Fed Bailout Prevents Crash – Shareholders of Financial Stocks Beware!

September 23, 2008
Author: Peter Stolcers, Founder of OneOption

According to Ben Bernanke, we are close to a financial collapse. Immediate action is needed and the details of the bailout plan are being hammered out. Both parties know what is at stake and I don't believe it will become a partisan battlefield. Until the plan has been finalized, the market will drift lower. The reversal last Thursday and the short covering rally last Friday were over-extended. Yesterday, the market took back some of those gains as uncertainty looms. Fed officials witnessed the aftermath of their decision to let Lehman fail. Bear Stearns, Fannie Mae, Freddie Mac and AIG lost shareholder equity, but their bond holders and obligations were preserved. Systemic risk quickly spread to other financial institutions and Goldman Sachs, Merrill Lynch and Morgan Stanley were on the brink of failure. The Fed bought time for the issues to be resolved in an orderly manner, however, that doesn't mean the outcome will be favorable for shareholders. The government has already shown its willingness to throw shareholders under the bus. Treasury Secretary Paulson is a shrewd businessman and he will underpay for assets that have no bid. Financial institutions will be forced to take a big hit and taxpayers want them to pay for their mistakes. In the process, it is possible that the government might actually come out "whole". That would make policymakers look good. In the meantime, financial stocks continue to drift lower. They may not fail, but tough times lie ahead. Regulation and oversight will reduce profit margins. The economy is slowing and this is no longer limited to sub-prime loans. Investors are getting out during the short-selling ban. They know this condition is temporary and they are taking advantage of the short covering rally. Risk capital is essential to growth and it comes at a high premium. Today, Bank of America announced that it is not extending credit to McDonald's franchisees. This is one example of how a solid business is finding it difficult to finance operations. It will take years for us to work our way out of this mess. Bad decisions have been made by individuals and financial institutions. In the end, someone has to pay. If the government pays too much for assets, the taxpayer will suffer and the national debt will rise. If the government under-bids, financial institutions and individuals will suffer loses. In either case, the end result leads to an economic slow down. In today's chart, you can see a defined downward sloping channel. The trend is lower and you need to stay bearish. There will be violent bear market rallies and you need to take profits as the market plunges. Conversely, sell the rallies. I believe the market will settle in to an orderly decline where we rally on the open and sell into the bell. Once a deal gets hammered out, look for a sharp rally at stalls around SPY 130. image

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