Yet another sign of stress and deflation is the nearly non-functioning Treasury Bill market. Since we are seeing money market funds ‘break the buck’ and liquidated, the money has to make its way somewhere. And in this instance, it is finding its way into the Treasury Bill market, where yields are approaching 0. In one extreme transaction last week, Treasury Bills trades above par, or in other worse, a negative yield. Yep, more deflation. I saved a picture of the Treasury Bill screen from that day for ‘posterity’ and will share it below.

Treasury Bill Yield Screen Shot


Will Deflation Lead to Depression?

First of all, let me just say that I hope not. But what is needed is the Government get out of the way and the market be a market. The interventions/intrusions that have become so commonplace and sickening need to end. Those of us that manage hedged portfolios need to be allowed to hedge ourselves. It is a stabilizer, not a bad thing.

Note how Wachovia, Nat City and others plunge even though short selling is banned. This shows the market is differentiating between the good, bad and ugly. Let the Darwinism back into the markets, let companies fail, let the system work it out. Will this lead us into a very deep Recession, yes of course it can. But we can see that no matter how many intrusions we have all been forced to live with, the markets march relentlessly lower. I understand that the Authorities are simply trying to slow down the unwinding process and let there be just a handful of good banks left at the end, this will likely take place anyway as poorly run companies fail. My sense is that the more they intervene/intrude, the greater chance for a Depression, and to be brutally honest, I would rather not see that happen to what used to be a great country. It can be great again if they just let it alone.

To tell you just how much they have intruded, let me give you a couple of real-life examples of what has happened as a result of the short selling ban. A friend of mine, that happens to be an exceptionally talented long/short manager called me while I was having dinner at the Ryder Cup and said ‘I had to shut down my business today, how on Earth I can run a long/short book when I can’t short things’? Another fellow said ‘do I change my convertible arbitrage fund documents to say that I can no longer run the fund as designed’? When I asked an options trader if I could do a particular options trade (an put option strike roll, where you sell one put option you own and simultaneously buy another put with a different strike price), he advised me to call my lawyer as no one understands the rules well enough yet.

Then, something completely surreal showed up on my Bloomberg screen yesterday, an index created by Bloomberg that tracks the performance of the ‘do not short list’. On this list are companies like Zale’s (ZLC), CVS Drugstores (CVS), Sears (SHLD) and 13 other non-financial companies, with a total of 964 companies now being in the list. What was originally supposed to be a list of important financial institutions that needed protection turned into a muddled collection of companies with good lobbyists. I thought it was a joke, but alas, it is the real deal, and makes me ill that it even exists. It is yet another failed intervention that will just squeeze a few weak shorts out of the market only to make it worse later on.

Bloomberg Do Not Short Index


Note how there were 412 stocks up, 524 stocks down and 26 unchanged in this index while the Dow was up 120 points on Friday. And oh by the way, the four worst losers in the index were, you guessed it, financials—Wachovia, GE, ING and RBS.

Another thing that happened on our trading desk that was unusual is that I was tracking the spread widening in Wachovia and Morgan Stanley, I instinctively picked up the phone to call my prime broker to borrow shares to short, and I yelled out to my partners, ‘Oh that’s right I am not allowed to short them’. I then watched Wachovia get carved in half in a few hours time and watched in dismay as my homework I did would have, in a free market, made money for my investors. Instead, I had to sit by and just watch. While this will all pass, and I think that the interventions and intrusions will soon come to an end (the only card they have to play, I think, is to directly hand our cash to the banks to shore up their balance sheets).
What concerns me most is the fact that we find ourselves in a situation where all the major brokers have failed, been merged into depositories or in the case of Goldman Sachs, converted into banks. On top of this, many banks have now bitten the bullet and many more are likely to follow suit; these will likely be regional banks and community banks. But consider this—not only is the financial system impaired but the Federal Reserve is impaired and the Treasury is likely next in line for impairment. When I think of the AIG bailout by the Fed, it really was an ‘end around’ where the Treasury bailed them out. Paulsen clearly couldn’t make it seem like he was playing favorites by letting Lehman go under and bail out AIG, so they lent money to the Fed to bail out AIG.