S&A Digest: This Number Will Make or Break the Market

Bailout on the way... The greatest financial crime in the history of our country... Sued for pointing out the obvious... Rule says "time to buy"... Badiali scheduled to appear on Fox... The one number to watch next week...

It's worse than criminal. It's despicable, tragic, cruel, and evil. A bill scheduled to pass this week commits our government to bailing out both the bondholders and the shareholders of Fannie Mae and Freddie Mac. If you had any remaining doubts about the ethics of Washington, I hope these events will clear your mind: The people running our country are crooks.

What's the problem with bailing out the two largest mortgage companies in the world? Let's start with this fact: There is no money for such a bailout.

Peter Orszag, the top budget analyst for Congress, says the bailout will likely cost $25 billion. Ha, ha, ha... I hope you remember that number. The fools in Congress have no idea how big the problem is – they're not even close. Together, Fannie Mae and Freddie Mac already own $6.9 billion of foreclosed homes. That's almost as much property as the entire rest of the financial system – all the other 8,500 commercial banks – combined. (Remember when you were told that Fannie and Freddie's lending was conservative, that their portfolios were "safer"? Ha, ha, ha.)

The recovery rates on these properties are unlikely to be above 50%. The bankers among you are probably smirking... Yes, recovery rates have been much higher historically. But there is a correlation in the bond market between the magnitude of the default rate and recoveries. The same will be true in mortgage bonds. Recovery rates will plummet as defaults increase substantially because the number of houses on the market will continue to increase, pushing prices farther and farther down.

As an example, consider Fannie couldn't sell a $110,000 Michigan home for $6,900. Assuming the default rate stops rising immediately, it's likely that around 10% of Fannie and Freddie's owned and guaranteed mortgages will end up in foreclosure. Assuming a 50% recovery rate, that's a $250 billion loss – more than 10 times the amount Congress is expecting. And don't forget, more and more homeowners – even folks with prime mortgages – will decide to simply mail in their keys as home prices fall. Why keep paying your mortgage when the bigger house across the street is selling for half what you paid?

Says Bond King Bill Gross of the deal: "It's impossible for Freddie and Fannie to raise capital without help from the government... Let's be blunt: to the extent the Treasury suggests they'll never have to use their authority, that's a sham. It's fallacious to suggest that the agencies could issue capital, preferred stock, without the co-participation of the Treasury. I don't think that's possible."

The current housing bill gives U.S. Treasury Secretary Henry Paulson the authority to spend as much money as needed to support Fannie and Freddie. Paulson says he will provide "unlimited" government financing. But there's no government surplus. Thus, these debts will either be paid for by our children and grandchildren... or, more likely, by inflation.

And so, the government will bail out a bunch of crony capitalists – Fannie and Freddie spend more money on lobbying than any other two companies in the United States – by either robbing its citizens of their savings (via inflation) or by taxing several future generations of Americans. This is the greatest financial crime in the history of our country. How much would you like to bet that not one single mainstream member of the press even questions the wisdom of this plan?

A subscriber raised a fair question: What should be done about Fannie Mae and Freddie Mac? Simple. There is a well-established bankruptcy process in this country that treats creditors fairly. Yes, allowing Fannie Mae and Freddie Mac to go out of business would make it, temporarily, difficult to get a mortgage. Rates would probably increase substantially. But private lenders would enter the market. And because housing prices would fall due to less-available financing, the overall affordability of the market would probably increase.

The people who tell you the mortgage market wouldn't exist without Fannie and Freddie are the same people who will tell you that without Washington, Americans wouldn't know how to farm, educate, manufacture, or conduct trade. Taxpayers have absolutely no reason to bail out the shareholders and the bondholders of Fannie Mae and Freddie Mac. America is, once again, being sold a bunch of lies. And this time they're going to cost a fortune.

From the "you gotta be kidding me" file... BankAtlantic has sued a Wall Street analyst for pointing out that it is one of the most likely candidates to follow IndyMac into federal receivership. Rather than bore you with the details of the analyst's report, I'll simply point out that BankAtlantic's share price has fallen from $20 to under $2 and it was one of the most aggressive lenders in South Florida. Why should pointing these facts out to investors lead to a lawsuit? I'm just glad no one has sued me... this year. Yet.

Dan Loeb's Third Point hedge fund announced a 6.8% position in The Phoenix Companies (PNX) last week and has since built an 8.8% stake. Loeb is trying to oust CEO Dona Young and merge the insurance company with another insurer. Phoenix went public in 2001 at $17.50, and shares are currently trading under $10. Loeb, known for his seething letters to executives, was relatively quiet in this filing. He did say Young should be held "accountable" for underperformance and said her performance casts "doubt on her ability to lead the Company in this environment." For a better example of Loeb's prose, click here...

Matt Badiali sent us his notes from Rick Rule's presentation at the Agora Wealth Symposium in Vancouver yesterday:

A couple things jumped out at me. First, Rick's sure the commodity bull market is alive and well. He cites the length and depth of the last bear market – 20 years. Mining companies simply didn't invest enough money in their pipelines. Rick points out we're still mining discoveries from the 1960s and 1970s. It takes a long time to spin up a giant mine.

Second, Rick's bullish on junior miners today. He says they are fairly priced now – he was saying fully priced six to 10 months ago. He thinks they'll be downright cheap by December... December is his target because of a wrinkle in Canadian tax law. In Canada, you can write off a loss retroactively back three years.

We pay attention to what Rick Rule says about mining stocks for two reasons. First, we know he's personally made a fortune buying these stocks at the right times. Second, he's one of only a handful of investment bankers who stuck with the business during its 20-year bear market. If you survived those two decades, you have to be pretty smart.

By the way... Matt Badiali will appear live Friday morning on Fox Business News to discuss Pennsylvania's Marcellus Shale. Be sure to tune in.

New highs: Covidien (COV), Heartland Express (HTLD), Western Union (WU).

In the mailbag... The right way to use trailing stop losses, again. And more about the FreedomFest speech. Send your comments to: feedback@stansberryresearch.com.

"Your newsletter is nothing more than a never-ending solicitation for more money. YOU SUCK." – Anonymous

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"After reading [the Trailing Stop Order Risk and Disclaimer] I hesitated to place my trailing stop for GLD. Is this a 'standard' thing for any brokerage, or just Scottrade's specifics?" – Paid-up subscriber Lyudmila

Porter comment: Beats me about Scottrade. I don't know anything about it. But I can tell you this: Don't ever tell anyone – especially your broker – what your stop points are, whether you're using a plain stop loss or a trailing stop loss. Telling anyone else in the market at which point you'll sell is like playing poker wearing a sign that says, "I'll fold every time you re-raise me." Keep your stops to yourself.

"Quick question about bank failures and bank runs... Suppose I held gold coins in a safe deposit at Bank of America... And they failed... Are my gold coins at risk?" – Paid-up subscriber John Scola

Porter comment: No. The property inside your box belongs only to you. And the bank can't go inside your box unless it's complying with a search warrant. (At least, that was true before the Patriot Act... I'm not so sure now.)

But here's my question for you. Do you really think the government is going to let you access that box in the event of a real currency crisis? No way. No way in hell. They'll make owning gold illegal overnight. And they'll instruct the banks to open every box and seize all of the gold.

Think it'll never happen? It already did. The best way to own gold bullion is to keep it someplace safe, where no one will know anything about it.

Regards,

Porter Stansberry

Baltimore, Maryland

July 23, 2008

This Number Will Make or Break the Market

By Ian Davis

Mark your calendars for this coming Tuesday, July 29.

On this date, a number will be released that will make or break the current rally.

This data gets released to investors every month... Last month it was horrible. The S&P fell 0.3% on the day of its release. And it was down 3% over the following four days.

On the bright side, the figure was so bad last month, it can't get much worse this month. You see, in the past, a number this low has only occurred at, or near, stock- market bottoms.

The figure I'm talking about is consumer confidence.

Every month, a business research organization called the Conference Board conducts a survey of 5,000 U.S. households. Participants answer five business-related questions, like "How would you rate the current business conditions?" Two of the five questions relate to the present economy. The remaining three relate to participants' expectations of the future economy. They answer these questions with "positive," "negative," or "neutral."

The Conference Board releases its findings in a "consumer confidence" index. The index rises as people become more positive, and it falls as they become more negative.

Investors pay attention to consumer confidence. It's a good indicator of how our economy is faring. Consumer confidence falls leading up to a recession... And it tends to bottom during a recession. (Falling consumer confidence is one reason I believe the U.S. is headed for – or already in the midst of – a recession.)

This sounds scary, but remember, stock markets are forward-looking. So the market doesn't necessarily fall during a recession. Once an economy enters a recession, its stock market is already looking ahead to the coming recovery.

Consumer confidence is currently at 16-year lows. From May to June, it fell 13.3%, from 58.1 to 50.4. If it falls again this month, the current rally will probably fizzle as investors head back to their bunkers. However, if consumer confidence rises even slightly, it will significantly boost the current rally.

Check out the following chart...

Consumer Confidence Heads For All-Time Lows

This chart shows we're heading for a near- or short-term bottom in the market. If the current recession turns out to be on par with recessions we've seen over the past 39 years, now is the perfect time to buy stocks. The S&P has gained an average 18.9% in the six months following extreme lows in confidence like this one.

But this recession may turn out to be even worse. According to the International Monetary Fund, we are in the middle of the worst banking crisis since the Great Depression. The U.S. housing slump is also the worst since the Great Depression. So if we are in for a repeat of the 1930s, consumer confidence probably still has a ways to fall.

We'll find out Tuesday...

Good investing,

Ian Davis

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