Counterparty Contingent Liabilities

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Includes: DIA, QQQ, SPY
by: Gene Inger

Counterparty contingent liabilities essentially underlie strategy implications in the backdrop of the superficial interpretations of testimonies by the Treasury Secretary, the Fed-head, and the SEC Chairman. By no means do I believe debt issues are adequately discounted, but I also do not believe that the pedestrian conclusions reached by a host of pundits and economists are accurate or give a fair perspective on a very tough job being engaged in by the Federal Reserve and Treasury Department.

In this regard, it's essential to slightly 'read between the headlines' and absorb some less attention-grabbing, but more pertinent, remarks as were made (unusually given that it was in 'open session') on the Hill. Secretary Paulson alluded to 'changing rules for packaging loans, causing a careful review and loan scrutinization'; he addressed contingent liabilities but nobody chose to drill into it versus camera-ready sound-bites. A couple senators tried, but didn't expound on the subject.

Uncertainty of off-balance-sheet bank losses was touched upon (it comes down to 'can't price yet'). Entitlements were mentioned as a huge problem and they did reference Moody's (NYSE:MCO) / S&P (MHP) downgrades 'as possible' on AAA United States bond ratings. Secretary Paulson stepped forward to quell forward candor, lest it be perceived as talking markets down. In reality, it's all true, but it also proves that they try to put a good spin on the subject of woes.

He did affirm our argument of 'risks are to the downside', hinted at capital structure changes coming and acknowledged what we've said for a year: the credit and debt crisis is not purely a U.S. subprime problem. Ripple effects extend far and wide; it's a microcosm of overall debt problems and probable global credit pandemic. (This can be forestalled as retroactive data that allows Japan and the EU to forestall stimulus.)

When the history of this is written (maybe I'm doing it in advance a bit), Chairman Bernanke will be less vilified, and possibly deified, once they 'get it'. I believe he saved us from a 'crash' already, via the Reg W waivers that shored-up brokerage net capital last summer (when they allowed vioation of the limits as bank-sides loaned money to brokerage sides). He should be credited with this 'save'.

Some bulls believe that because much outstanding derivatives debt don't have to be marked-to-the-market, that somehow means such debt isn't real, doesn't have to be dealt-with, or is sufficiently invisible to thus not be an overhanging factor. We dispute that, but do concur that 'shock value' is mostly behind. However, many remain 'resigned' to the reality of slow or even hard times, whether debt is fully 'revealed' or not does not in itself ensure a new bull revival.

This is all against what we called for since proclaiming a 'rotational distribution' or broadening top masked under cover of a strong Dow (NYSEARCA:DIA) and S&P (NYSEARCA:SPY) from early 2007 forward. Rotational lows will occur for big-caps, but likely not yet.

Back to my reasons for 'supporting' Bernanke. The Reg W waivers. He won't say it because it is crucial and sensitive, but that's the real deal. Instead of whiners and moaners, you'd have analysts congratulating the Fed Chairman's wise strategy (unlike his predecessor), as it hence actually avoided a market crash to date.

That's not to diminish, as an expression sums up, that deleveraging is a bitch. Nor to say that we're not headed for a liquidation-capitulation before the sea change, nor reverting the progress of our 'regression to the mean' in a number of areas, nor other forecast post-Gilded Age events.

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