Mark to Market+Bi-polar

So to expand on my last post. What allowed lehman to get to a 30 to 1 leverage? Banks are using a mandated mark to market system, where daily market price determines the value of the bank assets. For these banks their assets are bond/equity/derivative portfolio's. At the end of every trading day the banks risk managers would determine the current market value of all thier assets (and thier creditors assets for that matter) and assess risk/leverage based on the asset values relative to liabilities. When the value of all there assets were inflated they were sitting back and say "we're plush, let's take on more risk." When times are good asset values increase (preceived risk decreases) allowing the bank to buy more assets, inflating asset prices more, allowing other banks to buy more assets, inflating asset prices, rinse wash repeat... It becomes a perpetual motion machine, allowing asset prices to expand expotentially... scary thing about this system is that it can cause just as much irrational selling. It enables the market to get to extremes of optimism and fear (bipolar) regardless of actual asset value.

So think of the fed as the markets head shrink. Dr FED is currently perscribing some anti-psychotics to the market via liquidity overnight and bailouts during the day (roughly 200 billion for Fannie and freddy, 80 for AIG, 28 at bear). And some bedrest via suspension of the short sale rule. The markets can longer sell short the financials (let's now blame the hedge funds)...

Aside: I feel for the hedge funds, their always cast as traitors to the hard working american's pension funds. But they have a vital purpose, they are wolves that sort out the weak prey from the strong (companies that are mismanaged or obsolete) allowing cash to flow more easily to more effective avenues of growth. People respond to what they see and hear- it's far to easy to blame a greedy hedge fund when you hear your stock price is slashed or see a FOX news showing former employees leaving the corporate headquaters carrying boxes. What is impossible to see (and I'll agree quantif) is the new jobs it creates and the positive impact it might have in all other stocks a year from now. However the wolve idea can only work in a truely free market system where the pairies have no fences. The current environment put the wolves in the pen with the financial sheep.... so the Govie had to put muzzles on the them asap (no short sales). Don't fault the hedge fund because Lehman and AIG (aka a Hedge fund posing as an insurance company) are fat overstuffed greedy turkeys. Maybe some blood on the wall would occasionally remind the governance and the investors that is not always about immediate returns. But's too late for that because if we let the wolve loose everyone might drowned in a pubble of blood.

How is the market reacting? - FEAR... The govie has taking the position that we have to get out ahead of the Markets. The Scariest point is when the 3 month treasury rates went negative (this means investors for a very short period of time were willing to pay the treasury to hold their money) and then some money market funds went negitive causing over 50% withdrawls. These are considered the safest form of investment around this could almost be looked at like a run on the bank...

The above indicates fear of deflation... There is simply not enough money to go around to pay off every ones debts. So whats the fed doing to combat deflation, inflation. Lets start the printing presses. Our goverment is transferring bad assets from corporations to government and paying for by debasing the dollar through printing barrells of dollars.

I got to be honest, this is about the point where I am still searching for answer to the next cause and effect. I'm am not sure if current environment leads to a inflationally recession, a defaultionary depression, any combination of the two, or just a sideways moving lacklustor economy. The only thing I'm sure of is it does not lead to a strong growth (that is not to say assets might be undervalued at some point.)

So Lets call it an inflationary recession caused by Government stimulation. Who pays?- every taxpayer. Every dollar you own will become less valuable. How to profit?- Hard tangible assets like gold, oil, and commodities, like wheat and grain, will do well.

This is scary its like a fireman fighting a house fire with flame thrower (say that three times fast). I believe it safe to say, It was inflationary practices (decreasing rates) meant to created growth which got us here. The FED after September 11th reduced rates to fund growth. The cheap money did not fund sustainible long term growth it supported subprime mortgages and peoples overall debt bingeing none of which had any economic value.

Maybe the fed should have just let the free market do it's thing. Maybe interest rates where high because risk was high. Maybe this country's economy was not ready to grow... maybe it needed time to apply the technology and innovation created during the 98 bubble in such a way that real economic value could be realized and then expanded upon.

I hope you could see how additional bingeing could just lead to deflation where the opposite occurs and the value of the dollar increases as there are not enough dollars to go around. The safest place to be?- cash under your bed spread.

Whoa let's not get all pesimistic- the world looks at U.S. (the perverbial us) as AIG , not too big to fail, but too important to Fail. The market goes sideways until growth catches up...
Only thing I have here is buy a covercall ETF (the simultanious owning of a stock and sale of a call option, it basically allows you to collect on option premiums with very little risk). Covercalls out preforms generally in every market other then a strong bull market.

There is always overaction, I am certainly not well versed in the fundamentals. I do enjoy the technical analysis of the markets though. Technicals tell me that this could get alot worst before it gets better. However in the past when this type of pessimism permiates through the masses and everyone tells you not to buy, then that is the best time to buy. At least that is what the greatest investors of all time have done... However I don't think mainstreet has really realised yet how much this could kick them in the head. I think mass's are saying don't buy, but secretly they are telling themselves, "give it two years, the markets always come back."