How long until AIG gets booted out of the Dow Jones Industrial Average?

More imporantly, what the hell caused them to keep AIG in for so long?  Did it have anything to do with the Dow Jones-AIG relationship?  I doubt it but who knows.

I am looking forward to the rationale of who will replace them.   Can you imagine wanting to pick another financial firm when you have no clue what problems they have or how long they will survive?

I know….how about creating a hypothetical stock price for the Fed and the Treasury and put that in the index so we can just avoid having to deal with the next nationalization.  Besides, if the Dow index is supposed to represent the US economy and the balance of stocks in each sector, shouldn’t the new United Socialist States of America be a big component?

AIG is now owned 80% by the US government…another nationalization of our financial system.  I am no longer shocked by anything the President, Fed, Treasury, and Congress does.  Other than sovereignty (the right to do it to ourselves), why we ever fought the Cold War is beyond me.

Here is the Federal Reserve statement announcing this decision.  And as expected, they invoked the exigent circumstances clause (13-3) of the Federal Reserve Act.

A few thoughts from me:

Fannie and Freddie controlled almost 100% of the mortgage market.  AIG is a competitor with many different public and private insurance companies in the US and abroad.  The US is now in direct competition with its citizens and taxpayers, as well as foreign entities.  Our claims against foreign subsidies are greatly weakened.

I am doubtful that AIG’s liquidity needs will end with the initial $85 billion the government is putting in.

The idea that the US government is now the counterparty for all those Credit Default Swaps is absurd.

Please reread what I wrote about the THE ULTIMATE COUNTERPARTY on March 6, 2008 a week before Bear Stearns blew up.  Here’s a sample.

The biggest example that is still being ignored is the entire Credit Default Swap market. Every once in a while we see hints of the losses that will eventually hit, but they are always downplayed. Never mind that it is the embodiment of counterparty risk and has a notional amount of approximately $45 trillion. Somehow the lovers of CDS feel it is immune to loss simply because it is designed to counter counterparty risk. Eventually we will suffer from that ignorance.

There are multiple tiers where moral hazard meets counterparty ignorance. The higher it goes, the bigger the consequences. The ultimate counterparty? The United States Government.

I understand the consequences of an AIG failure.  I’ve been harping on the risks posed by Credit Default Swaps for quite a while and during all that time, I did not see our political leaders or regulators do anything to prevent this catastrophe.   I am not impressed by or calmed by or confident in our government and yet, I realize that the market will likely cheer what was called “a triumph of pragmatism over ideology.”  THIS IS NO TRIUMPH OF ANY SORT.   In the short term, this avoided a huge problem.  In the long term, we will pay for what has been done.

Despite the devastation of the past few days, HEDGEfolios did not give a dramatic number of new DOWN signals in either stocks or ETFs.  The primary reason for this is that I had positioned as much as I could over the past month to get to a more neutral ratio of UPs vs. DOWNs.  As a result, I didn’t have to react to the news from the weekend.  Additionally, this week’s signals are based upon analysis from the previous week and while it was slightly negative, it wasn’t enough to cause major concern.  What happened on Monday and today are not able to be reflected in these signals….that will only come next week.  You decide whether my methods work in calm or panicked markets.

Putting out fires.  Fire after fire for a year.  Thinking that you have all the tools.  Thinking that you have enough water.  But never dealing with the firestarter.  Never having a strategy of building a firewall.   I have great respect for real fireman, just not the guys we have relied on in the financial firestorms over the years.  They look like this:

The S&P and Moody’s downgrades of AIG has happened and it will rapidly push this situation to an end…either an end that prolongs the drama or the end.

If the government cannot find a way to ignore their lack of authority to lend to AIG and wiggle out of their suggestion that they will not make the loans, I do not expect another situation to arrive fast enough that could save AIG.

It is very surprising to me to see S&P and Moody’s make this decision without acceptance or understanding by the Federal Reserve and Treasury.  Therefore, it would not surprise me to see a last minute bailout program that makes all the past financial creativity exhibited by Bernanke and Paulson look basic.  If something like this happens, it will either be a new facility specifically created using some obscure provision in the Fed’s charter or it will just be a giant money laundering process to shove it through an existing conduit, similar to what they did with Bear Stearns on March 14th.

One extreme idea….have some other Central Bank lend directly to AIG.  Sounds crazy…right!?!  AIG is a global corporation doing business in about 100 countries.  If this is a global problem, maybe it is time for a global solution.   If this is solely a US problem, then we are probably screwed.  If our government cannot or will not lend to AIG, then I see no other workable deal.  I am not advocating this or any other solution.  It has not mattered what I think or what I have said.

Watching this sequence of Bear Stearns, Fannie/Freddie, Lehman, Merrill, AIG, WaMU……. used to remind me of dominoes falling in slow motion.

Now they are just accelerating.

When stocks gap up on the open and then trade down all day like they did on September 8 after the Fannie and Freddie bailout, I wrote that it looks like a downer to me regardless of how the media spun it as a big rally.  Here is a snippet from that post.

The Fannie and Freddie bailout by the Treasury did not occur during trading as is the government’s preference for tactical spiking of markets and screwing shorts.  As I have mentioned in the past, I don’t consider gap up or gap down moves on no volume to be particularly relevant.  So, the way I looked at Monday, I saw a down day by the smallest of margins, not a +25.48 move that media outlets reported.  Just take the value of the index fifteen minutes into the trading day and compare it to the close.  When you do that, you see that actual trading mostly represented sellers.

Turnabout is fair play.  So on a day like today, when we have the big decline on the open, I will be watching for the trading action from shortly after the open until the close.  At 9:45, the S&P was about 1218, that is the point I’ll use to measure today’s action.  So far, this does not look like a giant catastrophe or capitulation or any of the other dramatic descriptions that may have been forecasted.  I’ll wait to watch the whole day before deciding whether this was bullish or bearish.  If we close above 1218, I’ll be impressed with the bulls….for at least one day.

As you know, I am a huge critic of the government’s constant efforts to “calm the markets” or “provide confidence”.  Their actions over the last few hours and days are once again accompanied by these stupid assurances that they are doing what they are doing to restore calm and confidence.  How is that working out?

Calm?  Confident?  Is that the situation you see today?  If the government’s big role is to provide positive market sentiment…then that is how they should be measured….and on that standard, they are giant failures.

If BAC really goes through with a deal to buy MER for $29 per share on an all stock transaction, it is going to be a fun day to be an arb with this pair.

With BAC’s dramatic share appreciation since July and the premium it supposedly agreed to pay for MER, watch out.

Times of panic are great opportunities to evaluate yourself, your financial advisors, commentators, media etc.  I’ve mentioned this in the past during tough times and I think it is worth saying again.

The next hours and days will show people’s true colors.  Information will be offered as fact one minute and found out to be fiction the next.  Supposedly smart people will be advising others to do some really stupid stuff.  Others will be promoting an agenda that appears to be oblivious to everything that is going on around them.   Others will be silent because they said stupid crap a few days or weeks ago that will make them feel embarrassed.   Others never had a freaking clue to begin with and I just hope they stay quiet.

Not everyone will be wrong in what they say and do during this crisis.  Some bright people will present themselves as a contrast to all the morons.  It should be easy to identify the good and the bad.

I expect panic and I will be sitting back and evaluating it.  The time to have positioned yourself without panic was weeks ago.  If you cannot help yourself and panic, I understand that…it’s part of human nature.  I’ve been working really hard on Getting Centered for over a month since I started seeing some early warning signs (search backwards through my posts…I am not going to provide links to my prior comments).  My work is largely done.  It’s one of the great luxuries I have with my methodologies and investing style to be able to use any market event to learn rather than react.

So if you are able to join me and have positioned yourself as well as you can, pay close attention to what is said and by whom if we have panic.  Then compare it to what they said or advised you to do or what they didn’t say or didn’t advise you to do over the past few weeks and months.  Give credit where it is due and hold people accountable for doing a poor job.