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Despite rising prices in equity markets, liquidity risk is now an issue and will soon be a serious problem for cities, municipal and student loan organizations that require access to capital to continue to operate.

Humongous Bank & Broker is walking away from this market. Who will pick up the slack? The obvious next shoe to fall will be the declaration of bankruptcy of cities who will walk away from their financial obligations. Financiers will require them to cut back on services and payrolls, which will lead to massive economic problems.

So, despite a counter-trend rally that is ongoing Thursday, I believe that once the short-sellers have been squeezed, many of them declaring bankruptcy, the 2008 Bear will continue and that my 10 and 2 target (10,000 for the DJIA and 2,000 for the Nasdaq Composite) will play out.

The problems inside HB&B today will continue to become transparent. More losses will come. More capital will be needed to build bank reserves. There will be a crowding out in the capital markets that will force interest rates higher. Higher rates will produce more losses and failures of the guarantors of HB&B, and the financial institutions that hold illiquid assets.

This is a situation where cash is king. The cash that is being rapidly moved into equities in an attempt to catch a short-term rally will also flood out of equities and into short-term debt of major governments. That will drop rates to next to zero, with the result being that inflation will rapidly eat away at wealth, destroying trillions of dollars.

At the end of the day, the last traders standing (with cash reserves) will demand higher returns and that will push rates higher, thereby dealing the final knockout to short-duration debt instruments. As this wealth is destroyed, more banks and financial institutions will fail.

Traders today are rotating out of high-risk securities and into the equity of companies that are seen to be in the best shape to withstand a global economic decline. But, how long will it be before those companies are affected by the breakdown of banks and public institutions that failed to get through the liquidity crunch.

If cities and municipalities and banks, etc, are closing doors and letting employees go, then purchases of automobiles, computers and all that will slow dramatically.

The writing is on the wall. Banks today; the rest tomorrow.

So, as much as I, as a trader, want to maintain an even keel, while following prices, I do not believe that current price moves are value-driven. These are mostly short-squeezes and beneficiaries of the liquidity pumping by central banks.

As long as central banks pump reserves into the financial system to delay the crisis, if interest rates do not increase, then commodity prices will continue to surge. That is inflation, which is a wealth destroyer as well.

The US Treasury Secretary and Central Bank Governor are putting on the most positive face possible, and will do so starting in their testimony in Congress Thursday morning, but I’m not buying it.

Source: The Writing Is on the Wall: Banks Today, the Rest Tomorrow