Fed Plans Not Going So Smoothly; Harrisburg, PA on the Edge

Since the Federal Reserve announced last Wednesday that they would be injecting $600-900 billion into the monetary system through outright purchases of Treasury bond issuance, the cacophony of protest and derision has been boisterous and unrelenting. Chairman Ben Bernanke's purposeful nuking of the value of the world's reserve currency, the US Dollar, has raised eyebrows and voices from Shanghai to Sao Paulo as global finance leaders attempt to adjust their currencies to meet the expected influx of freshly-printed greenbacks.

Along with complaints from the global financial community, voices inside the United States have also weighed in, mostly condemning the action as unneeded, unwanted and eventually, inflationary.

What's worse, it doesn't seem to be working very well, as evidenced by today's 30-year bond auction, which saw lowered levels of participation and the highest yield in five months, exactly the opposite of what the liquidity tsunami was supposed to accomplish.

It's likely too early to tell, as the Fed has only today set down their Tentative Outright Treasury Operation Schedule, or TOTO, which as we all know, was the name of Dorothy's little dog in the movie, "The Wizard of Oz," an appropriate, if not slightly cynical metaphor for Mr. Bernanke standing behind a curtain pulling the levels and strings of the global economy.

Interested investors may want to print out the Fed's schedule as it should provide some guidance into which days would be better to buy or sell (warning: the Fed does not want you to sell) stocks. Those days with "operations" should be the prime selling days, and those without, opportunities to buy as the market will, no doubt, be on hold or falling. So much for free, fair and open markets. The Fed's interventionist policies have made Wall Street even more of a casino than it already was, and now they're using stocked decks and loaded die.

Things got off to another bad start for Bennie and his buddies this morning, as stocks backslid right out of the open, with the Dow falling 91 points, to its low of the day, shortly after 10:00 am. After that, however, with the banks holding firmly to the silver shorts which torpedoed a wicked rally in the precious metals late yesterday, it was once again off to the races, though the markets' pace more resembled that of a snail than a thoroughbred.

After two days of losses, the markets shrugged off middling new unemployment claims at 435,000 (below estimates, but sure to be revised higher next week), and, having convinced the sixteen suckers still trading via their e-trade accounts that the direction was negative, began the process of fleecing the sheep, all led to slaughter by the Fed-Wall Street money crunching machine.

Dow 11,357.04, +10.29 (0.09%)
NASDAQ 2,578.78, +15.80 (0.62%)
S&P 500 1,218.71, +5.31 (0.44%)
NYSE Composite 7,747.46, +45.15 (0.59%)
NASDAQ Volume 2,023,686,125
NYSE Volume 5,268,140,500

Advancing issues turned the tide on decliners, 4158-2329. New highs numbered only 362, a notable change from the kinds of numbers reported over the past three weeks. Only 49 stocks made new lows. Volume was right about average on a day in which the dollar was up against most other currencies.

So, the Fed may be getting what it wants when it turns on the money spigot on Friday with the first of 18 monetary injections. They'll keep at it every day except the days immediately before and after Thanksgiving, for a total of about $105 billion, through December 9. If that doesn't get stocks flying higher than a redneck on meth, nothing will, and that's just the Fed's point, to make asset values climb, staving off the dastardly deflation, a condition that would suit most Americans just fine. A big THANK YOU VERY MUCH to Mr. Bernanke from the middle class.

Most commodity prices are already much higher than they were just two months ago, when Bernanke first began to whisper loudly about the now-imminent liquidity push. Cotton, corn, wheat and almost all foodstuffs have been on a tear, so much so that the exchanges have been slapping on tighter margin requirements for many.

Crude oil was up $1.09 on the day, to a 2010 high of $87.81. Just in time for Christmas, the Fed's policies are about to send gas prices through the roof. Thanks again, Mr. Ben! After yesterday's drubbing, gold gained $10.70, to $1403.40 at last print. Silver also caught a bid, trading at $27.14, up 19 cents on the day.

Meanwhile in the aftermath of mortgage insurer Ambac's bankruptcy filing Monday (and delisting as of today),the city of Harrisburg, PA, the state capitol, hired the law firm of Cravath, Swaine & Moore to advise on a potential municipal bankruptcy, which has been rumored for many months. with the fall of Ambac, the dominoes may begin tumbling, first among other mortgage insurers, then to municipalities and into credit default swaps mostly in the hands of the nation's largest banks.

Considering the timing of the Fed's dramatic money creation scheme, might these funds be nothing more than a backdoor backstop to the banks again? They certainly were aware of Ambac's condition and that of the handful of other illiquid mortgage insurers. If this were the case, then all bets are off concerning market gains, as the money will never see the light of day. It will be parceled out among the nation's greatest criminals to cover their corrosive and rapidly depreciating swaps and guarantees between each other.

While Ambac's portfolio may be only a few billion short, the forward effect is to cause other defaults along the chain, and once the genie gets out of the unregulated CDS bottle, there's likely no putting her back in. The cascading effect of illiquid assets turning enterprises wholly insolvent could happen within split seconds, without warning, and it's already apparent that the band-aids applied to the insolvent banks thus far have not proved remedial.

Higher interest rates on Treasuries going forward will be a sure sign that the financial structure is about to topple, with over $600 TRILLION of notional exposure ready to come crashing down. This is the conditions under which we watch our financial markets these final days of 2010. If Bernanke's plan does not cause stocks to rise, interest rates to fall and general inflation (bad enough), it's a safe bet that financial reckoning day may come sooner rather than later.

Tracing out the scenario, the Fed would probably not allow everything to simply collapse in a heap. After a few days of severe declines in the stock markets, highlighted by drops in financial stocks, the president would likely call a bank holiday stretching anywhere from a week to a month in an effort toward calmness. Unfortunately, the effect of that would be wide-eyed panic, as most people would be without cash and maybe denied access to credit cards as well.

After that, who knows? Emergency powers? Martial law? A complete overhaul of the Fed and Treasury? The ripples would be worldwide.

It's the nightmare scenario, but in the current climate, the possibility of a massive failure is possible and palpable.