The Rude Awakening
Baltimore, Maryland
Thursday, August 23, 2007 ------------------------- - The crash resets…at $27 Billion per month,
- Shorting the financials at two-to-one,
- The Fed's not-so-magical wand and plenty more…
------------------------- Eric Fry, reporting from Laguna Beach, California… The Dow Jones Industrial Average is up 0.18% for the month of August…Just another ho-hum month. Let's just ignore the fact that the Dow tumbled nearly 1,200 points between August 8th and August 16th - that happened BEFORE the Federal Reserve waved its magic wand and made everything better. The wand that the Fed waved was a half-percent reduction in short-term interest rates. The stock market responded immediately with a robust rally…and the magic continued yesterday, as the Dow added another 145 points. But the Fed's magic is not all that magical. Like a warm cup of cocoa on a cold winter day, it makes you feel better. But when trying to cure serious economic maladies, rate cuts and warm cocoa provide identical efficacy. The nation's bankrupt mortgage-holders aren't any less bankrupt today than they were before the Fed reduced short-term interest rates. And the nation's almost-bankrupt mortgage-lenders aren't any less almost-bankrupt. But the Fed's magic makes everyone feel better; it makes them believe that everything's going to be okay. And so share prices go up…for a while. But larger problems loom, as Dan Amoss, editor of Strategic Investment, explains below… --- Mayer's Special Situations Resource Report --- "The Biggest Resource Breakthrough Since the 'Beaumont Miracle' of 1901" 64 publicly traded companies are already deeply invested… insiders are already raking in as much as $205,421 per day on the shares… But only one of these cutting-edge companies offers you the "secret wealth advantage" I reveal below… I urge you act quickly. I'll even front you the first $500… but only if I hear back from you by midnight Sept. 4…The Full Report Is Right Here ---------------------------------------------------- When Shoes Start Dropping
By Dan Amoss The Fed "blinked." The stock market lurched. CNBC cheered. Nothing changed. Last Friday morning, the Federal Reserve cut its "discount rate" by 50 basis points, lowering it to 5.75%. (This is the rate that banks must pay to the Fed if they need a loan to bolster liquidity). This policy change, the Fed announced, "will remain in place until the Federal Reserve determines that market liquidity has improved materially." The Fed is also lowering the standards for the collateral it requires to make these loans, emphasizing that it will accept mortgage-backed securities - the securities that have been pretty much "unsellable" for weeks. Friday's move prompted a dramatic stock market rally. But "goosing" share prices is much easier to do than resuscitating the credit markets. The Fed's rate cut, for example, will not cure all the credit-related catastrophes that have already occurred…but not yet come to light. Fitch Ratings, for example, warned yesterday morning that it would be placing $92.1 billion of securities backed by subprime residential mortgages "under analysis." This "analysis" will certainly lead to a few downgrades. Fitch has already hinted that at least $4.2 billion of these bonds are sure to be downgraded, bringing the total this year to over $17 billion in CDO downgrades from Fitch alone. Meanwhile, the coming wave of "resets" on adjustable rate mortgages (ARMs) is sure to add additional stress to the financial system, and to the overall economy. "RBS Greenwich anticipates that $27 billion per month of subprime loans will hit their first reset over the next 12 months," our colleagues over at the 5-Minute Forecast observed yesterday. "That's $27 billion -- per month. Ay-Yi-Yi! Financial stocks all over the globe are going to be reeling from this mess for years." So the next time you hear the media declare that the worst of the housing market is behind us, refer to the table below. The worst ain't over. 
History tells us it's usually foolhardy to doubt the power of the Fed to bail out financial markets, once the Fed starts a cycle of lowering interest rates. But the Fed is not all-powerful. The subprime/credit crisis is probably causing a lot of collateral damage in the multitrillion-dollar over-the-counter derivatives market. It's not like the Fed can immediately wipe the slate clean on every bad derivative trade made by hedge funds and banks. Much of the damage has already been done, no matter how the Fed responds. So this Fed easing cycle may be very different from prior ones. It's also the case that the discount rate is more symbolic than effective in today's complex credit markets. The heart of today's credit market lies beyond the realm of old-fashioned banks…and therefore, beyond the realm of Fed rate cuts. Much of the credit risk that everyone's so worried about remains hidden on hedge fund balance sheets, transferred there via highly sophisticated derivative markets. Downplaying the significance of Friday's rate announcement, veteran trader Dennis Gartman describes a dour future for the mortgage market in his excellent newsletter: "The decision to cut the discount rate and to open up collateral to mortgages and the like 'is not a shot of adrenaline to the economy, but is instead a shot of penicillin.' That is, the Fed is not moving to expand economic activity; it has moved to stem the spreading of contagion. If anyone actually believes that the nation's financial intermediaries are going to go out and suddenly become expansive once again, extending more mortgages at anything other than onerous terms, they are sadly and badly mistaken [emphasis added]. Having once been burned, the nation's banks et al. shall be like Mark Twain's cat that having once sat upon a very hot stove shall not sit upon any stove again, for they shall all look hot to him. The Fed's action on Friday has done nothing other than to quell the fever. The patient is far, far…very far…from being healthy. The Fed has not staved off recession; it has simply made the recession that is now upon us less likely to devolve into something much worse…and for that alone, the Fed is to be lauded!" Perhaps the Fed should be lauded because its announcement temporarily restored market confidence, but the mortgage crisis is far from over. As Gartman correctly observes, the Fed's recent maneuvers may help the nation's mortgage lenders to avoid disaster, but the days of EZ credit are dead and gone. And now that banks will be much stingier, homeowners will not be able to refinance their upwardly re-setting ARMs and homebuyers will not be able to qualify for attractive mortgages. Even in the best of circumstances, therefore, banks will be issuing far fewer mortgages than they did during the Halcyon days of 2005 and 2006. Unfortunately, banks that do not make loans do not make money. Many Wall Street analysts have been slow to recognize this fact, and are still expecting decent earnings from most banks. They are dreaming. At the same moment that banks will be making fewer loans, they will also be setting aside reserves to cover the bad loans they made in the past. So earnings will be squeezed from both ends at once. Because bank earnings are likely to fall, I suggest taking advantage of this trend by buying the UltraShort Financials ProShares (SKF). This ETF provides investment results that correspond to twice the inverse performance of the Dow Jones Financials Index. In other words, SKF's price would RISE about 2% for every 1% DROP in the Dow Jones Financial Index. As such, SKF is a double bet against financial stocks. SKF could pay off even better, of course, if the credit crisis deepens. At the moment, the markets for mortgage-backed bonds and derivatives are pretty much frozen. There is simply no trading volume to get out of illiquid securities like CDO tranches. French bank BNP Paribas summed up the situation by saying, "The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality or credit rating." "Liquidity" remains a very scarce commodity throughout the credit markets. Hmmm…despite the Fed's best efforts, America's nasty credit crisis might hang around for a while longer. [Joel's Note: Dan's healthy distrust of Wall Street sponsered swindles has lead to some healthy investment choices for his Strategic Investment readers. Care to learn more about ways you can profit when cover-ups and lies run loose up and down the Street? Click Here. Strategic Investments Special Wealth Protection Report ---- Imagine Getting Rich as Ignored Stocks Soar ---- While the Credit Crunch Crushes Wall Street's Darling Stocks, Learn How you could turn $200 into $1.2 million! You Could Get Rich Investing in Scientifically Selected Penny Stocks. My CXS Money-Multiplier System Finds Enormous Winners. And I've Made It Incredibly Easy. I Do All the Work, Telling You When to Buy and Sell. The Profits Can Be Awesome. You'll HATE Yourself if You Miss This One! Read On: Avoid The Common Collapse and Invest In Ignored Stocks ------------------------------------------------------ Rude Endnote: We received the following, concise response to Monday's Rude "Looking For Trouble" - "Good report - glad somebody at Agora can make their point in less than 10 pages. Keep up the good thinking." Rude Response: Good point. The 5'll be along shortly. Cheers, Joel Bowman
Rude Awakening aussiejoel@the-rude-awakening.com | 
