The Fraud of the Century

When the history books are written and they name this crisis, the word FRAUD should be included in the title. Stocks tumbled once again on Friday as word got out that the "bad bank" negotiations between Wall St and Washington had hit a snag.

Gee, what a shocker. As reported by CNBC above, neither party can agree on where to price the assets that are on the banks books. Translation: The price Washington wants to mark down the assets to puts 70% of the big firms out of business. I don't see how this gets resolved folks. The bad bank in its proposed form looks to be dead.

There is only one way to solve this crisis and I will continue to harp on it. Nationalization is the only way this mess gets cleaned up. I think Washington will eventually come to this realization once they find out how fraudulent these firm were during the housing bubble.

You know its pretty clear what happened to all of us during this supposed "boom". We were all basically scammed by Wall St. You can call it "Punk'd" if you want to be hip. The public is getting increasingly more angry about getting robbed as they continue to struggle and lose their jobs. I think Washington has finally caught wind of it. The politicians are beginning to realize that they risk losing their constituents if they agree to bail out these greedy group of criminals.

Understand one thing here if this is what has happened: If it comes down to helping out their Wall St buddies vs. getting re-elected guess which side a politician is going to take? Let me answer that Alex: Wall St your screwed!

What everyone now realizes is the housing "bull market" was nothing but a fantasy. You can also call it a sham. It did nothing to grow the economy. As you can see below, real GDP growth minus the housing ATM was virtually non existent even during the boom:

Housing prices exploded during the boom despite the fact that wages in this country have been virtually flat or declining since 2000:

My Take:

What happened during the housing boom was nothing but a massive transfer of wealth from the poor to the rich. We were all basically flat out robbed by Wall St. Call it a reverse Robin Hood. Look at the wages above. Median household income really hasn't moved significantly higher in the last 40 years!

How in the hell did we ever get here folks? We make on average 12 grand a year more per household versus 1966 yet housing is probably up 20 fold over the same period. The only way we got here was through exotic lending products that were devised by Wall St to rob you of all of your wealth.

The bankers sold us this mantra: "Don't save anything America. Just invest all of your money into a house. It will double 5 years from now." Yeah right. How did that work out?

The bankers finished this game with billions and a fleet of private jets while you the people ended up unemployed with a $2500 a month mortgage that you have no idea how you are going to continue to pay.

Bottom Line

Paybacks are a bitch and Wall St is about to learn a brutal lesson. Obama appears to be severely agitated by this whole thing. Now that Washington has gotten a chance to really dig into this problem they realize how bad it stinks. Senators are now proposing legislation that caps bonuses. As we tumble into a depression, Congress and the American people will demand that heads roll as a result of this pillaging of the middle class. They will accept nothing less!

Trading

From a trading perspective it was a very profitable day today. Once the GDP # came out better than expected and the futures didn't move I smelled blood in the markets. I took down all of my longs and went short via SDS and SRS calls. I already owned some QQQQ PUTS and SPG PUTS going into the morning.

I had some work to do in the afternoon so I sold My SDS and SRS at a nice profit once we dipped down around 120 points. I held onto the other two. SPG was the only disappointment today. They beat earnings but announced that 90% of their divi would now be paid in stock. The stock was down $3 at one point today but bounced back and closed down only $1.50 or so. I thought there would have been much more damage here considering the meltdown in financials today but I guess a beat is a beat when it comes to earnings.

I stayed short on the Q's and SPG headed into the weekend mainly because I didn't get home in time to take them down.

I don't know what Monday will bring. Closing right at 8000 makes things interesting. This is where the bulls have repeatedly defended themselves. If we break south on Monday I think we test 741 on the S&P. If we break down from there, it may be time to pay Lucifer a visit.

There is certainly a valid case to be made in the other direction. If 8000 is successfully defended, we could see a nice bounce out of oversold conditions. We also have a desperate Treasury that could roll out a bailout at any time here. I think I will most likely get out of the way and sit on my hands on Monday.

I have a busy weekend so I am not sure if I will have a chance to post anything.

Enjoy the Super Bowl and Go STEELERS!

$4 Trillion Dollar Nightmare

Good Evening Folks!

What a day today. Congrats to anyone who played the short side. Ladies and gentleman, the wheels are about to fall off.

There were some stunning developments in the markets today as we saw further signs of a full blown economic collapse. Here is a nice summary from Bloomberg:

"Jan. 29 (Bloomberg) -- Prospects for an economic recovery this year dimmed after reports today showed new-home sales collapsed, durable-goods orders slumped and a record number of Americans collected unemployment benefits.

“There really isn’t any hiding place in this economy,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts.

Orders for goods designed to last several years fell in December for a fifth month, the longest slide since comparable data began in 1992, the Commerce Department said today in Washington. Sales of new homes fell to an annual pace of 331,000, a rate that would take more than a year to clear the glut of unsold properties.

Today’s figures may heighten Federal Reserve officials’ concern, expressed yesterday after their policy meeting, about a “significant” danger the economy won’t start recovering until 2010. The intensifying housing crisis will also make it harder for President Barack Obama to arrest the industry’s decline with proposed tax breaks and steps to slow mortgage foreclosures.

The Labor Department said the number of Americans collecting jobless benefits soared to a record 4.776 million in the week ended Jan. 17. Along with the slump in durable-goods orders, the figures reflect efforts by companies from General Motors Corp. to Caterpillar Inc. to downsize amid a pullback in both domestic spending and demand from overseas.

For the full year, purchases of new houses fell a record 38 percent to 482,000, the fewest since 1982, Commerce said. The median price for all of 2008 fell 7 percent, the most since 1970, to $230,600.

The supply of homes at the current sales rate jumped to a record 12.9 months’ worth in December. That is more than twice as much as the five-to-six months supply that the National Association of Realtors has said is consistent with a stable market."

Sales of new houses dropped in all four regions, led by a 28 percent decrease in the Northeast and a 20 percent slump in the West.

The shrinking real-estate market is costing more and more jobs, from banks and homebuilders to manufacturers and retailers."

Quick Take:

Do I even need to say anything here? This is what happens when bubbles burst. I picked up a nice chart that puts the scale of this housing crisis into perspective. Here is the historical inflation adjusted history of housing prices since 1890 from Dr. Shiller of Case/Shiller index fame:

Does anyone still want to buy a home anytime soon? "Reversion to the mean" in this instance is going to be extremely painful. Housing prices still have a long ways to go on the downside until we get back to historical norms. This of course will do nothing but further deteriorate our banks balance sheets. Buying a home won't make sense for at least several years.

The job losses are only making things worse. Who wants to make a 30 year commitment on a loan when you have lost or are about to lose your job? On top of that: What bank would ever lend to them in the first place?

We now have close to 5 million people in this country that are now unemployed. Jobless claims rose again this week up to 589,000. Start preparing for a once in a lifetime collapse everyone. Hoard cash and buy necessities. This is really getting serious.

$4 Trillion Dollar Nightmare Spooks The Bond Market

It appears that it may cost $4 trillion to clean up our banking system. The bond market immediately crapped a brick once word of this got out:

"WASHINGTON (Reuters) - The cost of restoring confidence in U.S. financial firms may reach $4 trillion if President Barack Obama moves ahead with a "bad bank" that buys up souring assets.

The figure far exceeds even the most pessimistic estimates of how great the loan losses might be because there is so much uncertainty about default rates, which means the government may need to take on a bigger chunk of bank debt to ease concerns.

Goldman Sachs economists said ideally the public sector would step in to remove the hardest-to-value assets, which would alleviate nagging worries about future losses and hopefully help get lending going again.

"Unfortunately, with an unprecedented meltdown in mortgage credit and a deep recession in the broader economy, there is a great deal of uncertainty about the value of almost every asset," they wrote in a note to clients.

The government would not necessarily have to spend the full $4 trillion to buy the assets. If it follows the model used in a Federal Reserve program to support consumer and small business loans, the government could potentially put up just 10 percent of the total.

Spending $400 billion would certainly be more palatable to Congress than $4 trillion. It may not even require that much additional funding. Economists estimate that perhaps $250 billion of what remains in the $700 billion bailout fund could be devoted to the "bad bank."

That money could buy bad assets, which would then be repackaged and sold to investors to raise more money which could then by recycled to buy more assets.

Stephen Stanley, chief economist at RBS Greenwich Capital, said although that sounds similar to the sort of financial engineering that spawned the credit crisis in the first place, it would be structured so that the central bank or whichever agency oversees the program is last in line to take losses.

"If things turn out so bad that the Fed ends up on the hook for $1 trillion in losses, then the financial sector, the economy, and everything else will be dead anyway," he said."

Quick Take:

I'm not making this stuff up guys. Click on the links. Sometimes this disaster feels like a bad dream to me. I never could have imagined that the USA would ever destroy itself.

So how did the bond market react? Take a look at the yields on the 10 year:

Well if that isn't an ugly reaction than I don't know what is! Yields soared throughout the day as the treasury market reacted to reality that they now must finance a new economic stimulus. The $4 trillion bailout news that came out of Washington put further pressure on treasuries later in the day. A bond market dislocation would not suprise me if the government doesn't start buying treasuries. Bond traders essentially called Ben's bluff by bailing out of treasuries today. We all know where that ends if the Fed tries to do this. Either way Ben is now screwed.

Making things worse is the fact that the bond market is already getting dwarfed with supply as we attempt to pay for this debacle. There was a 5 year auction today that yielded 1.82%. This was higher than expected according to Bloomberg. This is a bad sign folks. Demand for our paper is already rapidly deteriorating and we haven't even "gotten started" as we prepare to finance our massive government "bailout" spending.

Bottom Line:

I must admit that today was very depressing. Everything is pointing towards a total financial washout and reset. Our country is not prepared for such an event. We are a country that's filled with people that believe they are entitled to live the "good life". Americans have spent like drunken sailors and saved nothing for the last 25 years We have no idea what its really like to forced to sacrifice. There will be a lot of anger, violence, and rage before we accept it.

On the trading side it was a very positive day. My QQQQ's PUTS worked out nicely. I also put my short back on SPG this morning which worked out nicely because the stock really deteriorated towars the end of the day. SPG's earnings are out tomorrow.

Usually when you see that kinda price action somebody knows that their earnings are going to stink. I didn't get a chance to enter anymore shorts because there was such a big move down near the open. I don't like to short the hole. I only did it on SPG because their earnings are out tomorrow and the stock wasn't down too much when I picked up my PUTS. SPG's balance sheet is a mess folks, and I gotta think their earnings are not going to be pretty.

I am starting to wonder if the 4th quarter GDP may have also gotten leaked. Stocks were shredded across the board. I held both shorts into the close. I may hop out in the morning if we see a big move down on a bad GDP #.

Thats about it today folks. Lets all hope we can find a way out of this without too much suffering. Today's news and the bond market action was terrifying IMO.

Obama will make his move very soon in terms of how he plans to stimulate us out of this crisis. Lets hope he gets it right.

I have my doubts.

Fighting the Fed: Good or Bad?

Good Evening Folks!

Warning! This is gonna be a long one!

I thought we could talk about the Fed along with some trades tonight. Trading wise, I went almost completely flat today and took everything off. Sometimes you need to take a deep breath, reflect, and re-evaluate as to where we are in this big bad bear market.

Let me share my trading day today:

First of all, I closed out with a mild loss overall. I sold my TBT(short treasuries) this morning at a loss because I am tired of getting manipulated by Ben's constant threat of buying treasuries(more on this later). This trade just isn't working right now because there is too much uncertainty in the bond market. Yields are fluctuating violently as the bond traders try to react to constant Ben's threats of buying the long end. I could have timed the selling of this better because TBT came back nicely later in the day after the Fed announcement. Oh well! It certainly wasn't be the first time nor the last time that I will make this mistake.

I also sold my short on SPG which is a large REIT this morning at a mild loss. I was glad that I dumped this early because this dog soared later this afternoon. I also dumped some(not all) of my SRS figuring that I could buy it back cheaper down the road. On the positive side, I sold some SSO(long S&P) and some QQQQ(Large cap tech) calls at a nice profit. I always try to stay hedged folks. You have to be in this market.

Fighting the Desperate Fed

This is the big dilemma folks. The old saying "Don't fight the Fed" is certainly ringing true right now as the economy falls off cliff. I kinda compare the current Fed to a Rabid dog that's been totally cornered. It looks like the "Cujo" Fed is getting ready to bite as the debt bubble continues to deflate despite their best efforts. This makes the Fed and its balance sheet extremely dangerous especially if you are on the short side.

The Fed is desperate because they are basically out of bullets:

My Take:

As a result, the Fed will now be forced to take drastic alternative actions because they are basically out of options when it comes to interest rate policies.

So what can they do? Well they pretty much told you in their statement today:

"WASHINGTON (Reuters) - The Federal Reserve on Wednesday said it is prepared to buy long-term government debt if that would help improve credit conditions and signaled some concern that deflation risks were rising.

In a statement issued at the end of a two-day meeting, the central bank's policy-setting panel also said it was holding its target range for overnight interest rates at zero to 0.25 percent -- the level reached in December -- and repeated that it thought rates could stay unusually low for some time.

"The committee ... is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets," it said. In December, the Fed had said only that it was studying that option.

The panel voted 8-1 in support of the decision. Richmond Federal Reserve Bank President Jeffrey Lacker dissented, saying he thought the Fed should immediately move to a program to purchase government bonds.

U.S. government debt prices fell sharply, suggesting investors wanted a clearer sign the Fed would become a buyer of bonds. Stock prices added to gains and the dollar rose.
With benchmark overnight rates virtually at zero, the Fed has turned its focus to what Chairman Ben Bernanke has dubbed a "credit easing" approach that targets specific assets and markets in the hope of restoring normal lending.

"Basically they are opening their wallets and are ready to start buying more assets and extend that if necessary," said Kurt Karl, head of economic research at Swiss Re in New York."

Continued Take:

Can you say desperation? This is a sad and scary statement from the Fed: The fact that they are willing to buy their own treasuries shows you how dire the situation really is out there.

Lets think about this for a second folks. Essentially the Fed is announcing that they are ready to buy their own treasuries in an attempt to keep interest rates low and thus stimulate lending. Treasuries are what we sell in order to finance our debt.

So, essentially what this means is our government is spending money that we don't have and we are financing it by selling treasuries to ourselves. Huh???? Are they really serious?

This is a friggin joke!

What will our foreign debt buyers think about the value of our treasuries when they start watching our country finance itself by buying its own debt? I can answer that Alex: They will run away from treasuries as fast as they can!

This would then leave the Fed bidding against themselves for treasuries in the bond market. Can you say circle jerk? How long do you think they can sustain this game as the government continues to spend trillions of dollars on massive bailouts?

The Feds balance sheet is already at $1 trillion dollars which is way more than anyone is comfortable with folks. If they attempt the treasury buying game its over. They might be able to do it for a short period of time before they blow themselves up but the end result is a certainty. There is simply too much debt that needs financed, and the Feds balance sheet is way too small to fund it.

This is why to date Ben has only threatened to buy treasuries. I don't think he is actually stupid enough to pull the trigger. If he ever pulls it, run to the bank and grab cash as soon as possible.

Bottom Line:

Contrary to what the market is telling you, things are bad and getting worse. This idea of the Fed buying all the bad assets from the banks without severely punishing or nationalizing them is a pure fantasy. It sounds like they are going to try to pull it off but it won't work. You can bet your bottom dollar that the banks will try to dump this mess completely onto the taxpayer. Lets hope our government is smart enough to stop it.

As you can see below, this banking crisis is a mess and its going to take hundreds of billions if not trillions in order to clean this up. These banks are completely insolvent:

Reuters is reporting today that the banks need hundreds of billions more dollars in order to stay solvent.

"WASHINGTON (Reuters) - Weakening U.S. banks will probably need hundreds of billions of dollars in additional funds beyond what has already been approved for the Troubled Asset Relief Program, the head of the non-partisan Congressional Budget Office said on Wednesday.

"I think the gap that remains in terms of the recapitalization needed by the banking system exceeds the amount of money left in TARP, I think by a good margin," Doug Elmendorf told the Senate Budget Committee.

While some of this capital could and should come from the private sector, "the odds are that more money will be needed than has been authorized so far in the TARP, probably to the tune of hundreds of billions of dollars," Elmendorf said.

Massachusetts Democratic Sen. John Kerry said more help for the banks from the government should be conditioned upon reforms. "You may even have to have some agreement as to change of management and other things," he told Reuters in an interview.

"You need to have an agreement from those banks that they're going to change their approach, they're going to write down their toxic assets, they're going to live by a new regulatory set of standards," Kerry said.

"There's a tough trade-off," Elmendorf said. "We can wait for the banks to fail, and then in a sense we get (the assets) automatically."

"We don't want to benefit the managers who made bad decisions," Elmendorf added. "On the other hand, if we let them stew in their own mess, we run the risk of driving the economy further into the ground."

U.S. policy-makers should move quickly, he said.
"As the financial system is rebuilt, private creditors will have to take some losses; and some banks may have to fail: It is neither necessary nor desirable for government to take on all the losses from bad assets," he said.

The CBO offers non-partisan analysis on the costs of U.S. government spending programs."

Trading:

Isn's it amazing that bank stocks can soar when reports come out like this explaining how insolvent they are?

So whats a trader to do? We now have a desperate Fed that's doing everything in their power to help out their buds at the banks. This has ignited a massive rally in the financials. The bulls are out there screaming "the bad bank is here we are saved!". Uhhh..NOT! Anyway, bank stocks are up 6 consecutive days. Gee do you think this "bad bank" idea was leaked to Wall St? Crooks!

This all being said, I would not be surprised to see a pullback over the next couple days. However, I am going to avoid trying to trade this sector. Fighting the Fed at a time when they are about to sink probably isn't a very good idea so I will head to other sectors.

I think the jobless claims number will be hideous tomorrow. I also predict that you will see a little profit taking as well. Prudential is up 100% since this rally started folks! Now is not the time to be a pig! As a result, I think we are in the red tomorrow.

I bought some QQQQ PUTS near the close. Shorting financials here is too risky in my view so I will play the pullback in other sectors like tech. I also may buy some SDS depending on the futures and the jobless claims number. I also will consider daytrading SRS tomorrow. Seeing this ETF sitting in the 40's is simply too tempting.

One other thought about today: The fact that the market could only muster a 200 point rally in severe oversold conditions after the bad bank news and a gift statement from the Fed has severly increased my suspicion around this rally. This could and should have easily been a 400-500 point day given the news.

I plan on playing small with tight stops. We could see a continuation of today so caution must be used.. I will also close out my positions before the bell because GDP comes out on Friday. This one is one giant wild card and I have absolutely zero desire to try and front run it.

There will be a time to fight the Fed folks and short financials. Unfortunately, I think this rabid dog still has some bite left.

Bad Bank/Worse Bank

Hello Everyone!

Ok, its time to post now that I have calmed down after reading about the "good bank/bad bank" proposal that supposedly is about to be unveiled next week. Before I get into this, I wanted to highlight how bad the news was that came out today:

- Consumer confidence falls to a record low.

- Case Shiller reports the biggest drop in housing prices on record(-18%)

- GE faces the risk of losing their Aaa rating from Moody's

- Companies continue to shred workers

I find it amazing that Wall St can continue to gobble up stocks despite the news flow above. You would think that after reading such news, the bankers would be running to the nearest bridge and jumping into the Hudson river "US Airways" style.

As bad as the news was above, it pales in comparison to what was announced after hours. CNBC is reporting that the Treasury is preparing to take the bad assets off of the banks balance sheet and place them into a "bad bank" on the taxpayers I mean errrr...the Fed's balance sheet:

"The Obama administration is close to deciding on a plan to purchase bad—or non-performing and illiquid—assets from banks, according to industry sources. The plan could be announced early next week.

The so-called "bad bank" plan, would address the key problem of how to price the assets by using a model-pricing mechanism.

The model would take account of the government's ability to hold onto assets, even to maturity, and pay for the them with cheap funding. Result: the government might end up paying more than current market prices for the securities.

On the other hand, if the government paid less than the value at which the asset is carried on the bank's books, the bank would issue common equity to the government.

In previous Troubled Asset Relief Program deals, banks issued preferred equity to the federal government. But the conclusion is growing within government circles, sources say, that preferred equity is not sufficient to make the banks healthy.

Clearly, the idea of a "bad bank" is gaining momentum. On Capitol Hill today, Senate Banking Chairman Chris Dodd said he was aware the idea is under discussion and "it makes some sense to me."

In the developing bad bank plan, it's unclear how the government would pay for assets. There has been discussion of a "certificate of net worth" in which the government gives the banks a piece of paper that essentially can be applied to capital levels. But sources could not confirm that funding mechanism for the plan or what role existing TARP money or the Fed would play in funding the so-called bad bank."

My Take:

Lets be clear here folks. We all know how the government plans on paying for these assets. Can you say taxpayer dollars?

This development is infuriating. The bank stocks are soaring after hours because there is absolutely zero mentioning of nationalization in this press release.

Folks, this program cannot work if the current banking management teams are kept in place and the banks aren't nationalized. The banking crisis was resoloved in the early '90's because we played hard ball and took their insolvent asses over.

The reason it won't work without nationalization is the banks will simply refuse to sell the assets at the price the government wants to pay because it will torpedo their balance sheets. This game was played in Japan without nationalization and it went NOWHERE. It turned into a giant stalemate. Bill Seidman explains why in this video.

Bill(FDIC Chairman at the time) was heavily involved with the successful resolution of the last banking crisis so his opinion should be highly regarded.

Some questions and thoughts from an angry taxpayer(Me!):

Why does the taxpayer continue to get pummeled as this crisis deepens? If we need to create a "bad bank" then nationalize the banks and do it the right way. If the current cast of characters on Wall St are allowed to wipe their balance sheets clean without any penalty then what will they have learned? What type of message does this send? If I was a greedy banker I might say to myself "Yahoo! We got away with it! Lets lay low and then do it again!"

I read that the banking lobbyists are heavily involved in the negotiations of this solution...No s**t really? I would be too if I were them. Wouldn't you take a deal from the government that involved them wiping away all of your debts? Talk about a no brainer.

Another thought I have here is if the pigmen are allowed to get away with this massive fraud and stay in power: Who is ever going to trust doing business with them again? How is investor confidence restored when the robbers are allowed run away with all of the money and then leave us with the bill to clean up the mess? I hate to be crude but this is like getting f**ked in the a** twice!

Bottom Line:

I am rapidly losing confidence in the current administration's ability to handle this mess. I see no "Change" in Washington. All I see is more of the same corrupt behaviour that plagued the last administration.

Wake up Obama! You only have one shot to clean this mess up. Choosing a tax cheat from the previous Fed that was directly involved with the failed policy of the 2008 collapse as your Treasury Secretary was bad enough. This resolution is worse! I pray that this "good bank/bad bank" report is not completely accurate. You need to do the right thing here.

Obama is not off to a good start. I was shocked when I read his administration started throwing daggers at China claiming that they manipulated their currency. Uhhh...This isn't too smart considering China is the largest buyer of treasuries! Geez...Are you trying to create a bond market dislocation?

On top of that, Obama's stimulus package was filled with infrastucture building that forces companies to use steel thats made in the USA only. This is the exact type of protectionism that threw us into a depression!

If you plan on bringing real "change" to Wall St and Washington: FIRE THE FRAUDULENT BANKERS THAT CREATED THIS MESS AND TAKE OVER THE BANKS IF NEED BE! Create transparency and mark these assets down to where they belong which is most likely pennies on the dollar.

Lets take a reality check here. No one will ever want to own these assets. Holding them on the taxpayers balance sheet is pointless. Lets call a spade a spade and take the hit and mark them to pennies on the dollar. Lets be honest: Who will ever want a subprime sandwhich that's sliced and diced with packages of both good and bad loans? Selling these assets would be similiar to selling a Fillet Mignon that's stuffed with dog doo. Last I saw there wasn't much of a market for this kinda steak!

Congratulations to the financial innovation wizards of Wall St! They were somehow able to invent assets that cost millions of dollars and turn them into something that's almostcompletely worthless.

Trading:

Let the financials run on the news here folks. It will create a nice shorting opportunity. I think its going to be a quick pop. Sweden's banks popped 20% on the news when they were saved in 1992 before the equity holders were wiped out.

In the long run I still think these banks are toast. They feds may attempt this sticksave but its not going to work. Once the banks and the feds cannot agree on the pricing of the banks toxic assets, expect the government to take them over and finally begin to start cleaning up this financial fiasco. Lets hope we don't go bankrupt in the process.

Our banks are insolvent folks and the last I saw 0+0=0.

Merrill's Rosenberg's Latest: Deflation Rules!

Here it is folks.

Not much to add here. The best economist on Wall St lays everything out perfectly. Inflation will be hard to create as production free falls to 25 year lows and unemployment sits at 13.5% and rising. Can you say depression? It won't be long now folks. The news flow continues to be terrible.

The fact that he expects $20 trillion dollars in household wealth to disappear by the end of 2009 is simply mind boggling. Be careful with stocks this week. We are pretty oversold and a rally wouldn't surprise me"


"Deflationary pressures are both building and spreading

Consumer prices may not have declined as much as the consensus expected, but the 0.7% decline in December represented the fifth decline in as many months for the longest stretch in over 60 years. And this is not just about food and energy because the core was also negative to the second decimal place and is now running at a -0.3% annual rate over the past three months which has not occurred since 1960. The deflation is visibly gripping a wide swath of sectors -- hotels, appliances, clothing, home improvement, autos, personal care products and services, airlines, and recreation just to name a few. We also see that tremendous deflation is coming through the pipeline based on the steep price declines we saw in the core crude and intermediate PPI for December - - both sliding at a record rate over the past three months (-83% and -25% at an annual rate respectively).

The deflation process is hardly temporary…

While the government is rapidly expanding its balance sheet and the Fed is dramatically boosting liquidity, these are only a partial offset to the fact that the $50 trillion household balance sheet is contracting at an unprecedented rate and it is the household that ultimately determines the demand for and pricing of the goods and services that comprise the consumer price index. In the interim, the fiscal stimulus will, at best, offset the rapid accumulation of excess capacity in the real economy. As industrial production data highlighted, capacity utilization rates in manufacturing have fallen to 70%, levels not seen in more than a quarter-century. And in the labor market, the 'real' unemployment -- the U-6 measure that provides the broadest definition of the labor force -- is at a record- high of 13.5%.






…and will take years to reverse

It will literally take years of fiscal and monetary pump-priming to bring these measures of economic slack to levels that will precipitate the next inflation cycle. In our view, that is too far beyond the forecasting horizon to be concerned about right now and we expect long Treasuries and indeed, any fixed-income instrument with both duration and relative safety attributes to be very compelling at this juncture, low coupons notwithstanding. It will not take much in the way of even further reduction in yields to generate high single-digit returns for long-term bonds given the convexity at low levels of interest rates. The odds of a bear market in the fixed-income market given how long this recession is going to last and how muted the recovery is likely to be thereafter, even after accounting for all the government stimulus, is quite remote in our view.

Deflation the primary risk for the foreseeable future

While the debate continues to rage, deflation, not inflation, is the primary risk for the investment outlook for the foreseeable future. Government intervention will act as an antidote, but the magnitude of the trauma on the household balance sheet from an estimated $13 trillion of lost net worth since the third quarter of 2007 -- a cumulative loss that we believe will approach $20 trillion by the end of 2009 -- is on its own, via the lagged effect on the personal savings rate, enough to drain consumer spending by between 2% and 3% annually over the next two to three years. And with the unemployment rate very likely heading to at the least test 9% in this cycle, it is truly difficult to believe that inflation is going to be revived in the intermediate term.

Sustained widening in the output gap a powerful backdrop

It is perfectly understandable, but still dangerous, to be clueless about the mechanism that determines whether we experience inflation or deflation. Even with the upcoming stimulus, this economy, which has been growing below potential since June 2006, will very likely continue to do so not just this year but well into next year as well. This means a sustained widening in the output gap -- in other words, growth in aggregate demand exceeding available supply, higher unemployment rates and lower capacity utilization rates -- will be a reality as far as the eye can see.

The deflation story is going to prove to be a much more enduring theme than many realize, in our view, and investors will want to ensure the portfolio is positioned for it, which comes down to five characteristics:

1. A focus on safe yield, wherever you can get it: long-term non-callable government bonds, closed-end muni funds and high-quality corporates.

2. Screen for dividend yield and consistent dividend growth in the equity market.

3. Whether it be credit or equities, a focus on companies with low debt/equity ratios and high liquid asset ratios – balance sheet quality is even more important than usual. Avoid highly leveraged companies at all costs. The same methodology should be applied to municipal bonds – differentiate between those with and without high cash reserves and high debt rollover calendars.

4. Ultra-selectivity with regards to financials since the real cost of debt and debt-service rise in a deflationary period, as do default, delinquency and charge-off rates. The same can be said for retailing, where margins become crimped. Screening for inventory turns is very important because cost-containment is imperative as top-lines are suppressed by declining final sales prices.

5. Focus attention on sectors or companies with these micro characteristics: low fixed costs, high variable cost, no unionization, high barriers to entry/some sort of oligopolistic features, and a relatively high level of demand inelasticity (utilities, staples, health care). Also focus on companies with high inventory turnover ratios in a deflationary backdrop."

Back to the '30's

Hello Everyone

So I am sure many of you are asking yourselves how bad this banking crisis is versus previous banking fiasco's. As you can see below, nothing comes even close to this one. The moves being made today by the government are nothing but one huge experiment. No one knows how this will play out or if it will work. We are in unprecedented times. My guess is this experiment isn't going to work and its not going to end well. We took greed to a whole new level this time. History has consistently shown us the bigger the boom the bigger the bust.





The 1930's Bond Market

Since I discussed this yesterday, I figured it would be helpful to head back into the 1930's and see what yields did during The Great Depression:

My Take:

As you can see, there was extreme volatility in terms of treasury yields throughout the 1930's. Bonds yields plummeted for about 2 years beginning in 1929 as everyone piled into treasuries seeking safety as the markets collapsed.

Notice that as we neared the bottom in the markets in 1932, yields soared resulting in higher interest rates as our debt became less attractive.

We are now nearing 2 years since this crisis began in 2007. Will we see a repeat of the 1930's in the treasury market? Time will tell but I think its extremely likely.

Remember folks, history always repeats itself.

I also wanted to also share a video that I watched on the blog Subprime Showtime over the weekend. Its about 30 minutes long but its well worth it. Its a nice history lesson on our economy and its crisis's dating back to 1835.