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Random Thoughts: The Biggest Trade in the History of Mankind


The Federal Reserve looks to destroy debt. Will it work?


Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

I've been writing for a mighty long time -- I've seen a lot of things, and have chronicled them in real-time for the last 12 years.

Just like many of us studied The Great Depression, history will review this historic stretch and provide valuable lessons; most of them, I would imagine, will be similar to what our grandparents taught us.

One of the more persistent themes in the 'Ville during the last few years has been the notion that policymakers are making decisions that are akin to drugs that mask the symptoms (cheaper credit) rather than medicine that cures the disease (debt destruction).

It's an intuitive argument; never in history has a problem been solved by exacerbating the same behavior that caused the problem in the first place.

Yesterday, while sharing some thoughts about how insane it is that a recession is now considered anathema, I had a random thought (shocker, right?). I share it below to save you the click:

And then there's this -- what if the USA is acting as a toxic debt mortgage dump? What if they -- I mean, we -- are Fannie and Freddie in reverse, the ultimate -- and perhaps only -- conglomerate big enough to digest and ultimately retire the excess debt? That would seemingly address the fact that risk hasn't been destroyed, it simply transferred from one reality (corporate America) to another (America Corp).

I hearken back to the days when Intel (INTC), Dell (DELL), Cisco (CSCO), and Microsoft (MSFT) -- the four horsemen of the tech apocalypse -- decided to sell OTC (off-board) out-of-the-money puts in lieu of buying stock. As shared in the 2007 article, Fire on the Mountain, when the BKX was a stone's throw from all-time highs and we fingered Level III assets as a root cause of concern, we touched on this tech topic:

I started my career in 1991on the worldwide global equity derivative desk at Morgan Stanley (MS) as the off-balance sheet proliferation began. We were pioneers in the field and during my seven years there, I watched as the largest technology companies in the world sold massive amounts of downside puts in lieu of traditional buybacks.

Their motivation was clear -- if they were to put the stock, their cost basis would be considerably less than it would be through straight stock purchases. If their short puts expired worthless, the gains weren't taxed as ordinary income. That loophole always seemed strange to me, but alas, that's a conversation for a different time.

They played the game because it was playable. And when they lost, they simply swallowed hard and wrote it off.

It's the last line that continues to play in my head. They swallowed hard and wrote it off.

We strive to see both sides in Minyanville; that was the genesis of Hoofy & Boo and remains at the core of our mission to effect positive change through financial understanding. There is a reason the stock market doubled in the last three years, above and beyond the trillions upon trillions of dollars in synthetic stimulus demand.

There is a belief that the government will be able to retire this debt -- make it vanish -- so we can return to our credit-driven spending habits of decades past. In other words, this is the debt destruction, albeit in a stealth manner.

The trick to that trade -- and make no mistake, it is the biggest trade in the history of mankind -- is managing the unintended consequences, be it the socionomic landscape -- which continues to devolve -- or the structural implications, such as an alternative world reserve currency, massive de-leveraging, trade wars, isolationism, or hyperinflation.

Many of these scenarios were considered grassy knoll conspiracy theories when we first discussed them. Not so much anymore.

Random Thoughts:
  • Russia is writing off 90% of North Korea's debt; are the battle lines being drawn with dollars and cents?
  • Do you think they know what a write-off is?
  • I am still short the Nasdaq -- timestamped at QQQ $69.65 with a $1 stop -- and while defined risk removes emotion, I can tell you that a 42-cent move -- 42 cents -- has never felt so...anxious. Whether the toughest fade proves to be a good trade remains to be seen; as always, we will update any and all actionable ideas on the Buzz & Banter (click here for a FREE two-week trial!).
  • Gratitude is latitude, regardless of how you're positioned.
  • Do you buy Rosh Hashanah and sell Yom Kippur, or the other way around?
  • "European banks pledged last year to cut more than $1.2 trillion of assets to help them weather the sovereign-debt crisis. Since then they've grown only fatter," according to Bloomberg. In other words, you can't have it both ways -- and the risk of this mood broadening is the "other side" of the perceived central bank panacea.
  • Structural Stimuli vs. Social Psychology: The Final Frontier.
  • Did you catch A Lonely Redemption over the weekend in the New York Times? (It's a worthy read.)
  • The longer the tape holds tough, the more performance anxiety will cause traders to worry about losing their G.I. Joes with the Kung-Fu grip.
  • If your firm would like to sponsor Festivus 2012 and give back to the kids -- come on now, it's a write-off! -- please let us know. The sponsor banners will appear on every Minyanville article from here to there, as well as registration and signage at the event. Plus, it's a GREAT event that celebrates the journey with our community!

Twitter: @todd_harrison

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