The End Game Approaches

We're about done here folks.

By "done", I mean done with the government's ability to screw around with markets, game the outcome and hide the sausage, if you will, at least to any sort of positive effect.

Today we heard from The Fed that their threatened program to start buying the long end of the Treasury curve will begin tomorrow:

That was, without a doubt, prompted by this:

Notice the highlighted area.

The big drop (this is the 10 year Treasury rate) was when Ben made his announcement.  But over the last few days the rate has crept back upward, erasing about half of the drop.  While this is expected behavior (higher rates) when the stock market is on a tear (like yesterday) as people sell Treasuries to buy stocks, both Friday and today the market was down - but the Treasury market was also being sold.

That's not supposed to happen, but it did.  It denotes selling - on a day when people should have been moving into Treasuries, not out of them.  This compelled Ben to stomp on this trend lest he be seen as a toothless tiger, and that just won't do for Sir FedsALot.

Who's selling into Ben's "expectations" and producing this?  Good question.  I don't know, but Ben does - he has real-time Fedwire information that he doesn't release. I'm willing to bet it is NOT domestic holders, and is likely foreigners - including perhaps, central banks and their minions (Heeeeelllloooo China!)

This "acceleration" is a major problem, as it appears that Ben is losing control - rapidly.  If foreigners are selling into the market we are literally nothing more than market recognition away from Armageddon in the bond market.

If you recall it was not long ago that I wrote a couple of very "Apocalyptic" Tickers. 

Do not for a second believe that the fact that the stock market rallied has defused the underlying problem.  It has not.

The underlying problem is not the stock market.  It is the credit (bond) market - that is, the underlying reality that there is too much debt out there in relationship to GDP, it cannot all be serviced, and as the economy contracts it feeds a vicious spiral where a default produces unemployment which drops both spendable income (and thus income available debt service) AND tax revenues, giving it to the credit market in all orifices.  This is "deflationary destruction" and it is inevitable when government pushes off the normal cyclical cleaning out that recessions do, as our government has.

President Obama thinks he can spend $3.6 trillion this coming fiscal year (an increase of some $600 billion dollars!) while tax revenues are collapsing.  Available reports are showing anywhere from 15-25% decreases in tax revenues, depending on exactly where and what you're looking at, and the available Federal data is deteriorating rapidly.

If the bond market sells into Ben's bid for the long end then rates will immediately start to climb once Ben finishes performing his "operations".

This will force him to do it again, and again, and again, until he owns ALL of the long Treasuries.

Don't think for a minute he will let that "printed" money out into the economy.  He can't, because if the market detects that it will ramp Treasury yields (and all other yields) even harder, making his "buying" of Treasuries a self-defeating act.  Instead he will force those "excess reserves" to go where the rest have gone - into The Fed vault.

The problem with this is that once he owns all the long-term Treasuries he can't sell them without collapsing the price, and now the solvency of our government rests with the ability to roll over short-end debt.  See, that which The Fed buys and Treasury sells is a funding circle-jerk, effectively removed from the float and thus the government's funding base.

Anyone care to take the bet on whether the selling pressure will move down the curve? 

If it happens, we're done - and neither Bernanke or Obama has the ability to prevent it.

President Obama has apparently summoned the big bank Presidents to the White House this Friday, for what is certain to be a major arm-twisting.

Attendees are expected to include Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Citigroup Inc.

I'm sure.  What will almost certainly be discussed is some "persuasion" related to the new PPIP, or as I might dub it, "Pee Pee In the Pot", for that's about the likely outcome.  I suspect that our Dear President will "make clear" that Geithner and this plan cannot fail, because if Congressional reaction today is any guide, there is no second act.

After all, Turbo Timmy said there was no backup plan right here:

That's a problem, you see, because it won't work, and when it fails Turbo is going to get fed to the lions.  It is time to start making tickmarks on your bedpost for every day Timmy keeps his job (at best) from here, in my view; if you come to Congress with a speech like that, then fail, you're done.

There are fleeting signs of improvement in some credit markets ahead of this.  Most notably the CMBX, which came in for the second day in a row in a significant way in the "AAA" tranche, as shown right here:

That improvement, of course, is based on the theory that the PPIP will buy up a good part of this and thus put a bid floor under these assets.  Proof is found in the fact that the lower tranches, which would not be eligible, have barely moved. That is, the spread contraction you see there is predicated on the plan working.

If it doesn't....

What's worse is how the banks are marking this stuff at present.  Have a look-see here; this started circulating around this afternoon (click for a popup of a larger copy):

If this is real then these banks and other institutions are living in an absolute dreamworld.  There is absolutely no chance that Construction loans, for example, can reasonably be carried at 100 cents or even at 97, as is being done virtually everywhere.  Hell, even Bank America is only discounting by a nickel.  Wells Fargo thinks they're going to get 87 cents held to maturity and Key 98?  IMHO they're nuts and from my point of view not only should the executives be in jail but the auditors should be too.

Here's a dose of reality for you folks.

I am confident, in the 90th percentile, that none of this is going to work.

All of these clowns still believe you can treat a drunk with a case of whiskey. 

We still have trillions of credit in the system that has to be defaulted or cleaned, The Fed can't print out of that without destroying the bond and currency markets and they know it, and even if they did, its the same as defaulting the debt in that the valuation hit is identical. 

That is, even if they were willing to destroy the only thing they have to sell (and they're not) printing to that degree would do the same thing as defaulting the debt in terms of the actual purchasing power impact for the banks and government. This is a default by another name, and does the same thing to the people holding the debt who get paid in trashed dollars as does defaulting on them.

Meanwhile the banks appear to still think this trash is all "money good."

No amount of "easy money" will fix the system when you get to this point.  The law of exponents makes that impossible.  You can hope to get organic growth in the economy going again, but that's not going to happen either, except in the very short term by "filling in the debt cracks" - a strategy that looks nice on paper but fails in the real world.

I see a possibility of of this scheme meeting with success, but it requires absolutely everything to go right, and the odds of that happening are low enough that I discount the scenario.  I must therefore prepare for something truly ugly, whether I want to or not.

What I believe we will see instead is similar to what we got after 1929; there was a short-lived rebound in the economy and markets, and it looked like we were going to come out of it with "just" a recession.

But the debt hadn't been cleaned from the system as they tried to prevent people from having to take the loss, and as a consequence able borrowers and able expansion of credit dried up, along with able providers.  The "second leg down" was the real bone-crusher, and it will be this time as well.

I believe we will not see "666" again on the SPX this month or next, and while there will be ups and downs in the market, the general direction will be positive for the next month or so.

But by the summer into the fall, when employment hasn't materially turned around and both spending and tax receipts have continued to fall, reality will set in.

Congress is increasingly becoming aware that all of these "fixes" thus far since the summer of 2007 have been nothing more than a scam and a fraud - a ripoff of the Taxpayer and Treasury in a vain and vile attempt to keep those who committed willful blindness or even fraud from having to bear the pain of their sins.  The American people are becoming increasingly aware as well.

Come summer and fall there will be no political capital available to play games, either in the American public or the Congress.  If Congress tries to appease the Wall Street pressure groups again, they will run the risk of having the Capitol put under siege by angry citizens demanding 535 immediate resignations - or worse. 

I further believe the American Public is getting damn close to the breaking point.  The tone among people I interact with daily and among what I see online and off is shifting from hope and faith to anger with each passing day, and each revelation of another 10 billion here or there that get funneled through some conduit to an offshore bank just raises the pressure another notch.  The people now want blood, and I believe the minimum they will accept are thousands of indictments, prosecutions and prison sentences along with forfeiture of these men and women's fortunes.  Madoff didn't satisfy, it further enraged. 

The government is running a very real risk, as I have noted in the past, of being declared by the people as "the felon" instead of "the cop", and if that happens I don't want to be anywhere near the angry mob that makes that decision.

So for now, enjoy the general upward to sideways trend in the market, but prepare.  While the spring may bring hope and summer one of discontent, I believe there is a very high probability that come fall, the peak of Hurricane Season, a very ill wind will be blowing both in New York and Washington DC.