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Clues to the Fuse

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Stopping an economic explosion is the task at hand.

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"This tape will destruct in ten seconds. This is your mission should you decide to accept it." Mission impossible

For the last few years in Minyanville, we've spoken about our finance-based economy that is dependent on higher asset prices to sustain our standard of living. Inherent in that is the concept of "financials in drag," which are companies that derive a large portion of their earnings from finance based operations.

As the weather warms in New York City and thoughts shift to sunshine, I'm reminded of when Minyans migrated to the mountains of Ojai in 2005 for our annual pilgrimage. To wit, this was lifted from my keynote speech:

I am particularly wary of the financials, the main beneficiary of the easy money policies these last few years. As the yield curve flattens, margins squeeze and compression builds in the system, the risk/reward seems particularly unfavorable.

Adding spice to that mix, a complex maze of derivatives has tied together the balance sheets of the world's largest organizations. With the emergence of bearded financials such as General Motors (GM), General Electric (GE) and Ford (F)-all of which have considerable finance arms-it's quite possible that a ripple in Fannie Mae (FNM) or JP Morgan (JPM) will have an exponential impact across a wide array of sectors and industries.

So-does any of this matter? We've heard the bears talk about derivatives, debt, the dollar, pension liabilities, social security, geopolitical risk, stagflation, oil, for a long time but it hasn't "mattered." In fact, as a function of the persistent price action, we seem to have built a collective immunity to bad news.

The problem that comes from engaging in high risk behavior for which the consequences are absent, even if only temporarily, is that such high risk behavior begins to appear normal, and the entire scale of risk gets adjusted and pushed out. When we look at sentiment proxies such as the volatility indices and investor's intelligence reports, investors seem to be saying that it doesn't-and won't-matter.

To be sure, we were early with those insights as markets tend to overshoot both ways. But we kept them on our Minyan radar, highlighting the risks last summer as we again pointed to General Motors and General Electric-along with retailers such as Target (TGT), which have massive credit risk on the other side of zero-percent financing-as inevitable casualties in the global game of derivative dominoes.

The media has been quick to paint Jeff Immelt with a blame brush this morning, much as they did Stan O'Neal, Chuck Prince and Warren Specter.

Let me be clear-as the Founder and CEO of Minyanville, I understand that the buck stops here, for better or for worse. I will also offer, in their defense, that the sheer magnitude of the derivative underpinnings coupled with the seismic shifts in the underlying collateral makes measuring risk massively difficult, if not completely impossible.

We can wag the finger and scold them for allowing the structural machination to manifest in the first place. Wall Street is notorious for packaging and repackaging risk as a matter of course and, some would say, greed. But the dye was cast long before problems rose to the surface of our collective consciousness, not unlike the economy Ben Bernanke inherited from Alan Greenspan.

The world knew there were massive structural issues last summer. We, at Minyanville, made absolute certain of that. The attendant contagion and current risk is akin to running after a fuse, trying to stamp it out before it ignites another batch of dynamite. That is our task at hand and the motivation behind the actions of the Federal Reserve. For better or for worse, this is the hand we've been dealt.

Good luck today.

R.P.

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