The Treasury Bailout Fiasco

Good Afternoon Folks!

Ahhh, another day another 300 point loss on the DOW. This is getting ridiculous isn't it? I can't wait for the day where I can sign on here and blog about going long the stock market. I prefer sunshine over dark clouds any day of the week despite the extreme bearishness you read everyday on this blog. Unfortunately.............I just can't be long yet.

I hate to say it but its time for another bearish post. I can't help it! I gotta call it like I see it and folks, the credit markets are still a mess. This crisis is all about the credit markets. Until these markets loosen up you gotta stay out of the stock market.

The equity markets are now dominated by what happens in the credit world. The credit market is the dog that wags the tail which is the stock market.

You must remember this as you invest right now. You cannot look at stocks being historically cheap because its not whats driving prices. Are there generational buys out there in certain blue chips from an earnings perspective? Hell yes, but not until the credit markets get straightened out.

The lack of availability to credit in this market is what is destroying equities. Hedge funds are continuing to liquidate as they are forced to leverage down and meet redemption requests. This is not a 1 or 2 week process folks. This could go on for several weeks, and it will continue to put constant pressure on equity prices.

Banks are hoarding the capital that they received from the Treasury as they try to fix their balance sheets instead of lending:

"Oct. 24 (Bloomberg) -- The cost of borrowing in dollars overnight in London rose as the increased likelihood of a global recession spurred banks to hoard cash even after policy makers pumped record amounts of the U.S. currency into financial markets.

The London interbank offered rate, or Libor, that banks charge for such loans climbed 7 basis points to 1.28 percent today, British Bankers' Association said. It gained for the first time in 10 days yesterday. The comparable rate for U.K. pounds jumped 19 basis points to 4.75 percent. The Libor-OIS spread, a measure of cash scarcity, widened by the most since Oct. 10. "

Quick Take:

The Treasury hoped to stimulate lending after investing $250 billion in our large banks. I guess that didn't work! If you are a bank and you don't trust who you are lending to and you are insolvent yourself, why would you lend?

Take a look in the mirror. If you personally were technically insolvent, would you lend someone $500 or would you keep the money and start digging yourself out of debt? Ummm I choose option #2 Alex!

Hank's Bailout Spree Continues

Well, it looks like the insurer's are next as Hank continues to spend our taxpayer dollars.

"Oct. 24 (Bloomberg) -- The U.S. Treasury is considering taking stakes in insurers as well as regional banks in the next round of capital injections to thaw a freeze-up of the financial system, a person briefed on the plan said.

A final decision hasn't been made on firms to be included, said the person, who spoke on the condition of anonymity. An initial $125 billion out of $700 billion approved by Congress was allocated last week to buy preferred shares of nine of the largest U.S. banks.

``Capital adequacy has been a major concern among investors'' in insurance companies, said Nigel Dally, an analyst at Morgan Stanley in New York, in a note to investors today. ``If the Treasury were to purchase preferred equity stakes in some insurers, it would help calm these concerns.''

Treasury Secretary Henry Paulson has shifted the government's financial rescue program to focus on equity purchases after markets deteriorated faster than policy makers anticipated. The strategy offers a quicker way to deploy taxpayer funds, Neel Kashkari, the Treasury official running the bailout plan, told lawmakers yesterday.

Earlier today, PNC Financial Services Group Inc. said it is acquiring National City Corp. for about $5.2 billion in stock after getting a $7.7 billion infusion from the Treasury. The purchase is the first in the government's phase two of a $250 billion program for financial companies, the person familiar with the matter said."

Final Take:

R.I.P. National City.

There is a large concern in the credit markets about the Treasury's actions. From what I understand, the big boys in the credit markets are concerned that the smart money is only going to invest in the debt and companies that the Fed and Treasury have promised to backstop.

The Fed and Treasury have taken on tremendous loads of debt onto their balance sheet as they continue to be forced to bailout practically everything. I mean take a look at who they have backstopped in the past few months: Fannie/Freddie, Bear Stearns, AIG, money market funds, discount window, all deposit accounts(via FDIC), autos, and now possibly the insurers. Don't forget we also had a semi bailout of our largest banks via capital injections.

I am sure I have missed a few, but when you look at the bailout list, its truly mind boggling.

The problem with throwing money out of helicopters is you put enormous amounts of pressure on the areas of the economy that you haven't bailed out. If I am debt investor, why would I invest in an area of the credit markets that's not insured by the US government?

For example, why on earth would I ever invest in an MBS(mortgage backed security) that wasn't issued by Fannie and Freddie. There are hundreds of billions of MBS securities that are floating around in the system that are not guaranteed by the US government because they were not done by Fannie/Freddie . I would value these securities at close to zero now that all of the Fannie/Freddie MBS's are guaranteed.

This is another "unintended consequence" of the housing bailout. The more industries or debt instruments you bailout, the higher the risk of future failures in other industries or debt instrument that is not backstopped by the government.

The Treasury plugs one leak by bailing out the insurers and then creates 5 more because it weakens the areas that have not been saved by the government.

You weaken the companies that you haven't backstopped because the smart money wants to follow the guarantees. So the Treasury has essentially increased the risk of blowups in the economic system by becoming bailout buffoons!

This is a big reason why the credit markets continue to be locked up. If banks and investors are worried about a total economic meltdown, they will simply pile into the Fed and Treasury backstops and wait. This leaves no money left for areas of the economy that must continue to function(like shipping) in order to prevent a global meltdown. The whole problem then feeds on itself!

The only way to fix this is to stop the bailouts and let the weak companies fail. They must ONLY use their balance sheet to ensure that the financial system continues to function. Anything past this is a waste of money and actually harms the system!

Bottom Line:

I continue to be bearish as long as the credit problems persist. I held onto my shorts over the weekend. I picked up a gold ETF and plan on adding to my positions here. I am getting more bullish on gold with each bailout that is announced.

This spending spree by the government will eventually create an inflationary monster that the Fed will be forced to deal with down the road.

All roads for now lead through the credit markets folks. Expect more suffering in equities as long as they remain locked.