The biggest news item last Friday and all weekend has been the collapse of Bear Stearns after their stock value got sliced in half.

Had it not been for the intervention of the Fed via JP Morgan, the markets would have tanked big time. To me, it was a clear case of a company being to big to let go because of the ramifications for all Wall Street firms. It’s not that Bear Stearns is the biggest player on Wall Street; they are big enough via their complex derivative trading schemes and tied in with many other investment banking firms that one failure would have had devastating effects on the other players as well.

I talked about this interconnectivity in “Counter Party Risk,” describing how leverage and derivatives have created a worldwide spider web tying international banks together in a scheme that will only hold if everyone sticks to their end of the bargain. If one fails, the domino effect can’t be calculated until the last domino has fallen since no one knows exactly who is tied into this web with how much capital or leverage. The Fed will be absolutely helpless because of the vast amounts of money involved.

I recently posted that derivative contracts are valued worldwide around $50 trillion. I guess I was wrong as recent reports put that number closer to $500 trillion. Mish over at Economic Trend Analysis made reference to the following chart from the Office of the Comptroller regarding derivative contracts (the comments are his, not mine):

click on chart to enlarge

These are mind boggling numbers and, based on the fact that all of these holdings are intertwined, one failure will cause many others to follow. Therefore it is simply in the best interest of the Fed and Wall Street in general, or the government for that matter, not to let anyone collapse.

However, given the enormous numbers involved, I have no idea what kind of a lifeline needs to be thrown to pull the participants out of this cesspool of worthless securities. But I do know that this environment can be extremely hazardous to your financial health if you haven’t sold your domestic and international equity funds. Events could now unfold at warp speed.

Whenever financial markets slide into bear market territory, there are bound to be numerous articles appearing online or in print touting the “benefits” of staying put with your investments. It is as if nothing has been learned from the all too recent bear market of 2000-2003.

MarketWatch featured such a story titled “Grit and bear it.” Let’s look at some of the ideas:

Wall Street giant Bear Stearns is severely wounded and the natural instinct for many investors is to run, not just from financial-services stocks but from the entire market.

“It’s a symptom of the entire financial-services sector,” said Michael Cuggino, manager of the Permanent Portfolio Fund. “I don’t think that ultimately Bear Stearns will be the only one to have this sort of thing occur. I don’t think they’re the only firm that can experience such liquidity crises.”

I just have to shake my head when reading such nonsense. Don’t these people realize that we are in bear market territory and may very well be witnessing the unwinding of the largest credit bubble ever created? Bear Stearns almost collapsed on Friday had it not been for a last minute Fed bailout. Without it, the ramifications for Wall Street might have been devastating. Next time, the Fed or any other while knight might not step in and then what?

These jokers in the above article are touting a model portfolio and talking about a bottom in the market. These stories are very similar to those I remember from late 2000.

My point about this ranting is simply that no one can foresee the future. Prices and price direction are the only things that are real because they can be measured. And right now, price direction points south meaning that if we continue in that direction, bullish portfolios will once again be annihilated.

I prefer reading qualified information from individuals with no axe to grind. I suggest you do the same and stay away from the nauseous repetitiveness of financial reality TV shows. While this may be great entertainment, be aware that’s all it is. My personal tolerance is about 5 minutes when watching botox enhanced individuals attempting to tell me what the market will do in the future or which mutual fund is a great buy.

Keep the big picture in mind; right now, the time is to be conservative and mostly on the sidelines.

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.”