Look Out Below – Support Has Been Breached and Panic Is Setting In!!

The Fed has done all it can to avoid a financial calamity. These problems have formed over decades and as a country, we are overleveraged. Investment banks and mortgage companies created complex derivative products and now they are paying the price. Unfortunately, these obligations are "off balance sheet" and the transparency is nonexistent. No one knows how to value these companies and they don't know how much capital will be needed to fix the problem. AIG needed support and the Fed did the right thing in this case. My understanding is that the company is solvent, it is just not liquid. Given time, it can sell assets at a reasonable price and generate cash. When credit agencies lower debt ratings, the reserve requirements skyrocket and that is why this problem seemed to come out of nowhere. If the Fed had walked away, the market would be much lower than it is today. I'll pat myself on the back with yesterday's suggested trade. If you would have bought 1000 shares of AIG and bought puts on the SPY, you are making a ton of money today. The stock is down $1 from the time I published the report and the SPY is down more than $5. The market isn't down because it hates the Fed's action. Over 100,000 jobs have been saved and the systemic risk has been reduced. Other financial firms rely on AIG's credit worthiness and they have interdependencies. The market is selling off because it does not know where the next problem will come from. The Fed immediately put new management in place and they took and 80% stake in the company when they arranged the $85 billion loan. Shareholders will be left holding the bag. However, if the Fed did not intervene, they would have lost everything on the investment anyway. The message is clear. The Fed does not want to bail out other firms. If it feels compelled to, the equity in the firm will vaporize. Any financial institution that has leverage is being taken behind the shed. Morgan Stanley and Goldman Sachs are plunging. Emerging markets around the world are also tanking. Russia was down 11% yesterday before they halted trading and they were not able to re-open their stock market today. Capital for new projects/investments will be tough to come by. For those of you who are familiar with the money multiplier effect, everything is fine until the need for cash arises. Deposits are loaned out many times over and the Fed only requires a fraction of the original deposit to be held in reserve. Lending practices have been loose for decades and Americans are up to their eyeballs in debt. The financial institutions that have extended all of this credit now need to raise cash. Unfortunately, no one is depositing more capital (cash) and their need for liquidity is increasing on a daily basis. This crisis is far from being resolved. Forced liquidation feeds on itself and today's bargains will be cheaper tomorrow. Get short and stay short!

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