Dear Hank:

I read in the WSJ that you and other officials are wondering what is causing all this turmoil even after you've done important supportive actions. "Federal officials and market players are struggling with the same issues: Why haven't the steps taken so far calmed the system? What can policy makers do next?" The answer is simple: huge pools of unregulated money are sloshing around the financial system. These big money pools are commonly known as hedge funds. Unnatural derivative securities give them unprecedented leverage to attack firms and create bubbles in commodities that then must eventually burst. Here are two examples - LEH and the oil markets.

First - LEH

The assault on the credit default swaps of LEH are being used in conjunction with shorting its stock to create fear and panic in its survivability. There is no limit on the amount of credit default swaps that a hedge fund can attempt to buy. No natural sellers exist for such swaps. So my placing orders for huge amounts of swaps in a weak market, while shorting its shares aggressively - even with virtual shares with no uptick rule - thanks to SEC timidity or stupidity or knavery. And the hedge fund can place huge orders for puts on LEH shares, too.

The press picks up the weakness, reports it and then endlessly and breathlessly speculates on why the firm's credit is under stress. And after the near extinguishment of the stock of FNM and FRE, and BSC, stockholders panic and sell. Lenders worry. Counterparties worry.

In the past, there were only so many bonds that existed for a firm like LEH. And most were held by "real buyers". Selling bonds short was very hard or impossible. Now, credit default swaps can be printed with impunity by speculative pools seeking to create weakness for a financial firm. No position limits exist. No short selling rules. The government's silly infatuation with "unregulated markets" and "unregulated capital" has permitted this to be done.

Second - oil markets

The oil price bubble of this spring was entirely due to these huge, unregulated pools of money, strongly supported by pension fund speculation in commodities. Demand data already showed weakness, while price rose to wild levels. And data has been flowing out how mislabeled speculative groups had huge positions hidden under the guise of "commercials" creating an illusion of real demand. Now the CFTC is slowly recognizing part of the problem.

From the FT: "The Commodity Futures Trading Commission, the main regulator of commodity markets, told the US Congress on Thursday it was imposing “enhanced control” on dealing by Wall Street banks and forcing them to publish new data on their positions. The CFTC’s measures will focus on swaps – private contracts between investment banks and clients such as hedge funds ... "

And more: The CFTC said that of the 550 clients of swap dealer it has identified through an unprecedented special survey, at least 18 were above the exchange limits thanks to the use of on-exchange and swap trading.

Again, in the oil market, there are a limited number of natural sellers of oil futures, viz, the oil companies. OPEC and governments who hold most oil in the ground for future delivery do not hedge in large amounts. So the natural sellers, like for credit default swaps, can be easily overwhelmed by the huge pools of unregulated money.

Conclusion:

Permanent elimination of this credit turmoil requires strict regulations of the huge big money pools. And the SEC and CFTC and even Congress, if necessary, must enact strict rules on short selling, position limits and credit derivatives to detect and prevent such wild market manipulations and distortions.

Sincerely,

Bunkerman

Markets

Interesting day, yesterday. The strong did well - WFC, BAC, JPM - and the weak suffered - MER, LEH, WB. Perhaps this is a sign of the end, as distinctions are now being made instead of total panic. Doing nothing, awaiting AAPL to hit around 145 to add.

World

It's remarkable how one can know the intent and action of Putin simply by listening to him and applying the rule that whatever he accuses the US of doing is in fact what he is doing. Read: "Commenting on the Georgian crisis, he [Putin] said Moscow was ready for political and economic co-operation with the west but not if it was going to be “pushed around” by the US. "Even one country with strong forces should not solve all the problems of the world by itself. It should attract allies and partners. It must not behave like some kind of Roman Empire,” Mr Putin said. :

So now we know that Putin is trying to create a new Russian empire. QED.

Word of the Day

"Verily" - adverb [$10]
Verily means really, truly.
Sentence: Verily, the ultimate permanent solution to the credit "crisis" is a combination of strict regulation of huge hedge funds, short selling and derivatives.

"Veriest" - adjective [$10] archaic
Veriest means so called in the fullest sense, complete, absolute (the veriest fool knows that). Superlative of "very".
Sentence: The veriest permanent solution to the credit crisis will require the panoply of strict regulation of huge hedge funds, short selling and derivatives.