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February 16, 2008

Credit Insurers Must Keep AAA Rating or Else
by Robert McHugh

This week, on Thursday, February 14th, Bernanke spoke, markets fell. Confidence in the Fed Chairman wanes. From a fundamental perspective, until something is done to bail out the credit insurers, so they maintain their AAA rating from Moodys and S&P, market rallies will be corrective. This is an economic nuclear bomb at 32,000 feet This is about bank solvency, bank risk-based capital, the bank credit function, not about the insurers themselves. Should a downgrade come to the insurers, billions of municipal bonds will effectively become illiquid, joining the trillion of CDOs (mostly subprime loan securities) that have already become illiquid. Without a bailout here, we are headed for a depression. Period.

None of this is lost on the markets. Technical analysis doesn't predict the news, it just recognizes those periods (Bear markets) when a cacophony of bad news, macroeconomic screw ups, frauds, etc... are likely to occur, which in turn send market prices lower. We are in one of those periods now. How far down we go depends upon how the Master Planners and the mass of human psychology responds to the current financial crisis. Some folks consider technical analysis rubbish, however the Dow Theory Bear Market signal came way back in November, and look at the bad news since. So far, the Master Planners fiddle, and apparently the mass of human psychology is looking to Barrack Obama for a solution, the guy who defines $75,000 of income per year as rich. If you make $75,000, Dartmouth College gives your kid (assuming he gets in) a 100% free ride. So, who's definition of rich versus poor is correct? And the Bear Market beat goes on.

The imminent downgrade of AMBAC, MBIA, and FGIC is the greatest systemic threat to our economy since the bank failures of the 1930s. Sure they were mismanaged, sure they deserve to go belly-up, sure they failed to properly assess the risk of a systemic slowdown in mortgage backed securities they insured, sure they failed to charge the appropriate credit insurance premiums to securities underwriters for that risk. But fact is, regulators blew it, which means our government blew it, and now the entire banking system is at risk, as is the ability for consumers to get a basic loan, because of loan restrictions banks face as underwater securities, due to declining market values on lower rated credit insured securities (due to a ratings downgrade) shrink risk-based capital levels. Time for Congress to get to work. Time for the most incompetent Fed Chairman since Eugene Isaac Meyer (whom FDR canned out of necessity in 1933), Fiddling Ben, to take the lead and put together a just and effective credit insurer bailout. If Hillary wins, will Wall Street cheer? Would she axe Ben? Would McCain? Gotta believe Ron Paul would.

The St. Valentine's massacre. That's how markets felt after listening to Hank and Ben on the hill Thursday, as they snuffed out a nice confidence-building three day rally earlier this week. Here are some of their uninspiring comments that day: Bernanke proffered, "the economy is likely to endure a period of sluggish growth ... followed by a somewhat stronger pace of growth later this year," as the effects of the Fed's rate cuts and a newly enacted stimulus package begin to be felt. But his faith in the fiscal stimulus package and past rate reductions by the Fed are worrisome. More is clearly needed. In fact, Republican Senator, Richard Shelby, from Alabama, disagreed strongly. In rebutting Fiddling Ben, he described the impact of the rebates as "negligible," and he likened its action to pouring a glass of water into the ocean. Based upon my own experience testifying on the hill, Senator Shelby knows a thing or two about the economy and the banking system. Too bad he isn't the Fed Chair.

Probably the least inspiring quote of the day came from Treasury Secretary Hank Paulson. Yes, Paulson doesn't get a free pass here. Senator Charles Schumer, a Democrat from New York, asked whether policymakers underestimated the severity of the situation. Paulson's response, and I quote, "It's one thing to identify a problem. It's another thing to know exactly what to do about it." In other words, he doesn't have a clue. Just great. The Treasury Secretary doesn't know what to do about the most serious economic crisis in 80 years.

Probably the most accurate remark came from Senator Robert Menendez, a Democrat form New Jersey. He criticized the Master Planners for what he believed was a too slow response to the housing crisis. "We count on those at the top . . . to sound an alarm during a crisis. Instead what we got was a snooze button . . . We've been behind the curve." Yes, just like in the 1930s.

Kind of strange: It looked like Friday was more of a day where folks did not want to take positions before the long weekend (U.S. markets are closed Monday), than a day where folks chose to dump positions. In other words, staring a long weekend in the face, we did not see panic selling or anything resembling that. This could mean the decline the past few days is merely a small degree corrective wave down, with another rally leg coming next week. There is a lot of back and forth going on, which is typically a sideways consolidation, often occurring after sharp moves. The trend going into the sideways move is usually the same trend that leaves it. Keep your eye on the Credit insurance crisis. That is key. If it gets fixed, we should see a Bear Market bottom follow. If it is ignored, we get the Great Depression of the 21st century. Think cash, precious metals, and get out of debt.

The Head and Shoulders Pattern in the Chart below warns that should the Industrials sink below 11,600, we are at great risk of a plunge all the way to 9,750.

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"Jesus said to them, "I am the bread of life; he who comes to Me
shall not hunger, and he who believes in Me shall never thirst.
For I have come down from heaven,
For this is the will of My Father, that everyone who beholds
the Son and believes in Him, may have eternal life;
and I Myself will raise him up on the last day."

John 6: 35, 38, 40

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

Copyright © 2004-2008 Main Line Investors, Inc. All Rights Reserved.

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