So, Fannie smells like its namesake and Freddie is more like Frauddie.

What has inspired this recent massive confidence boost?  Wait, who said it was confidence?

The SEC says, “Thou shalt not short”, and the blood that flowed in the streets retreated back in to the respective institutions in which it had spouted from.

The Treasury says, “We will buy the risk on the taxpayer’s dollar”, and somehow gold and silver decrease in value and the dollar holds its ground against other currencies.

The Fed says, “We have to raise rates” out of one side of it’s mouth while also saying, “The risks have markedly increased” from the other.  And yet the markets accelerate up in leaps and bounds.

What really happened?  Why are financial stocks rallying?  Because you can’t short them as easily if you’re a market maker or institution.  Any short positions that don’t have shares borrowed must be unwound.  Is this a magical cure-all for the financial markets?

Is Paulson’s plan for a blank check of nearly $1 trillion dollars to Mac and Mae a way to say, “Everything is OK”?

We have to examine the core underlying message here carefully to paint a more accurate picture of what’s going on behind the scenes.

Paulson needs lots of cheap money and fast to bail out a cataclysmic decline in Fannie and Freddie’s paper.  Meanwhile, Fannie and Freddie already out diluting their share holders with new issuances.  Why is that good for share holders?  They’re effectively seeing their shares watered down.  Oh wait, it’s harder to short during the next 27 days because of the SEC, so these stocks aren’t really rallying, they’re just floating on ether.  Ultimately the Fannie and Freddie share holders will see the equities go to 0.  Only the debt holders, particularly Japan, China, Russia and other governments, will come out with any cash.

Plosser of the Fed says, “We must raise rates sooner than later”, yet the financial system is still in peril.  Raising rates would boost the dollar slightly, but the fundamentals are weak because of a spiraling out-of-control current account deficit that may rise to $12T by 2010.  That would be a near treble from 2000’s level, which suggests the fundamental value of the dollar is being cut down by 66% (or a by two thirds) to 33% of its original value in 2000.  Wait, WHAT?  That’s correct, we aren’t even near the end of this fun ride yet.

In fact, it’s likely about to become much worse as savvy hedge funds and institutions find other ways to short weak companies, using options, derivatives and shares listed in other countries with more lax regulations.

At the same time the US government fancies itself the regulator of all markets now.  They’d like to tell speculators how many crude contracts they’re allowed to hold, after being told by the Federal Reserve, CFTC, independant researchers and many brokers that this will simply create more problems.  If there are less speculators, the markets will become less liquid, volatility will increase and the fundamental supply demand story isn’t over.  We may or may not be at peak oil, but one thing is certain, oil’s uptrend since $1 a barrel in the 1900s is far from over and Boone Pickins’ prediction of $300 oil by 2012 seems more than reasonable.

Where does that leave us?  We are in an area of extreme uncertainty.  Every rally is questionable.  Every dollar we hold in our bank accounts, retirement accounts and wallets are declining in value significantly.  Stagflationary pressures are now globalizing and the world economy seems poised for a marked slowdown.  We can hope and pray that this will pass and everything will be just fine, but after the second biggest bank failure in FDIC history (and more to come), we are nowhere near out of the woods, yet.

Posted by Alex, filed under Finance, Metals, Stocks. Date: July 23, 2008, 12:36 pm |

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