Our “Rich Uncle” Is Going Broke – Get Short!

November 25, 2008
Author: Peter Stolcers, Founder of OneOption

Thank you for all of your thoughts and prayers, they have helped me cope with my loss. Unfortunately, the market waits for no one and in just one day, new information is driving the action. Yesterday, the Fed infused $20 billion into ailing Citigroup. Just a month ago, they gave $25 billion to the largest banks in the nation. They hoped to mask the weakest player sitting at the table, but everyone knew it was Citigroup. It was just a matter of time until the sharks sniffed out the blood. The market jumped higher on the news and it was fueled by President-elect Obama's cabinet announcements. He reassured investors that dramatic action would be taken to stem the deterioration of economic conditions. This morning, the Fed announced a massive capital infusion. They will buy up to $100 billion of NEW debt insured by government sponsored mortgage enterprises (FNM, FRE). It will also buy up to $500 billion of mortgage securities backed by Fannie Mae, Freddie Mac and Ginnie Mae. The Fed also launched a $200 billion facility to support consumer finance (student loans, car loans, credit cards and loans backed by the Small Business Administration). This sparked an early rally. Unfortunately, it doesn't really change things; it simply postpones the inevitable hardship that we will face for many years. Who is going to finance all of this? If the United States had been fiscally responsible and they had cash in the coffers, a lending hand to the taxpayers would help us through tough times. For decades we have gone back to that well and it has run dry. In the last eight years, our national debt has gone up 250% from $4 trillion-$10 trillion. Americans don't have any money (they are the source of the problem) and we don't have any money to buy our own treasuries. We are relying on demand from the rest of the world and they will be buying our debt. Countries around the world are issuing new debt to finance bailouts and stimulus plans of their own. The competition for capital will be fierce and the desire to finance a "spend more than you make" lifestyle has crested. Two weeks ago, Standard & Poor's cautioned that a downgrade in the AAA debt rating of the United States might be in jeopardy if we continue to take on more debt and run budget deficits. This morning, we learned that GDP dropped .5%. That was greater than the .3% that was expected. Consumers tighten their belts and they reduced spending by 3.7% in the third quarter. That was the biggest drop since 1980. Home prices also recorded their biggest drop ever in the third quarter and they plunged 17.4% year-over-year. Stock portfolios have lost 50% of their value and 58% of Americans fear that their job is in jeopardy. Someone is going to pay for decades of over-spending and poor lending decisions. This problem does not just go away. We kept going back to our "rich uncle" for help and now he is broke. He is borrowing money based on his good name and there is nothing to back the debt except for his reputation. The best case scenario is that foreigners finance our debt and after decades of hard work and saving, we pay them back. This means that consumption will decrease and corporate profits will suffer for many years. The worst case scenario is that we can't work our way out of this mess and we default on the loans (US Treasuries). In that scenario, the whole world will pay for our mistakes and the entire financial system will collapse. This means that anything of value will be sold as people scramble to get liquid. The possibility while remote is greater than at any time in my life. Statistics show that people are buying safes, guns and gold coins. Every rally in the last few months has failed and this will be no different. I am confident shorting into the Unemployment Report next week and I feel that Thanksgiving sales will scare the $%^& out of people. Scale into short positions. A more conservative play is to sell OTM call spreads on retailers and REITs. image

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