Where is the Buying Coming From?

Today's headlines:

- Chrystler will declare bankruptcy
- Consumer spending drops 0.2% in March
- Kodak posts loss, suspends dividend
- Dow Chemical earnings down 97%
- ExxonMobil profit down
- Procter and Gamble profit down

DJIA up 98.

Where's the buying coming from? Maybe the sideline cash Russ Winter was talking about. Other than that, I don't know. I'll admit the numbers out of China, Taiwan, and Japan have started climbing back, which has surprised me. But I need to figure out what's going on here.

Or maybe it's about the dollar devaluation that occurred when Ben decided to print. Devalue the dollar and stocks go up. Sometimes. Maybe. At least that's what happened after the 1987 crash. Maybe what's throwing me off here is that I tried to bottom-fish too early, after the November 20th lows last year.

The Dollar

Jesse's Cafe Americaine reminded me today that the Treasury bond crash of 1932 came as a result of dollar devaluation.

I need to think about this some more, but if it is correct, it means that Treasuries can collapse despite deflation. In this environment, the Treasuries are not a bet on inflation or deflation, but on the value of the dollar. If this is correct, it means that betting on deflation means I short Treasuries and buy more gold. I short Treasuries because deflation has been and will continue to be met with dollar devaluation policy from Bernanke and Geithner.

To Bond or Not To Bond

So, I don't like how my Treasuries are treating me. I'm going to write down the pros and cons.

Contra:

1. First thing against bonds is the massive Treasury borrowing.
2. Then there's the fact that a faltering economy is causing a 7% drop in income tax receipts, exacerbating the supply problem.
3. Also, every big job loss announcement leads to a bond selloff as more government printing is expected to offset the losses.
4. Fed buying bonds. Unfortunately, this muddies the market and is probably a negative. If the Fed has to print to lower rates, then who would want to hold them at those rates?
5. The Fed printing can hold down rates, but that means that those lower rates are causing weakness in the dollar.
6. China has stopped buying a lot of bonds. If their economy recovers, they'll probably buy more commodities. If it doesn't, they won't be buying Treasuries anyway.

Pro:

1. If the economy recovers, dollar stays strong. If the economy weakens, the rest of the world is worse off, and the dollar gets even stronger. A strong dollar will make bonds more attractive.
2. Everyone hates bonds and thinks they're in a bubble.
3. The real rate of return is huge, as CPI is really -5%.
4. Bonds have sold off during this huge inflation rally that started in February.
5. Credit card defaults are going parabolic.
6. Commercial real estate defaults are going parabolic.
7. There's been a huge run into risk over the past couple of months.

My biggest problem here is that there's no reflexive, self-reinforcement working in my favor here. If anything, we've got a situation where any good news for bonds is killed by the Fed printing more money. I need to get out. But this is not the time. I need to wait for a more bearish sentiment to reappear.

The Quiet Coup by Simon Johnson

Simon Johnson take his experience of international crises from the IMF and applies it to the U.S. This article is first-rate.

Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks, with no strings
attached and no judicial review of his purchase decisions. Many observers
suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands—indeed, that is the only way that buying toxic assets would have helped anything.

The solution, from an economic standpoint is easy:

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize
troubled banks and break them up as necessary.

The politics, however, is not.

No Transparency in Stress Tests

No surprise here. The Fed gives little details about how the stress tests were conducted. Analyst Josh Rosner said, “The most significant numbers provided by the Fed in the paper appear to be the page numbers.” (Bloomberg) Why won't they give details? Because the banks would fail any test with any stress in it at all. So, instead, the Fed says, "trust us." If we really could trust them, they would give us the data.

However, even if banks pass the stress test and have money to lend out, they won't. Why? As the CFO for Capital One said, investments are much more appetizing than lending in this environment. He said that they will wait for things to get better before resuming lending.

Translation: We're losing our shirts on credit cards, so instead of lending any more, we will put all our deposits in Treasuries, wait for things to get better, and hope we survive that long.

Tactic and strategy: wait.

Holy Sh-Smoke!

From Mish comes this link to Ken Lewis's testimony about the BAC-Merrill Lynch merger:

Bank of America's attempt to exit the merger came to a halt on December 21, 2008. That day, Lewis informed Secretary Paulson that Bank of America still wanted to exit the merger agreement. According to Lewis, Secretary Paulson then advised Lewis that, if Bank of America invoked the MAC, its management and Board would be replaced.

Mish says:

It's crystal clear from the letter that a strong case can be made that Paulson and Bernanke coerced Lewis to carry out a merger agreement that was not in Bank of America's shareholders best interest. Lewis arguably did so only to save his own job and the board.

Here's Mish's post when the merger was announced:

“There was no pressure from regulators, absolutely no pressure,” said Mr
Lewis, who described the deal as “the strategic opportunity of a lifetime”. He said: “The first contact came on Saturday morning and we put the transaction together in 48 hours. The instant we talked it made sense.”

My [Mish's] Translation: "The pressure from the Fed was enormous. Anyone in their right mind knows this deal makes no sense to Bank of America".

In other news, the number of prime mortgages 60+ days delinquent owned by Fannie and Freddie rose from 497,131 in December to 743,686 in January, or 50%. These numbers are nothing short of apocalyptic.

How you get inflation out of these numbers, I don't know. What I suspect is that everyone is focused on what is easily seen: the amount the Fed is printing. The strength in prices of oil, copper, and weakness in bonds has been taken as a sign of inflation as well. I don't think so. I think it's just a by-product of Fed printing weakening the dollar. If you look for inflation on main street, there's none. On the contrary, there's epic deflation. Housing costs are down -20%, wages are down -6% according to the Withholding Taxes Blog, commercial real estate vacancy rates are ramping up to generational highs, and almost everything you can buy at a mall is 30-50% off. Bad assets at banks have tripled over the past year. They are nowhere near being repaired. Now, some of this may be exaggerated on a percent basis due to mergers. For example BAC also includes Countrywide and Merrill Lynch losses. But even when the banks are fixed, we still be stuck in the Japan scenario where more people are paying off debt than are borrowing.

Total 60+ day delinquent mortgages stand at 1,229,000 as of January 31st.

As far as bonds and inflation from printing goes, I will be watching the Pound and the UK. Their budget deficit for this year is projected at 11% of GDP. Ouch. I would love to short the Pound, but FXB is hard to borrow... I will keep my eyes open for another way to do this. Maybe I should just buy gold. It should be a good indirect play, as a collapse or panic in the Pound would push Pound-holders to buy gold to protect themselves. Moody's just said that the UK's debt rating may be downgraded.

And another thing... I'm not so sure that bankruptcies by GM and Chrystler are being priced into this market.

But wait, there's more: Bloomberg reports Fed’s Bear Losses Dominated by Commercial Real Estate. The losses are at 28% for commercial and 38% for residential mortgages.

And now for good news on gold: Bloomberg reports China Increases Gold Reserves 76% to Fifth-Largest. Well, the headline is more sensationalist than the reality. This number is since 2003. Big whoop.

Credit Cards

It seems that the Fed already clamped down on devious credit card practices at the end of last year. I don't know how I missed this, but the Fed has just released new regulations. Specifically, they have increased consumer protection against "universal default" rate increases, or increasing interest rates after an account is closed, or after transfer to another company or division. The Fed Bank of New York has added a nifty map of card delinquencies to their mortgage map.

No wonder card delinquencies are running away from unemployment. This is a change in the historical trend, and we all know that since all economic models are assward looking, we will have a rich treasure trove of "unexpected" losses.

And there's one other thing I must mention. I credit my friend Rich for this excellent insight: At the same time that people losing their jobs are defaulting, everyone with a job is trying to pay off debt as fast as they can. So CC co's are losing good customers at the same time that their bad customers are costing them more. This will shrink the entire CC pie, and make the bad portion proportionately larger. This trend will also drive delinquency rates higher.

We're Going to Bankruptcy

Chrysler's lenders offered to swap $2.5 billion in unsecured debt for a 40% equity stake in the company. This is a terrible deal, and they know it will be rejected. Bankruptcy, here we come. There's still the possibility that the banks holding this debt will get a last hour government bailout, however. I wouldn't put anything past this administration. The level of incompetence is such an astounding reversal of the campaign. I guess the difference is that Obama looks good in lipstick. Citigroup doesn't.

Last week, creditors rejected a Treasury Department offer to erase the debt for $1 billion cash. The new offer, which would swap 35 percent of the debt for equity, still falls short of the government's restructuring goals calling for Chrysler to retire at least two-thirds of its secured loans. - Yahoo

The two sides are so far apart that bankruptcy is certain. We'll have to see how it turns out. On one hand, washing away of debt is good, but on the other hand, this administration is so incompetent that they'll probably botch this anyway.

Looking in the Wrong Direction

The whole market is focused on bank earnings and stress test results. They're looking in the wrong direction. Geithner says that most banks are well capitalized. Unfortunately, I made a huge error in realizing this before the market did, while not playing this bounce. The banks are "well capitalized" compared to the way they were a year ago. The problem is that all the capital has come from the Fed. The second problem is that they need to keep all that capital on the books to reserve against rapidly rising mortgage, credit card, and commercial real estate loans. The third and largest problem is that most people don't want to borrow. This sets up the Japan deflation scenario. And while fiscal stimulus may help the economy by putting unemployed labor to work, the truth is that the benefits are only as real as the work done. Paying people to dig holes and fill them up again is measured as GDP, but it's a sham. It doesn't improve anyone's standard of living. In econ-speak, the multiplier effect is less than one in most cases. I don't see any major projects really contributing to efficiency, innovation, or making our lives better.

Oh, and by the way, there a hint of news out of China. It seems that the government is just a little worried that the growth in credit is unsustainable. I think they're right. It's not. There won't be any bubble to chase this time. I think they'll move to tighten credit. If I see credit tightening as well as inflation starting to appear, that will be a bearish sign to short Chinese equities. Right now, all the news points to deflation.

In the meantime, I am looking for a re-emergence of the deflation trade we saw yesterday. Inflation has had a good six week run. I'd like to see three weeks of the deflation trade before taking some profits. A sign that it will be time to start getting out will be when the market sells off on good news. That will show that sentiment is getting too bearish and deflationary. Just as until recently, deflationary news has had the contrarian result of equity buying and bond selling, in anticipation of more money printing and bailout shenanigans from the government. I'm pointed in exactly the direction I want to be. I just need the wind to shift.

Market Thoughts

The following post comes from an email I sent my friend Kenny. I'm too lazy to rewrite it, but it covers some of what I've been thinking about lately.

"I've been thinking about this. The market doesn't need fundamentals to rally or go up. Just look at the housing bubble or the dot.com bubble. What it does need is liquidity, monetary expansion, and credit growth.

"Bank credit contracted at a 2% annual rate last month. Who cares what the Fed does. The banks are the ones that touch the real economy, that connect the Fed with the real world.

"So I'm inclined to believe that this is another rally based on false hope. First, it's unsustainable, and second, I don't believe we'll have a V-shaped recovery. Best case scenario is a U.

"Anyway, that's my humble opinion, and I reserve the right to change it at any time. I've been wrong before and will be again. That's the only prediction I'm 100% confident in.

"Anyway, I've been thinking about China and was wondering what you think of when you put these little data bits together:

"lending in march was up 600% over march 2008
exports were down 17% yoy (year over year)
more new cars sold in China in Jan.'09 than in USA
recent copper purchases which pushed copper prices to six month high have all been stockpiled
chinese investors coming to SoCal to buy houses as investment
40,000,000 jobs lost in China last year
money supply growth of +26% for march 2009 (yoy)
commercial real estate implosion has shut down developer IPO boom
20% vacancy rate in office buildings in Beijing
yet there's conflicting data that people are borrowing to buy houses

I didn't tell Kenny (because I value his unbiased opinion), but I think there are signs of a flight into real goods in China. It looks like they may be looking at a nasty bout of severe inflation gathering steam later this year. I am going to keep a sharp eye out for possible confirmations of this, especially interest rates. The other thing I need to do is figure out how to play this. Gold is a possibility.

Stress Tests

The stress tests on the banks are a lot of hooey, and anyone with a brain can see that.

From Yahoo: U.S. Planning to Reveal Data on Health of Top Banks. Oh, Really. Propaganda is more like it. Thank god they're so incompetent they can't get their story straight.

The administration has decided to reveal some sensitive details of the stress tests now being completed after concluding that keeping many of the
findings secret could send investors fleeing from financial institutions rumored to be weakest.

Obama still hasn't figured out that murkiness, lies, manipulations, opacity, economic rent-seeking, and lack of transparency is what got us into this mess and destroyed trust in the system. It won't get us out. Who will believe a stress test that everyone passes, when 80% of them are on life support as we speak?

As a result, indicating which banks are most vulnerable still runs some risk of doing what officials hope to avoid.

Obama wants to have his cake and eat it too. Message to Prez-O, you can't say "this bank is better than that bank, but we're afraid to tell you because you might panic, so just trust me that they're all okay."

Goldman’s action has put pressure on other financial institutions to do the same or risk being judged in far worse shape by investors. The administration feared that details on healthier banks would inevitably leak out, leaving weaker banks exposed to speculation and damaging market rumors, possibly making any further bailouts more costly.

Thank god Goldman has finally done something useful. Maybe the administration will decide that the stress tests are a bad idea and just scrap them.

“The purpose of this program is to prevent panics, not cause them,” said one senior official involved in the stress tests who declined to speak on the record because the extent of the disclosures were still being debated. “And it’s becoming clearer that we and the banks are going to have to explain clearly where each bank falls in the spectrum.”

And we're supposed to believe the banks are okay because Obama will say bank A is less rotten than bank B, but you can eat both of them. Well, thanks, Prez-O! Rotten banks are my favorite meal.

Well, Here We Go

I'm now at my highest level of leverage in the history of my trading, 294% of equity. I would have been at 300%, but I tried to short a 6% position in DIG and it was cancelled twice. So, I'll call Schwab about it, but I'm not going to push it.

Here are my trades:

Buy 9% of SKF @ $59.56.

Sell 24 SDS @ $66.37, -11%. I needed to sell this to make room for SKF.

Short 74 COF @ $19.45.

More Signs of Bullshit!

Rosenberg reports that Kopin Tan, who I used to read when I had time to read Barron's, details statistics that show 84% of the market over the 50 day moving average, as well as financials "running 26% abovetheir 50-day m.a. in a gap we have not seen in 20 years." Let me break out my favorite pop-culture buzzword:

Sustainability.

Also from Rosenberg is news that the OECD leading indicator number fell 0.6 points in March, indicating further global economic contraction. Yet everywhere you hear that the worst is over and the global economy is recovering.

Sustainability.

And talking about sustainability, gasoline demand is now down yoy, after enjoying a short bounce in February. And considering that it went negative last year, we now have two years declining in a row. This trend is long-term now, and extremely entrenched.

Sustainability.

And now I'm looking at SKF, the ultrashort financials. It's at $61. NAV is $88. Is this sentiment...

Sustainable?

Finally, I have one other reason to short: all those traders buying now will sell when the news comes out. Buy the rumor, sell the news. That's the oldest trick in the Wall Street bag. And it always lures the suckers in.

Bullshit!

Screw this. I'm not making any changes to my portfolio. None. If anything, I need to leverage up more.

Everything I've read over the weekend tells me this is a bull trap.

Market down, but bank stocks up, as traders try to just hold on for the earnings announcements. COF is at $18.42. This is ridiculous. That makes the market cap 3.5 times revenue. Revenue? Are you kidding me? This has got to be a joke.

I'm even going to hold onto my bonds. They're just trading with the stock market. I saw numbers on a chart from Mish that showed Goldman Sachs is doing 52% of all program trading for stocks, and 75% of that is for themselves. If only one firm is doing all that, where's the market liquidity? What will Goldman do after they unload all that equity crap on some unsuspecting suckers? They'll buy bonds of course. Also, all the surveys are showing lots of bullish sentiment. Bullshit, I tell you.

My instinct tells me to throw a couple of grenades into the cave instead of running in and trying to hide from the bull stampede.

What about earnings (losses) season? Analysts predict a 38% fall from last year. And the Russell 2000 rallies 36% into that? Pardon me for being skeptical, but I just don't buy it. And if I don't buy it, I should sell it.

Inventories are still too high. Oil is at $53, but VLCC rates are $10K. There's no demand for oil, except as an inflation hedge. Copper is at a 6-month high, but the Baltic Dry Index is back down under 1,500 from its dead-cat-bounce high of 2,400. And if the market thinks Bernanke and Geithner are going to devalue-the-dollar our way out of this mess, then how are emerging markets rallying along with this story?

Nothing I see is sustainable. Take China, for instance. The government has targeted loans of 5 trillion yuan this year. They've already hit that this year, through March. Loans were up 700%, and the money supply +26%. Run to gold, I say. They will get inflation. This should be good for Chinese stocks in term of Yuan, but not in terms of dollars. I was thinking of getting rid of FXI, but China's equity market is at an 8-month high. Bullshit!

Just look at U.S. railroad data: down 20% from last year, according to Railfax. Autos, -44%, even food is down -18%. Coal (those dirty bastards) is only down 8%. Maybe I'll look at them more closely. If the U.S. keeps devaluing the dollar, they can just export all the coal to China, no matter how high the carbon taxes get. I will keep eye out for an opportunity to buy on dips and more carbon tax news.

So, I will read today's news. Next, I will do a leverage/allocation analysis of my portfolio. Finally, I will consider trades up to a 300% total equity position. First thought is short COF to double down. Second thought is short more DIG. Update will follow.

Work to do Next Week

The following passage is from Satyajit Das, emailed to me today:

The excesses of the CDS market are evident in the recent interest in contracts protecting against the default of a sovereign (known as sovereign CDS). For example, the CDS market for sovereign debt is increasingly pricing in increased funding costs for the US. The fee for hedging against
losses on $10 million of Treasuries currently peaked at about 1.00% pa for
10 years (equivalent to $100,000 annually). This is an increase from 0.01% pa ($1,000) in 2007.

The specter of banks, some of whom have needed capital injections and liquidity support from governments to ensure their own survival, offering to insure other market participants against the risk of default of sovereign government (sometimes their own) is surreal.

The unpalatable reality that very few, self interested industry participants are prepared to admit is that much of what passed for financial innovation was specifically designed to conceal risk, obfuscate investors and reduce transparency. The process was entirely deliberate. Efficiency and transparency are not consistent with the high profit margins that are much sought after on Wall Street. Financial products need to be opaque and priced inefficiently to produce excessive profits or economic rents.

The last paragraph I have put in bold print, because it is exactly how the Wall Street works.

As far as my own portfolio goes, I need to do something. I've lost all my profit for the year. First thing to go is the bonds. I'm afraid that the fact that the Fed is buying means that the tide is going against the bonds. Also, with the way central banks around the world are printing, it looks like gold is good. However, if the flight to safety tapers off, then gold may have problems as well. I've got to get rid of SDS. The COF short went against me in an ugly way on Thursday, but COF is a credit card story. They won't really benefit from mark-to-make believe, as they will still have to post losses based on write-offs. I don't think their credit card receivables were marked to market to begin with, but I may be wrong. Maybe I'll even short the ultrashort financials SKF. Ooops... too late. It's down to a 52 wk low of $65 from $303. Missed the boat on that one.

On the other hand, if everything's been going against me, then maybe it's all part of the market rally. But then again, the market rally might go on some more. Well, I've got to pull back on the leverage, and that means that at least the bonds must go.

A Quick Thought

A thought just popped into my head. I was thinking about reflexivity. If there is any inflation, that will just make the economy worse. That's because, if anything, inflation would boost commodity prices. Look at gasoline prices - they're back to $2.39 here in Cali and usage, which had been running slightly higher yoy, has turned negative again.

What's Happening (cont.)

Over the past month, we've had oil up, stocks up, commodities rebounding (a little), emerging markets on a tear, gold selling off, and Treasuries up on good news days, and down on bad news days? How is this possible?

The action in Treasuries shows that the market is expecting deflationary economic news, such as large job losses, to be answered by Ben and Tim with more bailouts and printing. Corporate and other bonds are all still showing high expected default levels. Rail traffic started to rebound, but has since fizzled out again. The Baltic Dry Index has collapsed again, to under 1,500. Here's the rail traffic chart:

In fact, the chart shows that the bounce is probably just seasonal.

Oil, stocks, emerging markets, and commodities up can be explained by a couple possibilities. The most likely ones are fear of inflation and/or devaluation of the U.S. dollar.

So far, I'm happy with my explanation for these different asset classes. But what about gold? Ever since inflation expectations have come back in the past couple of months, gold has been sliding. However, gold did rally strongly when Ben announced his money-printing plan. So, what's driving gold? Inflation, deflation, flight to safety, dollar weakness? Out of this list, the one that seems the easiest to answer is the flight to safety question. Maybe the rush into risky assets over the past couple of months has been greater than dollar weakness for gold. I don't know for sure. However, my instinct tells me that 0% interest rates and money printing must be good for gold.

We now have two questions to answer. One about inflation, and the other about the dollar. Let't try to answer the inflation question first: Will we get inflation soon?

What is the mechanism for inflation? Bank reserves have to be lent out to people who will buy goods or assets. Can that happen? It is possible because bank reserves are enormous right now (over $824 billion, up from $42 billion a year ago). However, that's only half the picture. The other half of the supply story is the demand story. Is there any demand for loans? No. Overall, most people and companies are either paying down debt or saving, not borrowing. So, we are still trapped in what Richard Koo calls a "balance sheet recession" in "The Holy Grail of Macroeconomics." Professor Prag said that whether their reserves are borrowed or not shouldn't matter to banks lending money. However, my suspicion is that the collateral that they've posted for the borrowed reserves is not Treasury bonds. I think a lot of it is default-prone loans. Maybe the banks are worried about their continued ability to borrow against this collateral.

The next question is about the dollar. Will the dollar collapse or strengthen? All the bailouts, fiscal deficits, and money printing are weakening the dollar. However, economic stabilization has propped up the dollar recently, as news was better than expected. Also, the value of the dollar is relative to the rest of the world, which is still doing poorly.

And here's why I read Rosenberg every day.

Did you know that the trailing year P/E ration for the S&P 500 is 100? 100! Maybe stocks are in a bubble... Not really. But when earnings fall 82% and prices only fall 57%, and investor bullishness goes from 18% to 42%, it sounds like the rally is fizzling out.

Bottom line: I'm staying put. In fact, after doing this analysis of my portfolio, I think I am positioned EXACTLY the way I want to be. I will be looking to short more oil via DIG if it hits a new yearly high. I will also look at more gold companies, especially those that aren't tied to copper, which is at a four-month high.

What's Happening

Ouch. The last two days has wiped out almost three months of work. On Thursday everything went against me. On Friday it was mostly even, which sold off tremendously.

What have bonds sold off so much at each of the last four unemployment rate announcements? The only explanation I've heard that makes sense is that the news is so deflationary that it's inflationary. The expectation is for Bernanke and Geithner to pump more money into the system.

Because I was surprised by the last two days, I realize a need to get back in touch with what's happening right now. What's the good of predicting the future without knowing precisely where I am now?

I will spend the coming week trying to figure out exactly what's happening, and then what will continue to happen if current trends persist.

Now I See What They're Doing

Thanks to Mish for this Wall Street Journal article.

The investment community was already suspicious last week when Secretary Timothy Geithner unveiled his plan, announcing that Treasury would select four or five companies as "fund managers" to purchase toxic securities. Given that the whole idea is to create a liquid market for these assets, we'd have thought Treasury would encourage as many players as possible.

But the bigger shock was when Treasury released its application to become a fund manager, a main rule of which is that only firms that already have a minimum of $10 billion in toxic securities under management can apply. Few hedge funds, private equity players or sovereign wealth funds come near this number. The hurdle would bar many who specialize in the very
distressed assets that the Obama Administration is trying to offload from
banks.

Let me throw one other bit of info and connect the dots. Recently, the word on Wall Street has been that Bank of America and Citigroup have been gobbling up toxic MBS and CDO's. However, I think something else is going on. BAC, C, JPM, and GS have $5.2 trillion off balance sheet. I would expect that a few of those off-balance-sheet entities (which have probably already outsourced management to Pimpco or Blackrock) will get Treasury funding for their own assets. This looks to me like the transparency will be nonexistent. As the housing, commercial real estate, and corporate bond markets continue to decline, the losses will be hidden. Short run, this might bump up stocks. In the long run, however, this will further destroy trust in markets as outsiders increasingly realize that the game is rigged.

Mark to Market

The FASB has effectively done away with mark-to-market rules for banks. They have bowed to pressure from Congress. The expectation is that this will allow banks to post large earnings reports for the first quarter.

However, the underlying fundamentals are still shaky. Consumer loan delinquencies just hit a new high. FHA loans are in trouble as well, and Fannie Mae npl's are over 7%. These are all record numbers, and show that the consumer is still in deep distress.

My first thought is that mark to make believe will zombify the banks. Banks will sit with large amounts of non-performing assets but mark them at higher than market prices. The banks will therefore be unable to remove these toxic assets from the balance sheet, as selling them would "discover" a large loss which would need to be booked.

Rosenberg asks who will participate in the PPIP when the banks can just mark everything to 100%? I'm going to predict that they will still use the PPIP, but that it will be surprisingly small, and very toxic. The banks will get rid of only incredibly bad stuff, at outrageous prices. PimpCo (as Mish calls it) manager Bill Gross says PPIP is "win/win/win." Combined with mark to make believe, I think it could turn out to be lose/lose/lose. Taxpayers lose because they're covering all of the losses. Pimpco loses because they have to put up something, and they will greedily bid too much, smelling a no-lose situation, and banks will lose, because they will keep too much on the books at mark to make believe.

And while I'm writing, I have a couple of thoughts on GM. Obama is throwing the Union under the bus. While this is the right move, it may backfire politically. Bankruptcy may be the best option for GM. However, I think Obama will blink and his bluff will be called. A competent administration could come up with a quick prepackaged bankruptcy solution. However, this administration hasn't impressed me, and I think they will butcher the restructuring. It could be long and ugly.

Deflation

The John Hancock tower, Boston's highest skyscraper, was sold after foreclosure for HALF of the 2006 price.

Lee Adler in Radio Free Wall Street says that all the Fed purchases of MBS are most likely coming directly from Fannie and Freddie. "How is this inflationary? Do you think Fannie and Freddie are going to be lending all this money back out?" No, I don't. Which confirms a long-standing suspicion of mine: The Fed is not monetizing so much as transferring the debt. Unless they print enough to cause a massive collapse of the dollar, it won't be enough to stop deflation. If they print enough to inflate, then we will have the side effect of a dollar collapse. Right now, I'm still siding with the deflation argument.

CDOs Becoming ‘Unmanageable’ as Trading Costs Surge, Fitch Says. CDO's are managed entities that buy and sell bonds and CDS. The crux of the article is that there's no liquidity left in the CDS market. The bid/ask spreads have become wide enough to drive a semi through. Since the bond market has been joined at the hip to the CDS market, I expect that problems in the CDS market signal upcoming problems in the bond market. For example, if CDO's can't hedge, will they dump their bonds? Will they hedge another way, perhaps by buying puts or shorting stocks? Who knows, except that it will most likely be messy.

Mexico Government Plans to Seek $47 Billion IMF Credit Line. This is not a good sign for emerging markets. It looks like the fundamentals have been deteriorating rapidly since the beginning of this year. Does the IMF even have $47 billion left, or will they have to sell more of their gold?