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Monday Morning Quarterback: Treasury Sets to Bail Out Banks


...if the private sector will be subjectively saved after reckless risk-taking, have we effectively embraced the notion of moral hazard?


"Last Dance with Mary Jane. One more time to kill the pain."
Tom Petty

Good morning and welcome back to the flickering pack. After a freaky streak of football madness, we power up for fresh five-session set. The bears struck fear into the heart of the rally last week but by the time the critters jogged to the locker room, the found themselves trailing the Matador Pack anew. "Déjà Boo," they could be heard muttering to themselves as they glanced at the clock, "Déjà Boo."

As we ready to kick off the second half of October, there's no shortage of news to chew on. We've got earnings, starting with today's (pre-announced) Citicorp mess. We've got expiration, which should exacerbate volatility in the next few days (prior to Friday's put funerals). And we've got a $100 billion bank bailout proposal, which is either tough medicine or a road to socialization, depending on who you ask.

Hang on to your hats, Minyans, the nutty strut has only just begun.

The Udder Side of Paradise

At the end of August Minyan Peter, the former Treasurer at one of the biggest banks in the Midwest, discussed the dynamic of asset-backed commercial conduits. That was the genesis of the summer credit crunch and the skeletons that remain in our collective closet.

Over the weekend, it was announced that the Treasury, along with Citigroup (C), Bank of America (BAC) and JP Morgan Chase (JPM), was hatching a plan to save banks from losses on mortgage securities by setting up a $100 billion fund to buy troubled assets in exchange for fresh short-term debt.

Hank's motivation is to facilitate an orderly disposition of assets although something more important (albeit less tangible) is on the table. While the total market for Structured Investment Vehicles (SIV) is roughly $320 billion, this proposed step is more than a numbers game.

At stake is faith in the system and the credibility of our government officials.

Citigroup, the world's largest bank, was sure to be asked some tough questions on this morning's conference call and this super-conduit may provide a near-term panacea. Therein lies both sides of the sword and the question investors must collectively ask. Where are the lines of distinction between big government and corporate and at what point do they blur from virtue to vice?

In other words, if the private sector will be subjectively saved after reckless risk-taking, have we effectively embraced the notion of moral hazard? What message does that send to those who have properly managed previous risk or those who will shape future risk? Indeed, while this measure may be needed to "save the system," it seemingly penalizes those who operated effectively to begin with.

For every action, there is an equal an opposite reaction. By shifting positions around the marketplace without forcing the realization of risk, it may eventually undermine the credibility of our financial system.

And if that happens, the ensuing multi-generational crisis of confidence won't be one that will be effectively managed by fiscal and monetary policy directive.

Food for thought as we edge through the most interesting of historical junctures.

Random Thoughts

  • Four of the five major Investment Banks announced on Thursday that, as of last quarter, their "Level III" investments (positions marked subjectively by internal management) grew 36.7% from $156.4 billion to $215 billion. As all of these firms reported profits (Merrill Lynch (MER), which posted a loss, is omitted from these figures), it seems somewhat clear that a significant portion of their assets was shifted to Level III "self-pricing." (BTIG).

  • Through the years, I've found myself in alignment with the thoughts of Jim Rogers. His latest musings, that the dollar and confidence in the banking system are fragile-albeit after a potential greenback rally-are most certainly worth a read.

  • Barron's had a great Crash Anniversary column in the weekend press, asking the question of whether it could happen again. While there were several structural differences (10-year treasury yields were 10.2% vs. 4.65% now), they noted several catalysts that could trigger a watershed decline, including geopolitical risks and China.

  • They summarized by saying that "the US may be playing a dangerous game, because the depreciating currency might be taxing the patience of world central banks that are seeing the value of their huge dollar-denominated holdings erode. While a run on the buck (and sharp market set-back) are possible, it doesn't appear to be in the interest of big dollar-denominated holders like China, Russia or the Middle East to precipitate a collapse in the currency.

  • Remember that SOX dandruff we discussed a week or so ago? These are important levels from a "No More Tears" standpoint. Particularly since the volume has been greater on the declines vs. the advances.

  • The chips, trannies and banks continue to offer classic non-confirmations of the current rally. Don't shoot the messenger, Mon Frere, just respect the message.

  • The Annual Minyanville Holiday Festivus is six weeks away as we ready to gather for holiday cheer and do our part to help children in need. Please join us for the soiree-an old fashioned southern barbecue followed by some serious rug cutting-in the heart of Manhattan. The entire Circle of Trust-our partners, professors and thought leaders in finance-will be there in force.

  • It's beginning to look a lot like Christmas? Perhaps, but investors may want to remember that hope isn't a viable investment vehicle.

  • Sharpen those #2 pencils as we ready for an earnings avalanche this week. The financials will lead the charge as Bank of America, JP Morgan and Wachovia (none of which have updated the Street in recent weeks), pull back the curtain. Intel (INTC, IBM (IBM), Google (GOOG), Yahoo (YHOO), eBay (EBAY), United Technologies (UTX), Honeywell (HON) and Caterpillar (CAT) will also share their tale.

  • Big week in Critterspeak. Hit 'em hard, Minyans, and hit 'em straight!


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