7 billion in Treasury securities on July 31, second only to Japan's $593.4 billion. Investors have been fleeing to the safety of U.S. Treasuries amid the turmoil on Wall Street, driving the prices up and yields down.
"Asian investors are rushing into U.S. Treasuries because they have been extremely risk-averse," says Chi Lo, head of investment research at Hong Kong-based Ping An of China Asset Management. "The $700 billion rescue is a new matter."

Europe's bonds a better deal

Lo says Chinese and other Asian investors — governments, banks, firms and individuals — will be reluctant to finance the Treasury bailout plan without higher interest rates as a sweetener. For now, Europe's top-rated bonds look like a better bargain: "U.S. bill and bond yields will have to go up to attract Asian buyers," Lo says. He sees yields on the benchmark 10-year Treasury bond rising to 4.3% from less than 3.7% now."

Final Take:

As you can see, China is already using the bailout as leverage and the bill hasn't even been passed yet!

Being an owner of half a trillion dollars in treasuries gives China a lot bargaining power. This is why this bailout was passed folks. Without China buying treasuries, we can't afford finance our debt and the game is over. China also happens to own huge amounts of the bad mortgage debt pie that Wall St. baked up.

IMO this was a $700 billion diplomatic solution that ensures China will continue to buy our treasuries. This gives us more time to continue to play musical chairs with our debt.

The problem here is the "musical chair" game is about over and there are two people left and one chair.

Bottom Line:

The reaction to the passing of this bill couldn't have been worse. UBS Trader Art Cashin(a man who I deeply respect) said on CNBC this morning that the "worst case scenario" later today would be if the bounce we saw this morning got sold off aggressively into the close.

He explained if we see this, the stage is possibly setup for a major plunge on Monday or Tues.

That exactly what we saw folks. Stay extremely conservative over the next two days. Lets see how the credit and stock markets digest the Paulson Plan. Today was the knee jerk reaction. Lets see how we trade when things settle down. My gut tells me that its not going to be pretty.

I wouldn't be surprised to see a Fed cut if we start to tank. The market and government are in a complete panic right now. They are running out of options, and nothing they have tried to do has fixed the problems. Expect the Paulson Plan to be a complete disaster.

Our financial Tsunami is gaining huge momentum, and I don't know what can be done to stop it.


ZMonet said...

Thanks for your insight Jeff. I finally took the plunge and took a position in QID (a NASDAQ ultra short ETF) as I saw the market selling off. I was initially waiting for a 4% rally or so before buying in, but when it got down to 1% I said forget it, this is just a hedge anyway. I'd love it if my QID position got knocked in half because it would likely mean my 401K and what little value I have remaining in equities would have bounced back. I tend to agree with you, this could get ugly. I'm also trying to look at it from the perspective that I (and probably most of us) have a long enough time horizon that this could still be a great opportunity when we eventually pull out of this down the line.

John Maynes said...

Jeff, this was your best post maybe ever. Congratulations! Right on the spot. :-)

Jeff said...


I look at it the same way. Hedge with some shorts and if the market goes up, your 401k comes back.

QID is one of my favorites BTW. Tech will get slaughtered as the consumer rolls over.

Take a look at TWM and SRS if you are looking for some more hedges. SRS(commercial real estate) and TWM(russell) are primed technically to get killed on a big selloff.

ZMonet said...


If playing these ultra shorts as a pure hedge, do you still trade them or do you just buy and hold?

Thanks for your continued help.

Jeff said...


It never hurts to take some profit at times. I actually sold some of my positions prior to the bailout bill being approved.

I wish I didn't after seeing how things played out, but it never hurts to sell at a profit. Like they say "Bears and bulls make money but pigs get slaughtered".

If you are up nicely on a short postion, I would sell some of it just like you would if you are in a long position. Especially if you sense danger like a bailout or a Fed rate cut whcich can senfd the market higher.

You can always put the short back on at a later date . YOu can often put it back on at a much cheaper price if the market rallies.

These ETF's are volatile so pay close attention to them. I had a position in SKF where I bought in at $130/share. I then watched it drop to $90 post Bear Stearns rally and then go up over 200 when we blew up in june. I sold 2/3's of it at around $175.

They can be wild rides because they are 2x what the market does.


opportunistic said...

"It never hurts to take some profit at times."

Thanks for the above, I exited most of my puts and all of my SRS about an hour before close Friday. I've been regretting it ever since. I feel a bit better now.

I'm hoping for a rally to get back in like you suggested. Which means we are likely down big Monday and SRS never sees double digits again.

Jeff said...


Me too. After reading the news today I am not sure where going to get one.

This market is so volatile. Its hard to play it.

I am sitting on the sidelines for a few days. I hate shorting the hole.

I am glad I still have some positions on. SRS moved huge this week didn'y it?

opportunistic said...

Oh well, I still hold dxd.

I'm going to be looking hard at ultra short russell 2k, s&p and getting back into srs and qid,

SRS up $20 in 2 days after months of being stuck in the mud was too much to pass up. I only sold half initially, that's typically how I play, but talked myself into selling it all a few minutes later.

Sadly I did better buying and holding for 3 days (9/19-9/22) than I did building a position since Feb and selling on Friday.

Are there risks to the etf's aside from the wrong play? ie Can some of the instruments, used to short, default in someway?

Jeff said...



SKF is all mesed up because you can't short financials. I wouldn't worry about default. There has been a lot of worry about the counterparty risk that take these trades.

Everything I have read says that they are fairly safe. I think a lot of the ETF shorts are done via CDS swaps versus taking short positions. Its very confusing and I don't totally understand it. From what I have read, I feel comfortable trading in them

The proshares shares are tricky.

I love TWM if you are looking at the russell. I plan on taking additional positions in SDS and TWM on any bounce.

PUTS are too expensive right now because the VIX is too high.

The best trades right now are the ETF's IMO.