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A Crisis of Confidence

August, 2008
Barry M. Ferguson, RFC

I like that phrase - 'A crisis of confidence'. Our new government wants us all to believe that there really aren't any problems in our economy. Our financial sector is just suffering from a 'crisis of confidence'. It's not like this sector is losing money. Actually, the billions in loses are piling up faster than we can count the zeroes. Throw in Fannie Mae and Freddie Mac and you have an ocean of zeroes with minus signs in front of the whole number preceding them. Crisis of confidence? Nah, investors just know there is something wrong. But as a word of disclosure, I just bought Freddie Mac myself. More on that in a moment.

The first car that I bought when I was in high school was a Mustang II. It was a real piece of 'you-know-what'. Everything in the world went wrong with that car and when I finally had my 'crisis of confidence', I decided to trade the car for whatever anyone would give me. It was four years old, it had 40,000 miles on it, and it would not go faster than 33 mph. It was a piece of garbage. Now I find out from our government that there really wasn't anything wrong with the car. I just had a crisis of confidence. Please!!!! The car was shot. Crisis of confidence my %#$!!

The same is true in our economy and stock market as we turn the calendar to August. The government sponsored mortgage companies known as Fannie Mae and Freddie Mac were pummelled by a crisis of confidence in July. Government leaders of all types were out pronouncing how well 'capitalized' the two entities were while at the same time, guaranteeing limitless government bailouts. Oh, I know - the government does not like to use the word 'bailout'. They prefer the word 'loan' or 'fed discount window'. The government does not like the word 'bankrupt' or the word 'insolvent' either. When investors show up at these institutions inquiring as to the status of their money, they are told to go away. They can't have it. The company is well capitalized but it is not in the best interest of the investor to give them any of their dollars back. Besides, everything is fine. Investors just need to cease their crisis of confidence.

It was quite ironic that we just celebrated our Independence Day on July 4. Since our crisis of confidence had driven the Dow into bear market territory, all the King's horses and all the King's men were summoned to Washington to work on putting our Humpty-Dumpty economy back together again. Of course, Washington is generally not the epicentre of fixing anything. At the heart of our market turmoil has been the sorry case of our financial lending system. It seems that our banks have lent all their money to folks that can't pay it back. Meanwhile, the banks took the liberty of leveraging up their newfound wealth with derivatives linked to lending practices under the guise of goosing our pitiful GDP. To be sure, the derivatives worked well to boost the earnings of the lenders at least in an 'accounting' sort of way. The derivatives aren't real money - it is just money that investors handed over to investment bankers and hedge funds that will never be in the interest of investors to be returned. Of course the lenders could keep lending because they packaged up their mortgage deals and sent them into the investment world as Freddie Mac and Fannie Mae stood ready to absorb the paper. Finally, Freddie and Fannie became ill on their 'capital' mortgage paper that turned out to be cotton candy on a July day. It was quickly melting and if Freddie and Fannie seized up, the mortgage and lending business upstream would seize up. Now we really have a crisis of confidence! As Congress debated a solution, it became apparent to all that Senator's Nit and Wit were like Jethro Bodine in a calculus class. Fortunately, our new leaders, Mr. Bernanke and Mr. Paulson stepped forward with a solution. All we had to do was to sign over legal authority for them to make things better, turn the US into a socialist nation, nationalize our financial markets, and toss our once revered Constitution in the trash. Senators Nit and Wit were more than happy to do so relinquishing them of any intellectual or patriotic responsibility.

Of course, the solution was to lend more money, print more money, and buy more stocks. Yes, the Treasury Department has gone into the business of stock ownership. And now, Freddie and Fannie have an unlimited line of credit courtesy of the Treasury Department and tax payers. Of course, Senators Nit and Wit had no idea what they were doing but they signed away capitalism. They made it official - our country is now run by bankers for bankers. And to think, they signed away our country in the month of July. I wonder if that could be considered 'treason'? At the very least, it shows the depths of our crisis of confidence. We obviously no longer have any confidence in capitalism or democracy. Maybe we should take the final step and rename our country 'The United Bank of America'.

If you remember back In March, as market conditions worsened, the Fed established two lending facilities for primary dealers of government debt. One allows them to swap a range of illiquid assets for Treasury securities. The other facility provides cash to these broker-dealers in a system that is similar to its discount window for banks. This is unprecedented and an affront to free market capitalists. We have surrendered and raised the white flag of freedom and democracy. Think about it. The fed is taking on 'illiquid assets'. What is that? Well, 'illiquid' means it is worthless and 'assets' implies worth on the accounting balance sheets. If a financial institution needs to trade an 'illiquid asset', it must in reality be neither an 'asset' nor 'worth anything'. In return, the fed hands out Treasury notes. Guess what? This is the manufacture of money. Welcome to Zimbabwe! Did you know that Zimbabwe has their currency printed in Germany? Did you know the company that prints their money just refused to print more? I guess they don't want to be paid in Zimbabwe dollars. Can you see the future for us through the Zimbabwe lens?

Further evidence of our descent into socialism was brought forth on July 22. Wachovia Bank announced that they had lost almost $9 billion and they had to cut their dividend to a nickel. Apple Computer announced they had made $1 billion. Guess who benefitted in terms of stock price? But before you guess, please remember that the Plunge Protection Team that now runs our country is mainly concerned with helping their banking buddies bilk us citizens out of billions. Ready? Yep, Wachovia finished up 27% on the day and Apple finished down 2.6% on the day. No, this is not a misprint. No, I am not insane. Yes, bank stocks are now the new pork bellies in terms of volatility! No, I am not making this stuff up. This is reality. For complete understanding, Wachovia started the day down some 10%. Obviously, the PPT (Plunge Protection Team) drew the line in the sand. A few days before, Citigroup rallied 8% after reporting that they only lost $2.5 billion. The ironically comedic thing to me is that the market regulators severely punish traders that are caught trying to manipulate the stock market. Yet, our new government does nothing, and I mean nothing, and I mean absolutely nothing, but manipulate the stock market every single day. Our government does not fix health care, poverty, or any social issue, nor do they attend to the future needs of the country in terms of energy or infrastructure. How could they? Presidents Paulson and Bernanke are standing at the printing press pumping money into financial stocks to try and make us believe all is well. What about Apple Computer? Yeah, they actually made a billion in their last quarter. The PPT did a quick scan of their 'buy' list and unfortunately for Apple, they are not a 'financial' institution. Thus, they simply don't register as a stock to buy. Folks, this is a microcosm of our new country. It has been taken over by bankers who run a monetary printing press night and day so they can shore up our pathetic financial ship. They don't have time for anything else. So, we have a banking rally based on giant losses. Hey, stop giggling. We all know the Fed ships them money anytime they need it so is a 'loss' really a 'loss'? Nah, not in a socialistic society. Capitalism is now dead and buried.

Let me make two points here. First, the buying in financials could be related to the new rule instituted to eliminate 'naked shorting' of selected financial stocks. The regulators just decided to enforce their own regulations when it came to the beloved financials. And I do mean only the financials - 19 of them to be exact. And, I'm sure only the best capitalized at that! 'Save me, SuperHank, save me'!! Now, the brokers could have gone on a buying binge so they would have enough shares of these beloved financials in case the nasty short sellers ever decided to short the financials again. If my theory is right, the financial rally will fade very soon. Two, President Paulson announced that he would back the beleaguered Fannie Mae and Freddie Mac mortgage companies by doing everything necessary - including buying their stock. Did I mention that I too bought this stock? Yeah, I know they are most likely insolvent but a man that owns a printing press is buying the stock. Now you know why I bought it! This is absolutely astonishing!! Our new President is using tax payer money to buy companies on the edge of insolvency! Uh, wait a minute. President Hank claims that both Freddie and Fannie were perfectly solvent and easily as well capitalized as Bear Stearns. Well, if you believe that one then you might believe that our mortgage troubles could be solved by even more lending. Uh…, oh yeah - that was the legislation passed by Congress at the end of July.

So why is the Fed fighting so hard to keep our bankers solvent? Of course, no one wants to see a financial meltdown, but on the other hand, no one wants to foot the bill to save all the lenders that spent the last five or six years lending to a bunch of people that had no ability to pay back said loans. Sure, that helped stoke the fires of a joke GDP and it made it look like our former country really had growth. But now that the new bankers have overrun us, growth is whatever they say it is. They will not let their banker friends fail even if it means printing jillions of fresh new dollars or even sending tax-payer money to the lenders of stupidity.

So where does this leave us investors and those of us that advise investors? We must realize that we are in a new era and that all the rules that we spent so many hours learning are now as useless as a microphone to Ashley Simpson. We must learn new rules to help us anticipate some kind of market direction. Therefore, I have a proposal. Since our government is so completely obsessed with trying to push the stock market higher, we need some new charting guidelines. Therefore, I am proposing a new chart pattern that I call the 'Fed Flare'. I thought about the 'Paulson Pop' but we need something that includes both the Treasury Secretary and the Fed Chairman. They have dual roles. So, let's go with the 'Fed Flare'. Have a look at the Dow Jones Industrial Average in Chart 1. The arrow is the 'magical' period in the market coinciding with the appointment of Hank Paulson as the 'Secretary of the Treasury'. We all know him as the PPT Chief but what's in a title? Anyway, the market went straight up and set records for its straightness! Coincidence?

Now take a look at the six circles that I have drawn. The first goes back to March of '07. The chart seems to indicate a 'bottom'. Here is where we must dig deeper. What 'caused' the bottom? Did investors realize that stocks were suddenly a value? No, the credit bubble began to pop and the Federal Reserve ceased their interest rate increase assault. Presto! The market rallied. The second circle occurred in August of '07. In my mind, this was the official coup de `etat. The market started to disintegrate quickly and guess what? The Fed 'injected' hundreds of billions and started cutting interest rates. Presto! The market rallied. The third circle came in November of '07. The market was failing. The Feds passed the 'stimulus package'. Presto, the market rallied. The fourth circle was in January of '08. Now the Dow was falling below the Paulson line of ascent and the Fed got serious. They cut rates, injected hundreds of billions, and presto - the market rallied! The fifth circle was in March of '08 and again, the market was sagging. The Fed cut more rates, announced the unlimited increase of 'Term Auction Facilities' (lenders give the Fed their garbage mortgage paper in exchange for fed notes), and presto, the market rallied. Double bottom? Not quite! The sixth circle just occurred in July of '08 and the market was really headed south. But again, to the rescue, 'Treasury Secretary' Paulson announced the full backing of Fannie and Freddie, and I assume any other 'too large to fail' financial institution. Presto, the market rallied. I call these brief bursts of rally on the back of a Fed announcement, a 'Fed Flare'. It is also important to note the increase volume of trading in 2008. It looks like the manipulators are staying busy!!

Chart 1 - 2-yr. weekly Dow
Chart courtesy of StockCharts.com

So what can we conclude?
1. Obviously, we can't trust charts completely now because the Fed manipulates them. Directional changes should only come from investors - not federalist interventionists!
2. Investors no longer run the markets - our Fed leaders do.
3. The two-year head and shoulders indicates a continued trend lower - the Fed is not doing a very good job over time. They are trying to save the Titanic with a thimble.
4. Every time we see a possible trend change, we must first review Fed actions to determine the reason for the change.
5. Fed Flares come in ferocious bursts. Typically, they are 200 points plus on the Dow and often, in the final thirty minutes of trading.
6. Fed Flares are very short periods of a steep upturn following a severely steep downturn.

Bailouts, handouts, Auction Facilities, rate cuts, outright stock buying, and outright manipulation come in short bursts. They are desperate attempts to save a lower-trending stock market. This is the new era and this is our new government. Learn to spot the Fed Flares and pass on your wisdom to other chartists! Maybe I should copyright the term! Hmmm…..

Disclosure: The views of the above are of this writer. The information herein is derived from sources believed to be accurate and up to date.
Charts courtesy of StockCharts.com.

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