Market Manipulators

If you look at the last two posts you may be confused. A week ago I argued things aren't as bad as the press is making them out to be -- earlier today I posted a proposed transaction designed to capture extreme market movements (up and down). What, you may ask yourself, has happened in the meantime?

The government got involved.

I don't mean namby-pamby involvement like taking over Fannie Mae & Freddie Mac and bailing out AIG. We're talking some serious money here -- $700 billion -- and an even more serious dismantling of capitalism.

Everyone's a libertarian until their neighbor puts something ugly in the front yard or until they start losing money. The current 'capitalists' in the government have proven to be no exception. In a startling move, Treasury Secretary Paulson announced a $700 billion bailout plan and beseeched Congress to pass it within a week. The plan: "Let me (Paulson) buy whatever I want to keep the markets going."

A little perspective here: $700 billion is bigger than the estimated cost of the Iraq War to date. The annual estimated cost to provide health care for the uninsured is $100 billion.

It gets better.

In the original plan, there was no oversight and no review -- the Secretary could buy whatever he wanted -- bonds, mortgage-backed assets, equity stakes in failing banks, equity stakes in failing car companies -- you get the picture. There has been agreement on oversight now with Congress, but this is still a HUGE grab of private enterprise by the government. Imagine what will happen when the administration and the Congress are run by the same party.

And if this wasn't bad enough, money being spent is like blood in the water for congressional sharks. The inevitable bills are being added on the bail out mortgage holders. One can only imagine what the final cost will be.

That cost, of course, will be raised though borrowing, driving down the value of the dollar and, eventually, driving up inflation and/or taxes. The long-term ramifications for our economy and our governance are staggering.

But I suspect that, if passed in a form reasonably close to what was proposed, we will see a substantial rebound in the market in the short-term.

And what if Congress doesn't play along? Will we see blood in the streets? It's debatable if, before Bernanke and Paulson made this argument, markets would have plunged and credit dried up, but now it's on the verge of being a self-fulfilling prophecy. I would not be surprised at a panicked reaction.

So I'm planning to hedge -- a reasonably straightforward procedure until lately. In addition to options, instruments many investors are not comfortable with or authorized to trade in their brokerage accounts as they stand, short ETFs have cropped up in recent years. These are designed to move in the opposite direction of the market or a sub-sector of the market. But in another manipulative move to prop up the market, short sales have been banned, effectively ruining these instruments as a hedge. Let's hope options are still allowed to pay off in October if they expire in the money.

So I would expect extreme movement in the market in the short term -- which way I don't know. It'll depend less on economics and more on politics but given our propensity to delay pain, I expect some form of bail-out to occur. Based on that, I would not exit the market, but if you have the ability to hedge the downside risk, I would seriously consider it.