U.S. Government Is Heading for a Slippery Slope

While Macro Man is tempted to hit shift-F9 again, perhaps the optimal strategy in this market has been pretty easy. Stay short equities, particularly financials, until and unless the Feds get involved with Freddie (FRE) and Fannie (FNM). And while the details are pretty nebulous, it looks like the US government will do whatever it takes to keep the GSEs afloat. So anyone who went home short equities on Friday might be about to experience A Nightmare on Wall Street: Freddie's Revenge. Allow Macro Man to suggest that if the US government buys equity in FRE, it should change the name of the company to Freddie Krueger.

And while it should surprise no one that the government is stepping in to prevent the Agencies from blowing up, Macro Man cannot help but think that we are perched on the edge of a slippery slope. Buying an "unlimited" amount of equity in these firms is highly reminiscent of the "price keeping operations" conducted by Japan's MOF and the HKMA in the 1990's.

And while Mr. Paulson has talked about protecting the downside for taxpayers, Macro Man is frankly more worried about the upside. As noted on Friday, he has little interest in his tax dollars protecting existing shareholders from losing their investment without enjoying the benefits of future upside- both in terms of earnings and share price appreciation. And it looks like we've taken a step closer to the convergence of Agency and Treasury bonds, in de facto if not de jure terms.

At the same time, we have news that the SEC is looking at policing market rumours, particularly those surrounding the financials. Something tells Macro Man that this will be a one-way street; anyone suggesting that, for example, PIMCO and SAC have pulled Lehman's (LEH) line will face reprisals, but anyone suggesting that Warren Buffett is going to buy Lehman for $100 per share will remain unscathed. The UK has a head start on this particular slippery slope, with the FSA pursuing banking sector rumour-mongers and imposing farcically low disclosure thresholds for short interest in banks doing rights issues.

It's all vaguely 1984-ish to Macro Man. If you use inappropriate language about a bank, they'll do you. If you sell the wrong bank short, they'll do you. If you wonder aloud on possible forthcoming bad news about a bank, they'll do you. Perhaps sellside analysts should just cut to the chase and rate every financial out there with a "Doubleplusgood" rating. Who knew that MiFID stood for the "Ministry of Financial Information Dissemination"?

And so we're left in an uncomfortable position. The financials are still in lousy shape, as the collapse of IndyMac amply demonstrates. But if being bearish on banks is turning into a thoughtcrime, and the BKX has been oversold since late May, what are the odds on a nasty short squeeze this week? There are a number of banks reporting over the next few days, but if their reports are filtered via the Ministry of Truth they can say more or less whatever they want without fear of regulatory reprisal- all in the name of "financial stability." Heck, maybe the US Treasury will buy a few million August 60 calls on the BKX just to get the ball rolling!

Or, the US could adopt the UK model. This morning, beleaguered mortgage lender Alliance and Leicester announced that it was in takeover talks with an "undisclosed buyer" in a deal that values A&L at 317p/share. This compares with a closing Friday price of 219.5p per share - nearly a 50% premium! It's hard to understand why someone would pay that kind of premium in this kind of market, but the announcement did the trick, conveniently taking A&L to a high of 338p/share this morning.

 

If this is the new model for Anglo-Saxon markets, it will make it bloody difficult to remain short. After all, any crappy company under the cosh could simply announce a "mystery buyer" at a ludicrously inflated premium, and the market would be forced to take it at face value. Any suggestion that the story could be a fabrication would be met with [REDACTED ON ORDER OF THE THOUGHT POLICE. THE AUTHOR HAS BEEN APPREHENDED AND TAKEN TO ROOM 101. TO READ MORE 'MACRO MAN' CONTENT, PLEASE CONTACT THE MINISTRY OF LOVE. POVERTY IS PROSPERITY. INSOLVENCY IS ADEQUACY. REGULATION IS FREEDOM.]

Comments

[Ishortyou:]

Hm looks like the shorties are going to have a bad time in the future.

2008 Jul 14 08:18 AM

[atauber:]

i agree the shorts are scraming WOLF....

2008 Jul 14 08:25 AM

[buyitcheap:]

Brilliant and insightful. It does indeed seem to portend a very bad time for shorts.

Disclosure: (long SKF but still love big brother.)

2008 Jul 14 08:31 AM

[Mandev:]

Russia turning to capitalism(in the garb of ' reforms') and
USA turning to socialism ! What a great comedy !

2008 Jul 14 08:31 AM

[bbzz24:]

Mandev,
It is not a comedy but reflection of ceased political propaganda in Russia and still ongoing one in th USA.

2008 Jul 14 08:58 AM

[phdinsuntan...:]

Banco Santander (STD) is buying U.K. lender Alliance & Leicester for £1.26B ($2.4B) in shares. Including an interim dividend, the deal represents a 45% premium to Friday's close. The spanish turned crazy

2008 Jul 14 09:14 AM

[gabe borens...:]

This is not about the rescue of two U.S agencies .This is about preventing potentially disastrous sequential economic events.We all know that the agencies in question are implicitly guaranteed by the U.S government -well ,the U.S had lived up to the expectations .By doing so investors can better redefine the risks.Clearly in the current environment fears and distortions are rampant.We know from the past that the distorted rumors (and there are plenty of them) create an investment psychosis which distorts the investment sense of reality.These concerns should have been expressed a year ago(I did) by the investors ,the FED and the rating agencies.Now ,that the key issues have been and are being addressed all we need is more time and rationale. The global record commodity speculation needs to be addressed.
The distorted inflationary perspective does not help. Historically ,the home prices have increased at or better that the implied cyclical inflationary rate.In this cycle we have a housing implosion.If the home prices (70% of the Americans are the home owners )were substituted for the rents in the CPI,inflation would not be an issue that it is now.
The recession that all the media and gurus are referring to ,is not in the cards(two consecutive quarterly GDP declines).The deceleration was more than compensated for in the current equity indices levels.
The real issue will be Europe and the Emerging Market economies.
In the U.S we may see more radical volatility ,but major rally lies ahead.

2008 Jul 14 10:32 AM

[Mbuna:]

Let it go down in history and be said that for those who advocate socialism for the rich, this was "their finest hour!"

2008 Jul 14 12:12 PM

[Jason Rines...:]

It has become exceedingly easy for a few bright guys with no ethics to force risk onto the U.S. taxpayer while extracting profits from hyperinflated ANYTHING. The game can be kept up for awhile until the tax bill hits the U.S. citizenship, in 2011 when the Bush tax cuts expire and new taxes to facilitate failed social states like California emerge. This is when the manipulated musical chairs game ends.

At that point, the dollar will collapse or we will be labeled as a fascist regime by the outside world as we default on public debt, and they will be correct. It's not nice what has been done to America. Fixing it is going to be rather unpleasant no matter which path the nation takes but any nation needs innovators and entrepenuars which shall someday be solid leadership. This is where money should be going in the burning forest, the seedlings, not preserving the old rotten trees stifling growth by stealing the sunlight.

2008 Jul 14 12:22 PM

[akapital:]

yup. we're basically living in an oligarchy, social welfare for the rich (much different from socialism)...but in fairness there is some trickle down benefit of all of this...it used to be enough trickle down to give enough working class people hope and courage...not sure if that trickle will still be enough to fool enough of the people...we shall see...

2008 Jul 14 01:11 PM

[morgan77:]

Great, creative article. The 1984 remarks were sadly humorous and ironic. Here's an article about how Fannie and Freddie will drive the market.

seekingalpha.com/artic...

It's by Kathy Lien.. Pretty good!

2008 Jul 14 01:27 PM

[Reinko:]

At the moment of writing, Freddie is down 14% and Fannie was 7% down but is flat again. So upswings are not expected if today's mood prevails over the long run.

By the way, isn't it a famous American saying that 'There is no such thing as a free lunch'?

So why did they create mortgage companies like Freddie and Fannie in the first place? It is true that they made mortgages cheeper for many years but that only generates higher house prices and in the end you are not cheaper. But you have to pay the bill for all those extra cheap mortgage years.

And what about all those foreign investors who bought stuff like that (debt, stock and securities)? It looks like a bunch of fools with too much money and too little brains! Back in 2004 I already warned against this stupid business model and it is nice to observe my insights coming out in sharp detail.....

2008 Jul 14 02:24 PM

[sivere:]

The entire financial system has turned into a giant gambling casino. The notional value of derivative contracts we know about (OTC) exceeds $700 trillion. This is 20X the world's GDP tied up in various contracts. How can anyone know how and what to invest in?

Congress, and only congress is constutionally granted the authority to create and regulate the US dollar. Congree created the Fed, who (especially under Greenspan) promoted and encouraged this derivatives bubble.

If we want our nation to survive, we need to act now, and tell congress to:


TakeBackTheFed.com
xFed.mobi (mobile)

2008 Jul 14 03:07 PM

[The Geared ...:]

I've been saying for months that these 'free lunch' shops are going to start a downward spiral for the economy. Too many people are of the notion that the US market is bullet proof.

And while it wears a pretty nice vest compared to most countries, nothing is that solid. This market correction might have been necessary considering the commodities factors, but it was escalated by the housing market. This set off the consumer confidence decline, along with the war, then oil, etc. Are Freddie and Fannie a bad idea overall? I don't think so.

But I definitely think the regulation of these endeavors is to blame for the slippery slope. Do it right, and it appears like America is able help the little man. Slip just a little and you dislodge the rock that starts the landslide. And yes, it's still dangerous to short.

2008 Jul 14 03:10 PM

[Rabbito:]

The republican mantra:

Socialise the losses
Privatize the profits

2008 Jul 14 03:38 PM

[bearfund:]

Rabbito, give me a break. I'm not a Republican. I don't like the Republican Party, and I don't agree with much of anything it's spent the last 15 years doing. But for crying out loud, man, both houses of Congress are controlled by Democrats. None of this crap can go down without Congressional approval. Greenspan was reappointed by Clinton. This is not about partisan politics; the politicians from both major parties (except for Ron Paul) are falling all over themselves to socialize losses. If you want to complain about Congress, fine. But spread the blame: there's more than enough for all of them.

2008 Jul 14 10:52 PM

[Rabbito:]

Good point bearfund

2008 Jul 15 11:34 PM

[buyitcheap:]

Rabbito, Bear, I like both your posts - the key is to elect people who have actually worked in the private sector (like Ron paul, Mitt Romney, Bill Frist, etc.) so that lawyers don't destroy us all. :-)

2008 Jul 16 09:22 PM