Paulson Doesn't Have the Answer to the Run on Deposits

by: Bill Cara

It used to be that I could report and comment on markets daily, but in recent days there is such a flood of breaking news that I could do this every three hours and not keep up. For the long-term oriented trader, particularly the happy ones who fled to cash many months ago, it’s best to stand aside.

There may appear to be great value in some of the Financials, but what you really are looking at are depressed prices, and nothing more. In some cases, those prices will go to zero, so just because a price is low doesn’t mean there is value. In fact, the equity in many of the financial stocks cannot be assessed because nobody yet knows the extent of the losses or the timing of a turn in the real property market or the future of the interest rate market. Hence the prudent thing for any trader with a time horizon longer than one measured in minutes and hours is to stay in cash.

Just so you don’t think that I was calling for a rally Monday, let me repeat precisely what I did opine early in the morning, after the equity futures showed that the DJIA would open up with a double-digit gain:

Bank earnings will start coming out this weekIf [ie, if is the operative word] this early morning enthusiasm is going to develop [ie, after bank earnings are out] into a summer rally (from an over-sold level), then either (i) losses or reduced earnings at the banks must be less than anticipated, or (ii) the hype and spin to come from Wall Street re the banks must be ridiculous. I expect to hear so much spin [ie, after the bank earnings come out] from Financial Entertainment TV that the rally will get underway. That folks will be one more opportunity to sell into strength and to reload with shorts in the Financial and Consumer Discretionary stocks and ETFs. This Bear market will not die until independent traders believe the banks have come clean about their losses and required capital raise-ups. That final wave of selling will take some bank and broker-dealer stocks to zero. The equity market is setting up for a last chance to exit. I expect the final ride will be a severe challenge to most portfolios. Ah, but that might not happen for six weeks or so.

What happened mid-day was Treasury Secretary Paulson indicating that the authorities (aka Interventionists) might not help Fannie (FNM) and Freddie (FRE) as much as traders might expect, and then the implication was that other banks would not be saved, causing FDIC to take them over like IndyMac (IMB).

After that, Washington Mutual (NYSE:WM) plummeted, closing down -34.7% (with angry depositors lined up around the block to withdraw funds), M&T Bank (NYSE:MTB) sank by -15.6%, and National City (NCC) closed down -14.7%. Mortgage lenders were smashed.

When the same run on the IndyMac bank happened on Friday, FDIC rushed in and closed the doors. Under federal protection, the bank re-opened and stopped foreclosures. Unfortunately FDIC doesn’t have the capital base to do the same with many more of these banks, and there are, in fact, many more in the same situation as IndyMac.

The Wall Street Journal Tuesday says that Paulson should be demanding the power to put Fannie Mae and Freddie Mac into federal receivership. Clearly, they are insolvent and do not have sufficient capital to withstand a run on deposits, but these institutions called Government Sponsored Enterprises are too big for FDIC to protect. So, what’s the answer?

I don’t think Henry Paulson has one. It’s why I called his actions as Treasury Secretary for the past two years and more “Paulson’s Folly”. The man should be impeached.

Overnight trading confirms the fears that Fannie and Freddie and some banks may not withstand the present run on deposits. Obviously, the Bulls are being routed, and their DJIA=11,000 line is not holding up, so traders are expecting the worst.

What is a trader to do? As I say, let’s wait for the reports of bank earnings and the ensuing hype from Wall Street Talking Heads. In the meantime, if you are anything but a day trader, do nothing. If you have uninsured deposits, remove them. Buy T-Bills if you must or short-term government paper from other countries. But, there is no reason, if you are out of the market, to lose your head. Only those who have failed to manage risks when they were alerted to them should be the ones to suffer emotionally today.