The Fed's Nuclear Option: Printing Without Selling Treasuries

Good Afternoon Folks

Its pretty quiet on the news front. I wanted to share an article from the Economist that I thought was very interesting:

"The sobering lesson is that conventional policy may not prevent a prolonged deflationary slump. This lesson has not been lost on policymakers. The nuclear option, conceived in America but untried in Japan, is to finance public spending or tax cuts by printing money. This requires the central bank to go along with the fiscal authorities (which may prove easier in America than in Europe). It could work like this: the government announces a tax rebate and issues bonds to finance it. But instead of selling them to private investors, it lodges them with the central bank in exchange for a deposit. It draws on this account to clear the cheques mailed to taxpayers. This scheme is essentially the same as the proverbial “helicopter drop” of money, but with neater accounting and a less erratic distribution of cash. It bypasses banks and money markets, and puts money directly into people’s pockets.

Monetising a slug of public debt in this way is bound to be inflationary. But by this stage, inflation would be a blessing: an economy where conventional policy tools had failed would suffer from falling prices. A burst of inflation would lift asset prices, ease the weight on debtors (whose real burdens are increased by deflation) and improve public finances. Some central bankers will shudder at the thought. Some, but not all. Ben Bernanke, now the Fed chairman, recommended this course of action to Japan’s policymakers in 2003 (when he was a Fed governor). Indeed, he went further. One way out of a slump, he argued, is for policymakers to commit themselves to a period of catch-up inflation, to break deflationary expectations and heal the wounds from past price falls.

If all else fails, it seems, the one sure way to secure solvency in the private and public sectors is to inflate away debts and buoy up asset prices. That nuclear option is the ultimate bail-out: rescuing the indebted by hurting those with savings. In essence, if not degree, it is not so different from conventional policy. Interest-rate cuts are a salve for debtors and a penalty on savers. Fiscal-stimulus schemes impose a cost on all taxpayers, even those well placed to endure a downturn. But the cost of a prolonged slump, in terms of idle resources, lost income, decaying skills and an erosion in the trust that keeps civil society going, would be far higher."

My Take:

Interesting and frightening theory from the Economist. It appears the Treasury is considering an internal print where they create their own bonds and hold onto them versus selling them via the treasury market.

These bonds would create their own internal deposit base from which they would then start dropping money out of helicopters via tax rebates. This would create massive inflation. I can totally see Hank and Ben pulling the trigger on this one if things get bad enough. It would be the ultimate move by these two criminals. This would the the classic new "theory" type tool that an academic like Ben would want to try.

This would be the epitome of "lack of transparency". It appears the Fed is desperate for inflation just like Japan was throughout the '90's. If interests rates eventually go to zero and the economy doesn't respond, this could be the Fed's response. It won't really matter at this point though because the economy would be on the verge of total collapse.

This would throw the deflationary play under the bus as we then inflate out of our debts. Consider this to be a "stealth" hyperinflation. Of course this is just a theory and I have no idea if it will actually happen.

If it does, the deflation trade goes out the window. Anyone getting caught short in this situation would be killed as all assets would rise because the dollar would be massively devalued.

Lets hope our economy never sinks to the point where this nuclear option is actually on the table.

BOO: The Insanity Continues!

Good Afternoon Folks!

Not much to say today other than fear continues to dominate the market. Watching the last hour before the close is like watching the ball bounce around on a roulette wheel. Will it be black or red? Who knows!

I don't think anyone has a clue which direction the market will break at the end of each day. We rise and fall hundreds of points every few minutes. Anyone that went long Thursday or today was sweating bullets near the close as we dropped two hundred points around 3:30 before bouncing back 100 right at the bell. Those on the short side have been sweating bullets all week after taking big losses!

This results in high volatility because there is a ton of fear selling from each side. Many of the bulls and bears prefer to sell on Friday because neither side knows what potential ghosts or goblins could be released from a news perspective over the weekend. In this type of market, holding over a weekend can be suicide!

One thing that was interesting today was JP Morgan announcing they are going to start modifying mortgages:

"Oct. 31 (Bloomberg) -- JPMorgan Chase & Co., the largest U.S. bank by market value, plans to modify terms on $110 billion of mortgages and forgo foreclosure proceedings on all real-estate loans while the changes are implemented in the next 90 days.

The offer extends to customers of Washington Mutual Inc., the savings and loan JPMorgan agreed to buy last month, the New York-based bank said today in a statement. Loan modifications may include interest-rate or principal reductions. The bank said it will establish 24 regional counseling centers to provide face-to- face help in areas with high delinquency rates.

The JP Morgan program is expected to help 400,000 families with $70 billion in loans in the next two years, JP Morgan said. The company said an additional 250,000 families with $40 billion in mortgages have already been helped under existing loan- modification programs.

The programs are aimed only at homeowners who ``show a willingness to pay,'' the bank said. ``Customers should continue to make mortgage payments to reflect their intent to honor their commitments.''

JP Morgan said it will also donate or offer a ``substantial discount'' on 500 homes to community groups in order to stabilize local markets. "

Final Take:

If this doesn't have disaster written all over it than I don't know what does! Why would anyone pay their mortgage regardless of whether they can afford it or not? If I overpaid for a $600,000 McMansion, I would be the first guy calling JP Morgan to get my bailout.

I'll "show a willingness to pay" JP! Just drop my mortgage by 200,000k. This is going to be a disaster for the banks if they decide to go down this road. Where do they draw the line in terms of who gets a modification and who doesn't?

If you are struggling to pay your mortgage, I would be taking advantage of this immediately whether your loan is with JP Morgan or not. My guess here is there is some serious political pressure being put on these banks to "lighten the load" for homeowners by the Treasury.

Washington is now deeply worried about torches and pitchforks. Homeowners are ANGRY as they watch Wall St get bailed out while they continue to struggle.

Bottom Line:

Folks, this whole nightmare is starting to unwind at a frantic pace. The government is trying to juggle too many balls at once as it tries to prevent a multi trillion dollar debt bubble from unwinding.

This is a house of cards that is about to come tumbling down. The government does NOT have the money to prevent this unwind from happening! They are going to end up defaulting on themselves if they continue this bailout mentality.

The Treasury announced this week that they are going to be forced to run $2 trillion in treasury auctions in order to try and pay for this fiasco. You can be sure that the demand for all of these new treasuries is going to be tepid at best. Yields will have to be raised in order to get it all sold. We all know what that does to lending rates. To the moon Alice!

I mean think about it, why would you risk buying the debt of a nation that is filled with a bunch of consumers that have no savings and are in debt up to their eyeball?.The T-bills will get sold but it will be at a price.

When these yields go through the roof, expect equities to swirl down the toilet bowl.

As for the market short term, good luck! My advice is to avoid it unless you have a very strong stomach. The bounce this week looks tired but we have the election on Tuesday. There is a lot of debate as to what happens to equities depending on who wins.

You would think an heavy taxing Obama victory would be bad for equities, but Wall St seems to be pulling for him so I wouldn't take that bet.

I plan on taking a breather here and hold onto my current positions until the election shakes out.

In terms of trades I hedged myself a bit today. I picked up some UYG and sold some of my short 2x inverses. I am still hedged to the short side but more protected from volatility. I also picked up some SRS today. This has pulled way back from its highs and I think commercial real estate is going to get killed during this downturn.

Happy Halloween!

So how is that rate cut helping you?

Good evening folks!

Today was an interesting day. Stocks were choppy throughout the day before ending the day with a nice bounce. We got a negative print on the GDP of -0.3 which was better than expected:

"Oct. 30 (Bloomberg) -- The economy suffered its biggest decline since 2001 in the third quarter, ushering in what may be the worst recession in a quarter-century and boosting the chances of Barack Obama and fellow Democrats in next week's elections.

Gross domestic product contracted at a 0.3 percent pace from July to September, according to a Commerce Department report today in Washington. The decline was smaller than forecast and stocks rose. Even so, the economy may be in for a larger drop this quarter after the record two-decade expansion in consumer spending came to an end.

Consumer spending dropped at a 3.1 percent annual pace, the first decline since 1991 and the biggest since 1980, after President Jimmy Carter imposed credit controls. The median forecast was for a 2.4 percent drop."

Quick Take:

The market seemed to focus on the fact that the 0.3 drop was better than expected. What they should be focusing on is the fact that consumer spending dropped 3.1% which was the biggest drop since 1980. Remember folks, the consumer represents 70% of the economy. If they fall off a cliff, the economy is toast. Consider this drop in Q3 to be a very ominous sign of whats to come.

Rate cut

So let me ask you a question. How is yesterday's rate cut helping you? Answer: Its not. It does of course help the bankers. What a shock right? The proof is in the charts. Think mortgage rates will drop following the rate cut? Think again:

Now lets take a look at the 10-year today a day after the rate cut:

Final Take:

Thanks for the help Ben! Now its even more expensive to buy a house. Gee, I am sure glad you got another chance to make your banking buddies even more rich after cutting rates for them! What a putz.

These cuts will do nothing but help Wall St's balance sheets. Rate cuts will no longer help mortgage rates because banks are scared to death to lend right now because they are insolvent and have no desire to lend to a tapped out consumer.

The metioric rise in the 10-year over the last few days is something to take note of. If this trend continues, mortgage rates are going to rise considerably. It appears the bond market is starting to rumble. What I find interesting in this trend is the 10-year is going up on days when the market is down. The exact opposite should be happening because investors should be flying to the safety of treasuries on down days.

Think the Fed is done cutting? Think again:

"Oct. 30 (Bloomberg) -- Federal Reserve Bank of San Francisco President Janet Yellen said the central bank may cut the benchmark interest rate close to zero percent from the current 1 percent level should the economy remain weak.

``We would do it because we are concerned about weakness in the economy,'' Yellen said today after a speech, responding to an audience question about the impact on the economy should the Fed reduce the main rate to as low as zero. ``I think we could, potentially, go a little bit lower than'' 1 percent, she said in Berkeley, California.

Recent data on the U.S. economy is ``deeply worrisome'' and the government should consider new ways to help homeowners and stem foreclosures, Yellen said in the speech."

Bottom Line:

If you have ever had a desire to visit Japan, I advise you that you wait because the USA is going to look just like it very soon. Why waste the money on flying there when all you will need to do is look out the window in a few months to see what its like over there?

Folks I say this because it appears we are following the Japan deflation playbook to a tee. Japan ended up with zero interest rates and zombie banks after their deflationary spiral. Sound familiar? We are only 1% away from being right there with them. The economy is detiorating rapidly. The consumer showed signs of collapsing in the third quarter. Its going to be a grinch style Christmas this year!

Company after company are announcing massive layoffs. Hell, even the US postal service announced they are going to layoff 40,000! The situation looks to be getting more dire by the minute despite the recent stock market rally. Yellen's speech above tells me the Fed is scared ****less.

There are reprocussions to zero interest rates. Money markets lose their profitability. Consumers on fixed income will become paralyzed and may not even be able to pay their bills as their return on equity vanishes.

The stock market continues to act erratic as hell. "Sybil" continues to beat to her own drum. Its almost impossible to predict whats going to happen on a day to day basis. Day trading at these levels is basically gambling at this point. We can rise and fall hundreds of points in a matter of minutes. Albert Einstein couldn't come up with an accurate short term trading thesis in this trading environment.

Long term its pretty easy to see how this is all going to end in a disaster.

Stay Tuned!

Leverage is a Bitch

Good Evening Folks!

Ahhh.... Another day, another Fed rate cut. Its now official folks, Helicopter Ben has officially matched Greenspan's Fed Funds Rate of 1%. Hooray! The housing bubble days are back! NOT!

So how did the market like the rate cuts? Well, Bennie was looking good for awhile until the last 10 minutes of the trading session. The DOW virtually collapsed at the close and fell over 300 points which took the DOW into negative territory. The GE news at 3:47 was one of the culprits. Take a look:

The Fed and the Treasury continue to scramble around like little rats in an attempt to pump massive amounts of liquidity into the system. Its the same old story week after week. Everyday another multi-billion dollar bailout is announced. The latest one today involves other countries:

"Oct. 29 (Bloomberg) -- The Federal Reserve agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore in its biggest effort yet to curtail the spread of financial market turmoil beyond developed economies.

The Fed set up ``liquidity swap facilities with the central banks of these four large systemically important economies'' effective until April 30, the central bank said today in a statement. The arrangements aim ``to mitigate the spread of difficulties in obtaining U.S. dollar funding in fundamentally sound and well managed economies.''

My Take:

Hell Hank, lets just bailout the whole world! The story and thesis remain the same folks. We are in the middle of the largest debt unwinding in the history of the world. This Ponzi bubble was blown up on leverage, and it will be torn apart as the leverage is taken out of the system.

This is what happens when you deregulate a bunch of greedy bankers. In 2003, the investment banks on Wall St were deregulated and allowed to lend out money at a 40-1 leverage rate off of their capital. This means that they lent out $40 on every $1 of capital that they had. All of the hedge funds and world banks all followed suit as the debt bubble grew to historic proportions.

This is all fine an dandy when the game is working and assets continue to rise in value. However, when this trend reverses, the leverage that allowed you to dramatically increase your profits on the way up now exacerbates your losses as assets come screaming back down. We are now witnessing this historic explosion of a giant debt bubble via deleveraging.

Banks can now only lend at a leverage rate of 12-1 instead of 40-1. This creates a giant black hole/loss of wealth in the financial system. What the Fed and Treasury are now trying to do is use their balance sheet to fill this black whole and keep the game going.

The problem with this premise is all of this wealth was nothing but an illusion! The Fed is trying to replace wealth that was never liquid. Many Americans assumed that they were worth $400,000 if they bought a house for $200k as the credit bubble rose and got it appraised a few years later at $600,000. The reality here is you were only $400,000 wealthier if you SOLD.

Most did not, and many others bought at the peak. Markets crash when there is a lack of liquidity in the system. The Fed is throwing money out of helicopters in an attempt to get banks and to lend and consumers to borrow. The problem is you can lead a horse to water but you can't make him drink!

The banks don't want to lend because they have about as much money as I do in my front pocket. The consumer doesn't want to lend because he is worried about keeping his job abd he is already in debt up to his eyeballs.

The banks have a severe disaster on their hands from a leverage standpoint:

If you use the example above, the problem the banks have now is they are stuck holding millions of homes at the $600,000 price tag when there was 40-1 leverage in the system.

The brutal reality is that the banks are all now facing is is there is now only 12-1 borrowing leverage in the system available for housing. This is about a 70% reduction in lending capacity(from 40-1 down to 12-1)!

It doesn't take a math genious to realize how screwed the banks are in this situation. They own billions of mortgage assets at peak prices that now must be sold into a lending pool that's 70% smaller. Its not hard to guess whats going to happen to housing prices over the next several years when there is 70% less money available to borrow. Can you say WATERFALL? Bank profits will WATERFALL down right along with them!

A very smart pigmen(who is way up the food chain) loves to laugh when he hears CNBC talk about all of the money that's "sitting on the sidelines". His quote to me after hearing this was "yeah right, let me know how much money is on the sidelines when they take the 40-1 leverage out of the system". This is the same guy that told me two years ago that Merrill Lynch was going to be the next Enron.

Bottom Line:

Tomorrow will be dominated by the GDP number tomorrow. If we get a bad print, we could see a giant flush. I am still very bearish on equities. What a shocker right??

The market is over priced for two key reasons.

1. 70% of the leverage must be taken out of the banking/financial system.

2. The economy is about to slam into a brutal consumer led recession.

This is a one two knockout punch IMO. The Fed is now about out of bullets. What are they gonna do go to zero? It will be Japan 2 if they do. The interventions are looking more and more desperate in the eyes of investors.

Sheila Bair from the FDIC announced today that she wants a $600 billion bailout for homeowners. You have got to be kidding me with this idea...Gimme a break! Socialism here we come! What an embarrassing situation for this country. We will never be able to call ourselves capitalists ever again after stomping all over the free market system.

If you are leaning to the long side(good luck to you), I would wait for a pullback before trying to chase this rally.

As for myself, I scaled into another short (SDS) this afternoon on the Fed rate cut bounce. Which ever way you are positioning yourself, play small and scale yourself into positions.

Stay hedged and be diversified in either event.

Until next time!

Merrill Lynch's David Rosenberg

Just a quick note this morning.

If you only have time to read one research note this morning:

GIVE THIS A READ

This is from Merrill Lynch's famed economist David Rosenberg.

Thanks to him I didn't sleep well last night. The data included on the economy in this report is flat out frightening. Make sure you read the whole thing. This is some awesome research.

Warning: You might need a sleeping pill after reading this so call your doctor and get some Ambien!

Enjoy

Fear Works Both Ways

Wow

That was interesting. This market continues to amaze me. The DOW took a moonshot on a day when consumer confidence hit an all time low:

"WASHINGTON (MarketWatch) -- Wounded by the financial crisis, U.S. consumer confidence plunged in October, reaching an all-time low, the Conference Board reported Tuesday.

The October consumer confidence index fell to 38 from an upwardly revised September reading of 61.4. Economists surveyed by MarketWatch had expected an October reading of 52.

Expectations turned "significantly more pessimistic," with the percentage of consumers expecting business conditions to worsen over the next six months rising to 36.6% from 21%, and those expecting fewer jobs rising to 41.5% from 26.9%."

My Take:

Today was another historic day on Wall St. One thing you need to keep in mind after seeing days like today. When you have this much panic in the markets, stocks can move violently in either direction. Fear works both ways. Investors can panic about missing the next big move higher just as much as they can worry about losing everything when the market begins to crash.

We had some obvious short covering towards the close as the pain threshold for the shorts became intolerable once we got towards the highs of the day. This exacerbated the move higher.

We have seen this move before:

Anyone remember the parabolic move below on October 13th?:




Final Take:

I think its worth noting how this bounce turned out. If you were a bull and bought at the top on the 13th, you are probably wondering where your next meal is coming from. As you can see there was an immediate reversal the following day followed by further violent selling the following week.

Now I am not predicting we will see the same pattern this time, specially with an imminent announcement of more fed rate cuts.

Now this Fed announcement sets up an interesting inflection point tomorrow. Most think a .50 cut is baked in the cake. If they go .75 does the market cheer the news and rally or do they sell in a panic thinking the economy is worse off than anyone expected? If we get the expected .50 cut, does the market sell the news? If we get only a 1/4 point cut, does the market tank because they were expecting .50?

Its going to be very interesting to see what happens. I am not going to get in front of this announcement with any new trades. I will hold what I have and adjust accordingly until after we hear from the Fed.

Bottom Line:

Lets see what kinda follow through we see on the rally today. Keep in mind only 1.4 billion shares were traded on the floor. This is light for such a big move which means you should probably take it with a grain of salt. Panic moves are never a sign of health for the market. We are still in a pretty tight trading range.

You gotta trade small in this kind of trading environment because the whipsaws can rip you apart. There really is no strong confirmation for the bulls or the bears at these levels. The news continues to be daunting, but the government intervention to prop up the markets is just as strong.

This leaves the bulls and the bears both in the dark. Its time to settle down and see what the Fed says tomorrow. Lets also see what happens in the credit markets over the next few days in response to the TARP and the commercial credit support from the Fed that began this week.

When this rally burns itself out which could be as early as late tomorrow, its going to set up a nice entry point to short. The news out there is too horrific for any of the bulls to hold long. This is a traders market. Many stocks had 50% moves today. I see very little reason why traders wouldn't take profits here.

Be careful out there folks! Keep any positons small and hedge yourself. The market is about as mentally stable as Cybil right now.

Capitulation is a MUST Before we Bounce

Good Afternoon Everyone!

Lets go back in history to 1929 and take a look at a chart. We need to capitulate like we did in 1929 before we bounce:

I have been listening to the bottom callers all day on CNBC that are looking for a significant bounce. I find it funny because they are all trying to cover their butts now by saying "we have hit a bottom, BUT I am not saying this is the bottom". I guess the "bubble boys" figure maybe now its time to add a disclaimer to the end of their bullish claims that NOW is the time to buy. What fools.

My other favorite pigmen line right now is "I think now its time to start nibbling on the consumer staples". Folks, this is the bulls way of saying "Run for the hills!". Anytime you hear them advising you to buy healthcare and consumer staples...Run for your life! God forbid they actually tell you the truth when they think the market sucks!

I am even starting to see some bounce calls on some of the bearish websites that I like to follow. This surprises me. Trading 101 in bear markets tells you that you need to have capitulation in stocks in order to wash out all of the weak longs before you begin to see any type of tradeable bounce.

Art Cashin has been saying this for weeks. Look at the chart above, we needed a "Black Tuesday" in 1929 before people felt comfortable jumping back in. When the market psychology is horrific and the market slowly bleeds everyday, you create a situation where the bulls aren't confident in going long.

This results in a "no bid" environment as people continue to sit on the sidelines. Any bounce is immediately sold into. Today was a perfect example. When the market jumped 200 points in the afternoon the bulls immediately sold into the rally. The bottom then fell out in the last hour as the buyers went back to the sidelines.

I simply cannot see any chance of a significant bounce until we see a 1000+ point down day on the DOW. The lack of trust, confidence, and continuous bad news simply is too much for the bulls to overcome. Psychologically, they are a mess right now. If you were a bull and walked into a pysch ward right now, you would end up in a straight jacket.

Capitulations are certainly not fun, but they are badly needed at times. Today would be one of those times. Investors need a reason to buy. They need to psychologically think that they are jumping in near the bottom. The problem we have now is how on earth can you have the confidence to buy when the DOW slowly sinks day after day?

I believe a washout is the psychological shift that is needed to pull us out of this for the short term. This will bring many buyers back into the market. Why? Because everyone knows the playbook. Brutal bear markets find bottoms after capitulation. Its been this way all the way through time. The smart money like Art Cashin knows it. He isn't going to send his clients back into this tsunami until he sees the classic signs of capitulation. That goes for every other veteran trader that's worth a crap on Wall St.

In this modern fast paced world we always love to say "its different this time".

History has almost always shown that this is never the case.

Bottom Line:

I continue to hold onto my shorts that I bought on Friday. I grew a few grey hairs in doing so today though due to the volatility! I will probably sell them off on any serious tankage. I see no significant bounce until we see a sharp capitulation type selloff.

We have the Fed back in the picture over the next couple of days. I am sure we will see more rate cuts. I kinda see this as a non event at this point. A half a point rate cut is nothing after bailing out the whole financial system!

We somehow need to restore confidence before we start moving higher.

I'll end this with some more great news:

"Oct. 27 (Bloomberg) -- Yields on Fannie Mae, Freddie Mac and Ginnie Mae mortgage bonds soared to the highest in more than seven months relative to government notes, potentially boosting home-loan rates.

The difference between yields on Washington-based Fannie's current-coupon 30-year fixed-rate mortgage securities and 10-year U.S. Treasuries climbed about 21 basis points to 224 basis points as of 3:45 p.m. in New York, up from 162 basis points on Oct. 20, data compiled by Bloomberg show. A basis point is 0.01 percentage point.

``It is the deleveraging,'' Mohamed El-Erian, the co-chief executive officer of Pacific Investment Management Co., said in a Bloomberg Television interview today from Newport Beach, California. ``There are still people who absolutely have to liquidate, and that is keeping a number of the spreads in the high end of the markets much wider than they should be.''

The average rate on a typical 30-year fixed-rate mortgage climbed to 6.08 percent at the end of last week, after falling to 5.92 percent on Oct. 22 from a two-month high of 6.38 percent, according to Bankrate.com data. That compares with as low as 5.72 percent last month."

Sigh...Just what we needed: Higher mortgage rates!

Stay tuned

Is Citadel going Down?

Rumor has it that the reason the futures went lock limit down on Friday was because the massive hedge fund Citadel was going down.

Here is the article from Reuters. It appears that Citadel went to the the government looking for a handout:

"CHICAGO, Oct 25 (Reuters) - Examiners with the Federal Reserve have questioned Wall Street counterparties in recent days about their exposure to debt and other holdings of Citadel Investment Group, the Wall Street Journal reported on Saturday.

The report came a day after Citadel, one of the world's largest hedge funds, said it has more than $10 billion in available credit. The Chicago-based fund was seeking to stop rumors it was liquidating some portfolios after its two main funds had lost 35 percent since January.

Citing people familiar with the matter, the Journal said the Fed had questioned the counterparties in at least two instances.

Talk has swirled in the market that Citadel had asked the U.S. government for a cash injection and that financial regulators were coming to inspect its accounts."

Final Take:

This seems to be the next kaboom in the stock market. I doubt that the Feds will start bailing out hedge funds. The Citadel was leveraged at 10-1. A 35% loss on their equity pretty much tells me they are toast.

Expect a violent market reaction if this turns out to be true.