Not only have investments in Subprime slime wreaked havoc with banks and hedge funds, a ridiculous amount of leverage has made the problem far worse and added to the rather sudden demise of various institutions. The latest victim was Carlyle Capital, which went from recently owning some $22 billion in mortgage securities to now expecting that lenders will seize its assets.

Lenders are as much to blame for having to take possible losses since they provided Carlyle Capital with $20 for every dollar of initial capital. The mathematical formula is very simple:

Excessive Leverage + Subprime Investments = Collapse

I am sure that we will not have heard the last of this hedge fund debacle and there will be more to come despite S & P’s assurance that the “End of Subprime mortgage write-downs may be in sight.”

The operative word here is “may.” Yeah right, tip of the iceberg is more like it. Bear Stearns appears to be the next victim. What about the upcoming difficulties with Alt-A and Pay Option ARM mortgages, which are due to reset by the millions over the next few years. I hope I am wrong, but I am pretty sure that most financial institutions have not yet disclosed all of their potential write-downs.

On a positive subject, reader Bradley submitted the latest information on the federal tax rebate:

President George Bush said each one of us would get a $600.00 tax rebate. It was previously slated to be $800.00, but they dropped it to a $600.00 tax rebate because of various budget problems.

If we spend it on gasoline it will all go to the Arabs—and none of these scenarios will help the American economy.

We need to keep that money here in America—so the only way to keep it here at home is to drink beer, gamble, or spend it on prostitution. Currently it seems that these are the only businesses still left in the U.S.

To that I am pleased to add that (former) NY Governor Spitzer is apparently leading this charge on the highest level to support these efforts.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Huge swings in the markets and an emergency rescue funding plan of Bear Stearns kept traders on edge.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains now -1.22% below its long-term trend line (red), which means we are in bear market territory.



The international index dropped to -10.06% below its own trend line, keeping us in a sell mode for that arena as well.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Wall Street’s high about the Fed’s $200 billion intervention was replaced by more rational thinking in that some of the main concerns like weak housing and continued credit concerns had not been really resolved but still remain a serious problem to be dealt with.

The markets retreated and received no support to the upside with oil prices topping $110/barrel. While the Fed’s decision most likely was the right one, it will not solve the underlying problem that many banks and financial institutions are drowning in a sea of ever declining mortgage assets that simply can’t be liquidated.

On that subject, a reader commented to my Tuesday post “Feeding The Bears” as follows:

The Fed is merely attempting to unlock a jammed market and we can only hope that they will succeed. The dimensions of the problems in the financial market are to a larger measure a result of an accounting convention known as mark to market which makes only sense in a highly liquid and efficient market. Once a market jams, mark to market account perpetuates a downward spiral we are seeing today.

While the reader is correct, I have to add that lack of marking assets to market via off balance sheet entries as well as “mark to model” or “mark to fantasy” accounting gimmicks has greatly accelerated the credit crisis most institutions are currently in. Banks brought the current problem on themselves by not marking to market earlier on as is customary in the financial industry.

Whenever a company decides to avoid reality, they can use the available (legal) tools to do so. This would be no different than if I as an investment advisor were to contact my custodian and ask to mark my client’s assets to my model, because we had a bad month, and I don’t want clients to see that at this time. Yeah right, for me (and my custodian) to do so is illegal—if it weren’t, I’m sure that would go over real well with my clients, if there were any left.

Allowing financial assets not to be marked to market contributes to abuse and the hiding of losses. This may work for a company and allow it to stay afloat temporarily but, during the unwinding of the largest credit/real estate bubble the world has ever seen, it will merely postpone the inevitable.

Euphoria returned to Wall Street yesterday as the Fed, in what I consider a desperate move to curtail the financial meltdown, let banks borrow money from the Fed using questionable assets as collateral.

The whole idea seems odd to me since banks were not able to liquidate their Subprime holdings in the open market place (no bidders) but now found a willing and able party (the Fed) to cough up some $200 billion in real cash. In other words, the Fed offered real money in return for illiquid, not sellable Subprime loans.

Yes, the assets pledged for the loans had to be AAA rated, but ratings these days seem to be questionable if not worthless. Given the fact that there are some $11 trillion in mortgages outstanding, this intervention does not appear meaningful at all. However, that did not matter to Wall Street, what mattered was the perceived solution to a problem. Up and up we went, with the Dow gaining over 400 points with most gains coming from short covering.

While that is an impressive gain for a day by any standard, it merely recovers the losses of the past 5 days or so. One day (or 2 for that matter) does not make a new trend although judging by some of the emails I received you’d think that happy days are here again. Let’s look at the major trends in the domestic and international market as represented by our Trend Tracking Indexes (TTIs):

Domestic TTI: -0.82%
International TTI: -8.68%

While anything is possible, there is no way that I would enter this market on the long side at this time. We’re still in bear market territory and, until the numbers change, I will hold my positions as stated. Day to day events should never be a basis for sound long-term investment decisions and, as always, I will let the market tell me when it’s time to make the next move.

For more on why interventions don’t work, see the WSJ blurb called “The Fed’s Hallelujah Rally.”

Al Thomas, author of “If it doesn’t go up, don’t buy it,” made these market observations titled “Humpty Dumpty Market” in his last weekly update:

….and all the King’s men could not put him back together again.

A smart investor will not let his retirement portfolio become one of the Humpty Dumpty broken pieces. He will sell now.

Whether you agree with Al or not, he sure calls it as it is. My personal view is very much the same and, despite the lessons taught by the last bear market, many investors are on track to repeat the same mistakes. How do I know? Based on the e-mails I have received I have to wonder if some readers of my newsletter simply view it as another source of entertainment, like CNBC, to be listened to and not acted upon.

Here’s an amazing statistic as reported in “B of A says merger on despite Countrywide woes:”

Countrywide said last week that 90-day delinquency rates in its $28.42 billion adjustable rate mortgage portfolio climbed more than 900% from a year earlier, up to 5.4% from 0.6% during the same period last year.

The lender also warned that 71% of its ARM borrowers are making only the minimum payment allowed — and that 80% of those loans had not required borrowers to verify their income prior to receiving funding.
[emphasis added]

An increase in delinquency rates of 900%? OK, I can see how this can happen given the unwinding of the credit and housing bubble. I can also understand that these numbers can/will get worse. What I do not get is the fact that B of A is continuing with its acquisition of Countrywide after having squandered a few billion dollars already:

Bank of America announced in January that it would acquire the rapidly devaluing thrift in a $4 billion deal to be completed in the third quarter of 2008.

The lender lost $422 million in the last three months of 2007, despite CEO Angelo Mozilo’s pledged to return the company to profitability by the end of January.

I understand that B of A is trying to buy an undervalued asset, but what if that asset no longer exists or becomes worthless by the time the housing slump ends? Those odds seem pretty high to me, so if you know of any reason why this purchase is a financially sound decision for B of A, please share it with me.