R.I.P.

by Larry Levin

The questions and concerns over the fate of Lehman Brothers have come to an end. You won't be able to trade its symbol, LEH, any more. LEH has filed for bankruptcy, ending a storied 158 successful years in a blaze of glory. Fear and greed are powerful emotions that are amplified on Wall Street, and the management of LEH has succumbed to its greed via mortgage lending and Frankenstein packaged securities. R.I.P. Lehman Brothers.

But Lehman Brothers wasn't the only company to go down today. Merrill Lynch is also gone. Although MER did not file for bankruptcy, it was forced to allow a buyout by the Bank of America. In my opinion, the counterparty risk of MER to LEH was too large; if it wasn't purchased, Merrill Lynch would have also gone bankrupt on its own.

That's probably a large enough story for the day, but it doesn't end there. AIG, the largest insurer in the world, is a heartbeat or two away from bankruptcy. Considering AIG's massive One TRILLION dollar balance sheet, this firm's demise would be a bigger problem than Lehman Brothers.

Today's 504-point Dow loss was the worst down day since Sept 17th, 2001; the first day the market traded after it was closed due to 9/11.

I'm sorry, but it's getting worse as I type this. Washington Mutual, the largest thrift bank in the United States , was just downgraded by S&P. It downgraded the ratings of Washington Mutual and Washington Mutual Bank because of increased market turmoil. S&P cut the counterparty credit rating on Washington Mutual Inc. to BB-/B from BBB-/A-3, and the rating on Washington Mutual Bank to BBB-/A-3 from BBB/A-2. The outlook is negative. Increasing market turmoil and the related impact from managing its concentrated mortgage franchise in this troubled housing and credit cycle led to the downgrade of WAMU, said Victoria Wagner, an S&P credit analyst, in a statement. The company's weak equity pricing in the markets is also a concern, and it increasingly appears that market conditions could overtake credit fundamentals and leave the company with greatly diminished financial flexibility.

Reactions to LEH:

It's a financial crisis, but we'll get through it, commented David Henderson of Raven Securities, an independent broker. Hopefully [Federal Reserve Chairman Ben] Bernanke will have some soothing words for the market this week.

These supposedly sophisticated suits -- there isn't a commodity trader on the floor who would do what they did. Every trader knows it isn't what you make, it's what you don't lose, said Lenny Pomerantz, a 30-year veteran of the Chicago Mercantile Exchange and Board of Trade. I am appalled that major financial institutions that are theoretically advising other investors and institutions on what to do to be financially stable would put themselves at such enormous risk by leveraging anywhere from 30 to 35 times, he continued. It is insanity.

When they leverage their capital at 29-to-1, as an accountant I just can't fathom that, said Michael Weisberg, an independent accountant who keeps the books and does the taxes for numerous CME traders and firms. They didn't need a perfect storm to put them under, just a storm.

For Russell Wasendorf, CEO of Chicago-based futures, options and forex firm PFGBest.com, it comes down to a lack of transparency and communication. When you have these mammoth investment banks taking positions that they can't even evaluate, you have a very big problem in our financial services industry. The regulatory agencies have all given the large financial institutions an almost free rein, [yet] the smaller firms are more heavily scrutinized [even though] they are far more transparent.

Of course there were indirect losers in the general market today, but there were also direct losers who were holding Lehman Brothers bonds. The man who cajoled the Federal Government to rescue FNM and FRE, Bill Gross of PIMCO, took a big hit today. Many pundits were aghast at his audacity to demand a bailout for the GSE's, because everyone knew what he was really asking for: a bailout of his massive position of FNM and FRE bonds. Today, however, the government decided not to bail out PIMCO again via LEH. Bill Gross went down with the ship.

In addition to PIMCO were Vanguard Group Inc. and Franklin Advisers Inc. that will face losses of at least $86 billion stemming from the collapse of Lehman Brothers Holdings Inc., the biggest bankruptcy in history.

The Federal Reserve is acting more and more like a pawn shop. The Fed is allowing almost anything to be put up for collateral these days, but its money used to be reserved only for AAA rated bonds. It widened the set of assets eligible as collateral for loans of Treasuries to include all investment grade paper, and raised the size of these Treasury loans to $200bn. The Fed also suspended rules that prohibit banks from using your deposits to fund their investment banking subsidiaries. And that investment banking has been doing great lately - right? One of the biggest changes the Fed made, however, was to accept equities as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history.

The Fed is also allowing banks to extend funds to their brokerage affiliates, which is in violation of Federal Reserve Act Section 23A. Section 23A of the Federal Reserve Act, originally enacted as part of the Banking Act of 1933, is designed to prevent the misuse of a bank's resources through non-arm's-length transactions with its affiliates and to limit the ability of a bank to transfer its federal subsidy to its affiliates.

What's clear now is #1, the Fed doesn't care what the law is, it will do whatever it wants and #2, the Federal Reserve is effectively now LONG the stock market. How are you going to feel when the market drags the Fed's balance sheet down with it? But it doesn't end with the Federal Reserve. Oh no; they have a sweet deal. What's worse is that they don't eat their own losses if there are any - they're yours! That's because The Federal Reserve Act says that the profits (or losses) from The Fed flow through to the Treasury (after operating expenses) which means that now, suddenly The Federal Government (The U.S.S.A.) is potentially directly exposed to losses in the stock market. This is bad folks, potentially real bad.

Real Time Trading Signals*for

Trade Date: 9/15/08

E-Mini S&P Trades*
(before fees and commissions):

1) OTF buy @ 10:30am at 1225.25 = b/e (1 lot)

2) Today was virtually untradeable.

3) Algorithm positions (2)...combined total...-3.50

ZB (30 Year Bond) Trades*
(before fees and commissions):

1) No bond trades were filled today.


Sign up as an AvidTrader Member to receive "The Technician" Value Area's each day. The market then has an 80% chance of filling the Value Area. Many traders familiar with the Value Area and the techniques that go along with it use it to help them decide what trades to do each day. Join and see how this technique can help you trade more successfully!