With all the market declines from July 15th to August 15th, you might expect the NYSE Short Interest report would have shown a massive increase.  During the period covered by the most recent report which had the Dow off by 7.5%, short interest actually declined  3.5%.   It’s still near the record highs, so keep that in perspective.  But as I have mentioned, you can place the blame on the decline entirely on the bulls.   Meanwhile, this report indicates that the bears didn’t get greedy with their new downtick opportunities.  And simultaneously, they did not cover a lot of their positions.  Some holding on by the shorts is due to the past 4 years of a bull market which makes most of these positions losers.  Bulls will tell you that this is just more fuel for their fire but then you might have to wonder what the hell was their excuse during the past month when short interest was at record highs.

When the market was declining last week, bullish traders were ticked off about the new short sale rules which allowed for sales on a downtick. They cried that this was causing the decline and accelerating it. Of course this was bullshit.  The responsibility for the decline rests with longs that were bailing out and asset sales to deleverage hedged positions.

I’d like to finish the title with “…Fear itself” and give credit to FDR. But I cannot do that because it would imply that all fear is irrational. That all we need to do is overcome or ignore the fear and the real threat will just go away.

Instead, I am fearing something else. What I fear is what I know I do not know and what I believe Chairman Bernanke knows but cannot tell us other than through the severity of his actions. I have to go with that or I would give up on the institution.

You see, I have tremendous faith and respect for Ben Bernanke and all the members of the Fed. And yet, I look at all their actions over the past few weeks and the actions of the other central banks and it all seems so excessive compared to to what has been made public about the dangers in debt and equity markets. I cannot buy into the argument that they were just responding to equity markets near record highs or a few billion dollars of subprime losses or a few hedge fund blowups or redemptions or commercial paper or whatever other fears have been made public. When you factor in the nonexistent borrowings from the discount window over the past week - it just doesn’t make sense. None of these calamities on their own seem worthy of the actions taken and to be honest, all of them combined do not rise to that level.

The Fed is made up of our best economic minds and they know all too well the risks of Moral Hazard and Adverse Selection. They are making decisions that will affect monetary policy for decades and they will be judged by history. I believe in their intelligence, their respect for the institution of the Fed and their commitments to the oaths they have sworn. And that is why my fear remains - I know I do not know what they know.

Substantially zero - that’s the amount of borrowing at the Fed’s discount window when you subtract out the $2 billion of “solidarity” borrowings from C, JPM, BAC, and WB on Wednesday.  The H.4.1 statement was highly anticipated and it was telling.  The stigma is either really bad or this liquidity crisis is more like a Crisis of Confidence Men.  Note that “Confidence Men” are better known by the slang term - “Con Men.”  Most media outlets are quoting the average daily borrowing figure of $1.2 billion - I guess because it sounds bigger and more impressive than my substantially zero figure.  Some commentators have suggested that the math implies that other banks actually did borrow money earlier in the week and then repaid it before Wednesday.  To do that you have to assume that C, JPM, BAC, and WB did not borrow prior to Wednesday’s publicity stunt.

What Would JP Do? 100 years ago we had the “Panic of 1907″ that included many of the same fundamental causes that we have been dealing with for the past month. A decline in stock prices precipitated a liquidity crisis with the banking system (sound familiar). Obviously, the highly leveraged trusts of 1907 are less sophisticated than the highly leveraged speculators of today. And of course, the run on the Knickerbocker was more extreme than the run on Countrywide. But these are scary similarities nonetheless. What JP Morgan did back then was something I have always admired. So now that Ben is facing a similar situation, I hope he is asking WWJPD?

If there was ever a bigger example of “pushing on a string” I’ve never seen it. When the Fed lowered the discount rate, I dared to suggest that few ever used it in the past, and few would likely use it this time. Yesterday’s farcical borrowing by Citi, JPMorgan Chase, Bank of America and Wachovia was an amazing and sad display of how contrived the Fed intervention has become.  They all borrowed the same amount, at the same time, and issued canned statements together.  Some people have called it patriotic and supportive and symbolic - I call it camouflage.

If banks needed to be bailed out with the “brilliant” discount rate cut, then why do they need to be encouraged to borrow?  There is a stigma of borrowing at the discount window and now that the spotlights are on, which bank wanted to be seen with a hand out?  Apparently no one.

But due to yesterday’s show by the director (Fed) and the actors (big banks) this giant smokescreen has made it all okay.  All you need to do is say “I am not in trouble, I don’t need the money, I am just supporting the Fed.”  And here all this time I thought the Fed was supporting the crumbling financial system.  Silly me.  It appears that I was wrong and the banks are all out there supporting the Fed.

A week after 9-11 comes one of the biggest potential disasters - the next FOMC rate decision. The Fed has really painted itself in the corner with all of its very creative intervention. Investors have gotten their fix and it’s never enough.

• Injected liquidity - not enough. Inject more and more often.
• Lowered the discount rate 50 bps - not enough. Should have been lowered to the Fed Funds Rate.
• Cut Fed Funds at the next FOMC meeting - not soon enough. Should cut before 9-18
• Get one bad economic report indicating threats to recession - CUT FED FUNDS NOW!!
• Cut Fed Funds 25 bps now - not enough. Should have cut 50 bps.

Whether the Fed likes it or not or whether it was their intention or not - they look like they are responding directly to stock market needs. Who’s in charge here? Who’s in charge of what? Who’s the adult? At some point, I’d start asking questions like that and figuring out how to use some of that brilliant craftiness to deal with the fact that 9-18 is coming.

They have set themselves up for failure if they do not give in to some of the lesser demands between now and the next scheduled meeting. If they go silent and do not respond, people will be screaming loud enough to make Cramer’s rant look sane. If they do not cut Fed Funds on 9-18, this market will likely suffer much worse than the percentage decline they responded to over the past few weeks. Then what do you do. Can you afford to draw the line then after what you have done now? Investors feel the Fed has caved in to them and they got some of what they want. IT’S NEVER ENOUGH.

Too big to fail.  That’s the message I get about CFC in this crisis.  As the nation’s largest mortgage lender, it isn’t so unexpected that they would get bailed out in this new economy that has become (at best), a hybrid of free market capitalism.  CEO Mozilo did all the right things by tapping himself out with that $11.5 billion credit line draw and all the other stuff that obviously went on behind the scenes.   How involved was the Fed in directly dealing with CFC?  To be honest, I am so overwhelmed by all the government intervention and their sentiment management that I am almost past caring.  Bank of America did a great thing for their investors.  Their investment is a sweeeeeeeeet deal.  As for CFC shareholders, I think many of them are speculators now and the long term holders that you can still call investors - well I suspect they are just happy to have been bailed out.

Buyback enthusiasts will tell you a bunch of reasons for justifying these purchases and one of the most common is that this is “the best use of the corporate cash.” So to evaluate that, let’s look at the company that has probably bought more of its own shares than anyone else in the past few years.

Microsoft has repurchased approximately $71.2 billion worth of its shares from Fiscal 2002 until June 30, 2007. The value of those purchases has risen about 6% in the past 6 years. A whopping 6% vs. about 18% for the S&P 500 over the same time period. In the most recent quarter ended June 30, 2007 - the repurchases are actually under water. Compared to the S&P 500, investing in MSFT was not the best use of cash.

So what else has MSFT been doing with their cash since Fiscal 2002? According to their filing - here you go:

We make significant investments in new products and services that may not be profitable. We have made and will continue to make significant investments in research, development, and marketing for new products, services, and technologies, including Windows Vista, the 2007 Microsoft Office system, Xbox 360, Live Search, Windows Server, Zune, and Windows Live. Investments in new technology are inherently speculative.

“Inherently speculative” - you got that right. The Zune, the Xbox, IPTV - the Entertainment and Devices Division has been a giant failure and yet, after losing over $6 billion since 2002 I am continually confused why Robbie Bach is still considered a genius. Was this a good use of cash? Nope - but it did make their share buybacks seem not so bad.

When I look at MSFT - the poster child of share repurchase programs - I don’t see how investors find it so easy to agree with the notion that buybacks are the best use of corporate cash. Just look at the competition - Google, Apple and Nintendo - and try to figure out how much they have spent since 2002 with buybacks. Seems to me they found the best use of cash had more to do with helping them to make innovative products that consumers want.

Unlike most market participants, I am not a huge fan of buybacks. So it was fun for me to read what Jeff Matthews had to say at his blog the other day. If you don’t know what I am talking about, here’s the link. I’ll be following this up with another post in my Buyback Pushback series.