Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Five Things You Need to Know: The Day of Reckoning Is Here, What Next?


Remember, in a true bear market no one wins, not even the bears.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. What Just Happened?

It is doubtful anyone left work on Friday expecting to walk in Monday and find Bear Stearns (BSC) a $2 stock courtesy of a $236 million bid by JP Morgan (JPM). In early trading BSC was trading at around $3.75 per share, off 87% from Friday's close, but still well above the JPM bid. Word on the street is, "Hey, the building alone is worth $2 billion." We'll see. So what really just happened?

First, the collapse of Bear Stearns forced the Federal Reserve to finally recognize the debt destruction taking place in the market. As a result, a deal was structured where JP Morgan will purchase Bear Stearns with the Federal Reserve providing the financial backing.

Remember, this is not a credit crises, it is a debt crises. This is not a rescue of Bear Stearns, it's an attempt to manage systemic issues that would have become apparent almost immediately this morning had the deal not been announced. Put another way, it's an attempt by the Federal Reserve to manage an ongoing debt crisis using extraordinary measures, most of which have not been implemented in more than 70 years.

2. Further Fed Actions

In addition to securing the JP Morgan-Bear Stearns deal, the Federal Reserve took two additional measures that should be explained. The first was lowering the Discount Rate by 25 basis points to 3.25% and the second was the creation of yet another debt crisis acronym, the Primary Dealer Credit Facility (PDCF).

For more on what the Discount Rate cut means, see this Special Edition Five Things.

The PDCF allows the Fed to loan money to primary dealers, the first time since the Great Depression the Fed has extended credit or financing to non-banks. The PDCF moves beyond both the Term Auction Facility (TAF) and the Term Securities Lending Facility (TSLF) in the scope of who the Fed can lend to and what collateral will be accepted.

Click to order

3. Why Is This Happening?

Beyond the most flippant reply, "Too much debt," why are such extraordinary measures needed to manage this financial crisis? Because this is a true debt crisis, not a liquidity crisis.

During a liquidity crisis, the issue is one of supplying money to those who, for whatever reason, have suddenly shortened their time preferences. Because banks lend out more money than they have on deposit - fractional reserve banking system - if everyone goes to a bank and demands their money at the same time, a fair characterization of what was happening last week to Bear, a liquidity crisis occurs if the bank does not have enough cash on hand to satisfy the demand. But if the issue is too much debt supported by too little value and income generation, liquidity does not matter.

In this case, time preferences are retreating, risk aversion is growing, and access to credit is diminishing.

4. What Is the Best Case From Here?

Federal Reserve Chairman Ben Bernanke has repeatedly stressed the Fed's role as a lender of last resort should markets require that help, but what does that really mean? Does that mean the Fed will refuse to allow firms deemed large enough, dangerous enough systemically, to fail? Not really. As we are seeing with Bear Stearns, it means that it steps in to allow insolvent institutions to fail with jeopardizing the financial system due to counterparty failure. That was the issue facing the street late last week as it became increasingly apparent Bear Stearns was facing insolvency.

One thing should be clear, and at this point it's more bullish than bearish for the long term: we are not following the Japan roadmap that led to that country's prolonged bout with deflation. In the next few weeks we can argue over what steps will be necessary to reduce the impact of the debt crisis on the system and the economy, but we will not be arguing over whether those steps will be taken.

Equities will not squirm through unscathed. But it may take being hit over the head with the earnings hammer for stocks to see their fully realized lows.

5. What Can You Own?

Look at what is outperforming on days like today. Consumer Staples (XLP). Healthcare (IYH). Pepsi (PEP), Coca Cola (KO), Johnson & Johnson (JNJ) and Wrigley (WWY) are some of the stocks actually up on the day.

In a true deflationary debt crisis, however, all assets will be punished. Where investors may find some solace is in relative outperformance. Remember, in a true bear market, no one wins, not even the bears. The goal is simply to not lose any more than one has a right to lose.

No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos