The following comes from a July 30, 2008 press release by the Federal Home Loan Bank

Today, the Housing and Economic Recovery Act of 2008 was signed into law by the President.

The FHLBanks are referenced in this legislation, and the most notable changes are as follows:

• The Secretary of the Treasury is authorized to purchase Federal Home Loan Bank obligations in any amount deemed appropriate by the Secretary. This temporary authorization expires December 31, 2009 and supplements the existing limit of $4 billion.

“Any Amount Deemed Appropriate By The Secretary” of the Treasury, Henry Paulson and whoever succeeds him between now and December 31, 2009. Does that make you feel confident or does it scare the hell out of you? Do you feel comfortable placing unlimited power in the hands of one person?

I especially liked the concept that this new power “supplements” the existing limit of $4 billion. To me a supplement is a small addition. To the government, a supplement apparently means “unlimited”.

Please read this wonderful commentary by Lee Hamilton, former Congressman in which he states:

The framers of the Constitution, mindful of “taxation without representation” suffered by colonists under the British crown, took care to specify in the Constitution that the ultimate power to tax and spend resides in the hands of the legislative branch - which is closer to the people - not the executive branch.

The power of the purse is the most important power of Congress. James Madison in the Federalist papers called it “the most complete and effectual weapon with which any constitution can arm the immediate representatives of the people”. It checks the power of the President and gives Congress vast influence over American society, because federal spending reaches into the life of every citizen……

Congress used to have the “Power of the Purse”. It does not anymore. They gave it away. In my opinion, The Housing and Economic Recovery Act of 2008 approved by Congress and signed into law by the President a few weeks ago, is not only scary, it has ruined the Constitution and the importance of the Founding Fathers’ system of checks and balances. How this is not Unconstitutional is beyond me.

In the past few days, there has been much talk about the strength of Fannie and Freddie and how they were able to raise debt and how they don’t need to be nationalized. Do you really believe that? Do you think that would have been possible without the unlimited powers of the Treasury? The whole thing looks like a sham to me.

Consider that the Treasury Secretary can lend to Fannie and Freddie and almost any bank that wants to use its FHLB branch as a conduit in Any Amount Deemed Appropriate By The Secretary. This opens up the opportunity for a giant abuse of power whenever it is required to make everyone feel comfortable about the mortgage and debt markets. For as long as this power exists, I do not understand how any American can look at the balance sheet of any bank, any FHLB, any GSE or more importantly, the balance sheet of The United States of America and have any confidence.

Please click here and watch this video of Rep. Ron Paul (R-TX) about the “Mother of All Bailouts”. Warning….you will might should be troubled by the open ended nature of the Housing and Economic Recovery Act of 2008 and that little bit about raising the national debt by $800 billion and that little bit about big brother tracking every one of your credit card transactions via the IRS.

After the SEC ban against naked shorting of Fannie and Freddie and 17 other companies was allowed to expire on August 12th at midnight, FNM opened at $8.00/share the next day. From that Wednesday to Friday August 15th, FNM traded in a range of $7.55 to $8.62 and closed the week at $7.91. If you believe in the short ban, you might have thought that the shorting would have immediately crushed FNM, but it did not. Of course, the loudest supporters of the SEC’s attempts to limit shorting were mostly silent. That’s what happens when the facts get in the way of the bullish hype agenda. The way the anti-short crowd promoted things, you would assume that the SEC’s ban would be largely responsible for “stabilizing” Fannie and Freddie from July 21 to August 12 while the ban was in place. That’s interesting given that FNM opened at $15.25 on July 21 and closed at $8.02 on August 12. I wouldn’t call that stabilizing.

But when FNM started plummeting again during the week that began August 18th and hit its low of $3.53 on August 21, suddenly the removal of the naked shorting ban was used to explain why the stocks might be declining(in addition to the missing Uptick Rule). Of course, this is stupid. There happened to be a few other things going on than just the initiation, implementation and then removal of the SEC’s ban. It’s just really convenient for people pushing an agenda to ignore facts in opposition to their argument and then apply coincidences that support their claim. Never mind that FNM has advanced 80% since the August 21 low at a time when the short ban was not in place.

The naked short ban had some effect on the stocks because all market rules impact trading in some way. However, it is tough to identify what effects it really had and to what degree. We do know that it did not provide stability and it did not prevent selling of the stock and it did not guarantee that buyers would show up. During the naked short ban, the protected stocks went up and down. Without the naked short ban, the protected stocks went up and down.

Maybe it is unfair to place the success or failure of the naked short ban by just analyzing Fannie’s stock movements. Okay. Pull up the charts of the following 17 companies that were on the SEC’s list of 19 companies protected(I am excluding BNP Paribas and Daiwa since they do not trade on the NYSE)….AZ, BAC, BCS, C, CS, DB, FNM, FRE, GS, HBC, JPM, LEH, MER, MFG, MS, RBS, UBS). Do a price study of these stocks on the following dates…. July 15th close, July 21 open, August 12 close, and today’s close.

You’ll find the following performance:

• From July 15 close to July 21 open - all 17 stocks appreciated with an average gain of +35.7%
• From July 21 open to August 12 close - 11 of 17 stocks declined with an average loss of -17.5% and an average gain of +6.3%
• From August 12 close to August 27 close - 15 of 17 stocks declined with an average loss of -7.9% and an average gain of +2.5%

Here’s my take…The announcement of the ban on naked short selling caused a short squeeze and speculative momentum play from the announcement date (midday on July 15) until the ban actually took effect starting with the open on July 21st. Regulators like the Fed and the SEC love to put temporary floors in markets and create bullish spikes by squeezing shorts and encouraging bullish speculative trading on the momentum that follows. Bernanke did that on several occasions since August 17, 2007 so I guess it is only fair that Cox had his day. I find it interesting that Cox tried to prevent manipulation by short sellers by manipulating short sellers. Good one! Is this the kind of thing that gives investors confidence in markets and regulators?

As for the price action during the naked shorting ban, it did not suggest that the ban had an identifiable effect. Just consider how many of the covered stocks declined during the ban period of July 21 to August 12.

Since the ban ended, most of the protected stocks have declined. If you have read this whole post and still believe that the removal of the ban and manipulative short selling was the primary reason for the declines, please don’t waste your time reading my crap. It will not help you.

Naked short selling has been, is, and should be illegal regardless of whether the regulators choose to enforce existing rules for all or some of the stocks.

When Cox announces his next attempt to limit the effects of shorting, either naked or otherwise, please realize that the implementation of these rules does not materially affect prices. However (and this is the important part), the announcement of rules provides the majority of the gains and those gains are very short lived.

If you are running forward, the best posture is a forward lean. I’ve been leaning heavily in the bullish direction since mid-July and that has worked out quite well. However, if you expect to change direction in the near future or if you just fear that you are being too aggressive and might fall over on your face, it helps to do two things. The first is to slow down and the second is to get centered.

For the last 3 weeks, I have been working on those two strategies as I have gone from 80% UP signals to 63% (now). This week was more aggressive than last and I gave 429 new DOWNs vs. only 27 new UPs in the stocks I cover and 112 new DOWNs vs. only 1 (USO) in the ETFs. That may not sound like I am going slowly, but just consider this….I evaluated over 900 candidates for new DOWN signals this week and decided to avoid such an extreme move and did less than half that amount. To me, that is slowing things down. As for “getting centered”…. I am not quite at the 50/50 level and I may not get there exactly, but I am much more comfortable at 63% than I would be at 80%. Note that 80% felt like the right “lean” a few weeks ago. But that was when I was confident in the direction and pushing to optimize the ground I could cover.

Am I expecting a bearish reversal in the market? Yes.

I am just not convinced that the reversal is exactly right now. I am willing to forgo some bullish profits as I neutralize the portfolio a bit during this period. My analytical work on direction relies heavily on the ability to be as balanced as I can at the moments that are pivot points. So as I start to feel the shift, even if I am not convinced a change is imminent, I work really hard to find what I call the “portfolio center of gravity.” If you are a runner, sprinter or athlete of any type, you’ll know what I mean. If you are a physics geek, you’ll know what I mean.

Evaluate your portfolio. How far are you leaning in either direction? How fast are you moving? If you are uncomfortable with either or both of those factors, consider going slower and getting yourself centered. If the market reaccelerates in the bullish direction, you will be sufficiently balanced to rapidly position your portfolio to profit. If, on the other hand, the market heads lower, you will have a better chance to avoid losing your balance, and losing your gains.

I call FNM and FRE “toy stocks”.

Countrywide (CFC) became a toy stock before it disappeared. Bear Stearns (BSC) became a toy stock before it disappeared. Subprime lenders like Novastar and New Century became toy stocks before they got delisted.

When a stock no longer trades based upon fundamentals and gets in the hands of speculators that love to treat it like a plaything, it’s a “toy stock.”

On a day like today, with FNM and FRE up over 30% from their open to their intraday high based upon Freddie Mac being able to borrow more money, these toys made some people happy. Just don’t confuse an investment with a toy.

There are a bunch of stocks that I obviously don’t get. Over time, approximately 68% of the 53,000+ signals at HEDGEfolios have been correct. However, there are a few stocks that I am chronically challenged by and when you take a look at the performance of past signals on any PROFILE page, you might run into one. For example, click on this link for Alcoa (AA). Inclusive of the current signal, I have been wrong on AA 13 out of 27 times since HEDGEfolios began (significantly below the 68%). That is not good and it is below what I expect of myself. But it is what it is and unfortunately, it is not the only one.

So why the confession? Portfolio management gurus will tell you the importance of identify and dealing with your trading weaknesses but don’t say much about how to actually do that. While I agree with that and as a general concept of going through life outside of trading, it is important to know your strengths and weaknesses. Nonetheless, I just don’t think it’s as easy as it sounds to identify a weakness and by definition, to learn how to overcome it. So I thought I’d share one of the ways I deal with this issue in the hope you might get something out of it.

If you’ve traded the same stock over the years, be objective and determine how many times you have been right. If it’s below your expectations, analyze what happened. Let’s say that you win 50% of the time, but your winners are significantly bigger than your losers. That wouldn’t concern me. However, if the situation is reversed or if your losers and winners cancel each other out, you should think about avoiding making trades in this stock.

For some reason, with the thousands of stocks that are available, too many investors get hung up on a small set that they trade over and over. If one of these stocks gets the better of your fundamental or technical analysis, make sure you recognize that if you decide to trade it again.

In my case at HEDGEfolios, I have committed to covering thousands of stocks and I don’t have the luxury of avoiding the ones that keep kicking my ass. So, I have a list of difficult stocks and when I am about to make a new signal in them, I try to evaluate whether I am making the same mistake.

In life, avoidance is not a way I advocate dealing with problems. However, in trading, as much as you’d like to believe you can identify a weakness and then modify your analytics to improve performance….I’d prefer avoidance. Learning from mistakes is great, but avoiding situations that encourage you to make the same mistake is greater. In trading, you will run into difficult stocks and it is not necessary to keep forcing the challenge.

Media and politicians are hyping Freddie’s $2 billion of debt offerings as a big win. They even go so far as to say this means that there is less likelihood that Fannie and Freddie will be nationalized. Click here for the hype.

I don’t see it the way they do. If you believe the government is going to take over, there is minimal risk to buying the debt at higher yields. I might be impressed if the Treasury came out a few minutes before the offering and said “We will not nationalize Freddie Mac” and then debt investors bought the debt anyway at market interest rates for 3-month and 6-month paper. But that is not what happened.  I might be impressed if they sold equity without a discount even though a bailout would wipe out that new equity. But that is not what happened. They offered new debt at high yields. That is not impressive to me. I don’t see this offering as any evidence that a government takeover is less likely.

During one of my research efforts in support of a different post, I came across this JP Morgan position piece (circa 2004) attempting to convince participants in trade transactions how useful CDS contracts might be.  Please click here and read it.

This nonsense is just one example of how far the industry is willing to go to promote “financial innovation”.   The CDS market is unregulated and apparently unlimited in its suggested applications.  It’s out of control and we are all at its mercy.

Last week, I implored bullish investors to Pay Attention to some early signs of weakening that I saw during my assessment of the market.  Now that another week has gone by, I am suggesting that you should Pay Closer Attention.  In general, many previously strong stocks are slowing and some are weakening.  Although this isn’t usually enough to encouraging me to change an UP signal to DOWN, it does change my behavior. When this happens, I pay closer attention and tend to be more cautious about putting on new longs and more aggressive about exiting.   The light volume that typically occurs in the three weeks preceding Labor Day makes market assessment very difficult.  Some commentators tell you to downplay or almost ignore what happens during this period and wait until the big players get back from vacation.  To me, that’s crappy advice and instead, I just ask you to pay closer attention.

The psychology of looting is an interesting phenomenon. First you have an emergency like a flood or hurricane or earthquake or civil unrest and the anger and frustration just boil over at a time when law enforcement is overburdened with the actual emergency and doesn’t really have the capacity to deal with the looting. Normal law-abiding people suddenly turn into criminals and an attitude of “gotta get mine” or “I gotta get me some of that” takes over. Hey, if the other guy is taking stuff, I guess it must be okay for me to share in the goodies. After all, most of us have been cheated by society to a sufficient degree to feel entitled to getting some of what was either taken from us or not given to us so looting isn’t really stealing …is it?

Of course I am being ridiculous in this observation. Looting is a crime. Although, I am constantly amazed by the non-looters who often show some deeply absurd compassionate understanding and suggest that the looters really didn’t commit a crime. I have no compassion for any of it.

What does looting have to do with stocks and our economic situation enough for me to discuss it here? I see deep analogies to the bailouts in the financial industry and the psychology of looting that was exhibited by the automakers who I think finally said “I gotta get mine” with their request for $50 billion or so in government loans. We have an emergency, our regulators/politicians are overburdened trying to deal with the emergency and then the mob shows up to loot. And of course, there are the bystanders who show compassion for the auto industry who have apparently not been given enough help and suggest that it’s only natural that we should give them more during the emergency.  I have no compassion for looting.  GM, Ford and Chrysler are showing up to loot.  It’s as simple as that.

Last year I jokingly complained that I got No Jackson Hole Invitation.

The Federal Reserve Bank of Kansas City is sponsoring its big economic symposium in Jackson Hole at the end of this week and I’ve not been invited. There’s no skiing this time of year but I’d still love to be there. It’s a tough ticket with only about 100 invites going out to the Fed members and other “prominent central bankers, finance ministers, academics, and financial market participants from around the world.” Obviously, I would never expect to be in this crowd and I have no idea what really goes on there. But my impression is that it’s groupthink at its worst. One economist debating with another economist might lead to an economics lesson, but I wonder what it means for the rest of us. For example, Chairman Bernanke’s Friday morning lecture is entitled “Housing and Monetary Policy” and while I am sure the past few weeks have provided a few good revisions to the final draft, what will it do? Who will hear it but a bunch of the same people who have contributed to the mess that we now have?

Guess what? I didn’t make enough (read none) friends at the Fed lately(read never) to garner an invite this year either! It’s funny even thinking how long I would be able to hold in the laughter if I was there listening to these brainiacs or how long it might take to blurt out a few “BULLSHIT!” interruptions as they discussed their policies or economic predictions. It’s better for all of them that people like me are not there. After all, would you really want to compare thoughts and predictions on the likely consequences of government intervention policies and economic statistics from someone like me to the leading economists on the planet?

Speaking of that - maybe you should reread last year’s Jackson Hole speech by Bernanke(click here) and now that we have the benefit of hindsight (and lots of it) to determine whether he said anything so insightful last year that helped us out over the past 12 months. I didn’t find much other than this nice comment about half way through:

Ben Bernanke ……”It is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions.”

Oh well, none of this is important. What matters is the perception that he and his Jackson Hole buddies know what to do. HMMMMM!?! I am having flashback hell right now.

Rewind to last year…on the day when Bernanke spoke. Here is what I wrote about getting impressed by Knowing What We Should Already Know.