The Good, The Bad, and The Ugly: We Ain't Seen Ugly Yet in the Market

The Hopelessly Toxic Institutions have been allowed to almost seamlessly fail, The time is Now to Recap the Good Ones Still Standing ~ Or We Will See Ugly in the Stock Market

As I have harped on since the last bear market, when consumer confidence swoons, so too does investor confidence. That is why we occasionally see the stock market sell off into consumer confidence reports. However, as I have also harped upon, when the stock market takes out a swing low set on a consumer confidence date it is a sure indication that investor confidence has been shattered and downside risks increase immeasurably ~ almost immeasurably that is, except to those clued in to the bearish consumer confidence pricing models. That would be you guys, I know, because I have been more than vociferous about this point. So, here we find ourselves swooning into another consumer confidence Tuesday.

As we enter this CC Tuesday, it is important to note that investor confidence has diverged from consumer confidence. Most consumers still have their jobs, the sun still rises, and the bars are still open at 5 pm for the working stiff. But the investor is out of pocket some serious change. From peak to trough, the stock market has already lost roughly 30% of its value, and for the unlucky investors who have been listening faithfully to the false reassurances of Wall Street institutions and owned financial stocks, well, some of the stocks in their portfolios have been repriced to one penny.

The point I am making is there is almost ( never say never) no way in hell the stock market will set a bear market cycle low the Sept 30 CC Tuesday, as the investor is now shaking like a leaf in the frosty autumn winds. He is in far worse shape than the consumer. His proclivity to go long shortly after CC reports has expired and his animal spirits have turtled. Bunker mentality abounds, even I have been afflicted by the bunker mentality in recent weeks, in fact, ever since the bar on the SP500 on Sept 4 took out the August 26 CC Tuesday low at 1264. That was the day that signaled the SP500 had boarded the southbound train headed for my bearish pricing Consumer Confidence models targeting 1089-1109 roughly.

Other reasons that the stock market will be held hostage for the next few days are numerous. Numero Uno is that Congress can't return to Capitol Hill to vote in a stabilization package until Thursday October 2. Weekly jobless claims will be out at 7:30 am, and with the prospect of jobless claims to escalate to 500,000 one just might expect stock market participants to shudder at that number ahead of NFP Friday expecting to show a loss of 100,000 jobs lost in September.

The stock market, in short, has more bad news to absorb before this week is over, with or without a stabilization package. My bearish timing models suggest the earliest to anticipate a stock market low would be next week, but, a stabilization package on Thursday October 2 that is approved after the weekly jobless numbers might just do the trick. As an aside note, that is also the day investors can return to their short selling. How coincidental would it be to sign an emergency stabilization bill on the day short-sellers can return to the market? The timeliness of such an event will almost assuredly keep short-sellers sidelined for more than a few weeks if not a few months for the most part!

For me, the only question I have for the stock market is this: to crash or not to crash? Yes, today was ugly, and has the earmarks of what looks to be the beginning of a crash. Signature crash moves tend to last 4-5 days with the final two days being the worst of it. So, today's 100 point range in the SP500 would then be considered just the warm-up pitch. A four day crash that starts from today's high at 1221 could well extend into another 200 or 300 points lower between now and Thursday.

We could be looking at a retest of the 9/11 lows at 939 or the 1998 yr lows at 929-936. Yes, that would be what a crash might look like from here were it to happen this week. So, word up! My damn bearish CC models, which up to this point have proved to be fairly decent guides for us, had better not fail us now! The trader in me says let the crash come as the greed on Wall Street deserves it, but the sensible side of me knows that signals the credit crisis will devolve into far worse hardships for Main Street.

I have made no bones in recent weeks about agreeing with the critics who have argued from the get-to that this bill in its present form is flawed for the American people and for our capitalistic system what is left of it. As Alan Abelson pointed out this week, "what Paulson was proposing was the creation of a blind pool to end all blind pools, funded with your money and ours!"

The issue for the banks is no longer one of liquidity, but of capital and solvency. The market in recent days has been absorbing the losses of WM and WB instantly and seamlessly, with the help of the independent self-funded FDIC. Here is today's press release from the FDIC.gov on Citigroup's acquisition of Wachovia's banking operations.

For Wachovia customers, today's action will ensure seamless continuity of service from their bank and full protection for all of their deposits." said FDIC Chairman Sheila C. Bair. "There will be no interruption in services and bank customers should expect business as usual.

On the whole, the commercial banking system in the United States remains well capitalized. This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury," Bair said. "This action was necessary to maintain confidence in the banking industry given current financial market conditions.

And less than a week before, the FDIC made this press release on JPM's acquisition of Washington Mutual:

On September 25, 2008, the banking operations of Washington Mutual, Inc - Washington Mutual Bank, Henderson, NV and Washington Mutual Bank, FSB, Park City, UT (Washington Mutual Bank) were sold in a transaction facilitated by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC).

The FDIC has assembled useful information regarding your relationship with this institution. Besides a checking account, you may have Certificates of Deposit, a car loan, a business checking account, a commercial loan, a Social Security direct deposit, and other relationships with the institution. The FDIC has compiled the following information which should answer many of your questions.

All deposit accounts and all loans have been transferred to JPMorgan Chase Bank, National Association, Columbus, Ohio (JPMorgan Chase Bank). All former Washington Mutual Bank will reopen for normal business hours as branches of JPMorgan Chase Bank.

Your transferred deposits will be separately insured from any accounts you may already have at JPMorgan Chase Bank for six months after the sale of Washington Mutual Bank. Checks that were drawn on Washington Mutual Bank that did not clear before the institution closed will be honored as long as there are sufficient funds in the account.

The rapid absorption of these two very large institutions proves to us that the markets can adjust and absorb institutions which would previously have been considered "too big to fail." The mechanisms are already in place for seamless transitioning. Yes, we have been seeing a string of runs on our junkie financial institutions strung out on excessive debt and leverage. These too big to fail firms that are failing are our worst fears now being realized, and yet depositors can still go on banking at their old branches under new names ~ almost as if nothing has happened. The man on main street is still whole, for the time being. Hopeless Wall Street institutions too strung out on shaky collateral have been allowed to fail this past month and the world did not come to an end ~ at least not yet.

But, our sounder financial institutions must still be saved. The "Domino-Effect" that has so badly walloped Wall Street this month can not be allowed to also take down our sounder financial institutions. So, the time to stop this domino-effect is right now, on Thursday, when Congress reconvenes. And Congress better do a far better job of "getting it done right." If they hope to do it right, they better be listening to the valuable inputs we have been receiving from Graham Fisher's Josh Rosner, Institutional Risk Analyst Chris Whalen, and various others.

In short, the RTC-based model proposed by Paulson should adopt a different tack if it is going to have the measure of success they hope for and are touting are capable of producing. There have been many alternative solutions to the Paulson Plan proposed thus far. But many of these solutions, one way or the other would not be politically palatable or feasible.

However, one alternative would be to adopt an agency/mechanism something along the lines of the RFC-based model under Jesse H. Jones' leadership back in the 1930's. After all, if the threat we face is a Depression, then we best ought to adopt a model based on the one agency that proved capable of "whipping the forces of the Great Depression." Leadership will be a key issue for us, because there will be a leadership vacuum when Paulson leaves the Treasury next year. Under that model, the RFC assessed which banks were sound enough to reopen after the banking holiday in March 1933 and which were not. Fortunately, some congressman on Capitol Hill already get it. Senator Schumer understands fully why the model needs to be RFC-based and not RTC-based. You can hear him explain it in his Bloomberg interview here:
http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vLeJGt1yem3I.asf

House of Representative Brad Miller understands too that the balance sheets of our shakiest financial institutions must be allowed to fail while simultaneously recapping are institutions that can be saved. I am sure a few others on the hill understand this almost-entirely-forgotten principle of the capitalist- based model too. And I believe both Miller and Schumer are both Democrats. This is almost far too encouraging! Still far too many on the Hill simply do not grasp this. Although I can't speak for Bernanke I know must almost certainly grasp this, being the Great Depression student that he is supposed to be. Hank, I am not so sure about.

The Taxpayer Can't Be Everybody's Goat on Wall Street

J.P. Morgan taught us precisely the value of letting firms with shaky collateral fail exactly101 years ago today. During the Rich Man's Panic of 1907, it was the speculative Knickerbocker Trust that placed all of Wall Street in dire jeopardy. It is well worth retelling the story today (here is a snippet from chapter five of my new book that I hope to have finished by the election)

The Knickerbocker Trust, along with many speculators had been attempting to corner the market of United Copper. On Monday October 21, 1907 fears of a copper glut ensued following rumors that the Morgans and Guggenheims were interested in developing new copper mines in Alaska. The shares in United Copper's stock immediately plummeted at the prospect "spreading ruin and dragging stocks to levels unseen since the 1893 depression."

The foundation for all those outstanding loans at Knickerbocker Trust virtually collapsed in one day ~ over a rumor no less! Knickerbocker's business model, based almost entirely on the direction of United Copper's share price, caused the failure of the entire trust company. Risk management at the Knickerbocker Trust was not a strong point. To not see the risk or flaw in their business model or to protect against that flaw was a huge mistake.

The fall in United Copper's share price greatly alarmed the Knickerbocker Trust's 18,000 depositors and the panic amongst Knickerbockers depositors quickly spread like wildfire to depositors at other trusts around town.

Pierpont Morgan of JP Morgan sent the future Fed Chairman Benjamin Strong of Bankers Trust to audit Knickerbocker's books. During the audit, Benjamin Strong is reported to have caught a glimpse of the grim faces of the Knickerbocker depositors from the back room: "The consternation of the faces of the people in line, many of whom I knew, I shall never forget."

After the audit was conducted, Ben Strong reported back to Pierpont. Upon hearing the gloom and doom results of that audit from Strong, Pierpont wrote off Knickerbocker Trust as hopeless. Put out to pasture, the trust failed the very next day on the afternoon on Tuesday October 22. The bellicose Pierpont Morgan at the time, "I cant' go on being everybody's goat. I have got to stop somewhere."

The next day Pierpont put together a rescue pool comprised of Morgan, George Baker of 1st National Bank, and James Stillman of National City Bank. In an audit of another trust company (the Trust Company of America) conducted by Ben Strong, the results were found to be far more favorable. Upon hearing this good cheer, Pierpont exclaimed, "This is the place to stop the trouble then" and the three bankers pooled $3 million to save the Trust Company of America. Evidently, the Trust Company of America had much less exposure to United Copper's share price than the Knickerbocker trust.

The domino effect of failures on Wall Street has been frightening this September, but some of them were hopelessly strung out on bad debt and excessive debt to begin with. Their collateral was too shaky and a cleansing process is necessary. Since they would not unwind their assets, and the Federal Reserve and US Treasury could do more than urge them to do so, they simply wound up choking to death on their toxic waste instead. But as I said before, the time and the place to stop the trouble is now, we can't let the sounder institutions fail as well. It is time to we all buck up and collectively become J.P.Morgans.

See good bad ugly chart in post below!