The strongest “sector” from a long-term macro perspective unbelievably is the Biotech Index. The chart below is monthly! Let’s keep an eye on the group for some short opportunities because the corrections are going to be hard and fast, but not for the faint of heart, or the prop guy with a tight stop-loss for the day.

Please click on image above for higher resolution chart

Is the CRB Index running its course, with an ongoing rally in the US Dollar and fires burning in Europe over severe austerity measures in countries used to Socialism? Or will the mighty Chinese economy pull us all through whatever is going on. The weekly chart of the CRB shows how it’s turning over after running into a myriad of moving averages as well as an important Fibonacci retracement level. Therefore, a good area to find short trades if we continue to fall and/or the US Dollar continues to surge, are commodity stocks.

Please click on image above for higher resolution chart

On that note, here’s one idea. BP and RIG both are in severe trouble. Technically, fundamentally, from a public relations standpoint, and the amount of damages they’ll have to pay is still unknown. But although they’re good candidates to short, at some point, both stocks will be extremely attractive buys. For now, the breakaway gaps in each suggest lower prices to come. However, at the moment, both are extremely oversold, so I would only short them if they break last week’s lows. Otherwise, let’s wait for a retracement and then we’ll hit the bid.

For now, the most important observation I’ve made thus far is that the most reliable indicators have been Fibonacci Retracement & Projection lines as well as specific moving averages. If you don’t know how to use Fib Retracements and Projections, tune in to my radio broadcasts on T3 Live, the internet’s most advanced stock research and advisory service. In these volatile times, you need guidance from the best traders on Wall St., who trade during the day, completely transparent, buying and selling in real time while talking on the radio explaining what’s happening. T3 Live has been on CNBC, Fox, MSNBC and mentioned in all the major financial publications. Check it out with a free trial here.

There really are a tremendous amount of both long and short trade opportunities out there. The problem? Gap after gap after gap!  It gets extremely frustrating for those that try to trade  the tape rather than a portfolio strategy.  Nonetheless, it’s just a matter of finding the market’s pulse and trading with it. Right now, to be 100% directional is suicide. One shouldn’t go beyond 80/20 during the day and 60/40 overnight. Here are some ideas on both sides. I’ll announce their entry, or trigger on the radio:

The primary MACRO THEME for the month is going to be a rising Dollar with a flight to quality, the carry trade continues, bond markets know interest hikes are coming, probably after the streets of Europe stop burning. Short look at the commodity stocks vs. long the tech names. Once again, I’ll be on the radio with many more names on both long and short trades. It’s been a long time since the VIX has been above 40. Let’s hope it stays here for a few weeks at least.

Aside from the macro backdrop that may or may not be causing a pending market correction, there are several trades popping up on my proprietary models on both sides of the market. So there are NO excuses to be purely directional when you’re proclaimed to be a market neutral Long/Short trader.

On the macro front, I’m generally in-line with the coordinated re-inflation of global economies via the debasing of their respective currencies. Therefore, I’m bullish long-term on things like Oil, definitely Gold, Dry and Wet Bulk Carrier fleets, Railway stocks, and Silver (perhaps more than Gold). But I’m not bullish on base metals that go into manufacturing, such as copper, aluminum, steel, etc… There’s WAY TOO MUCH production capacity or acquisition debt added at or near the top of the credit bubble, and the adjustment, although already taking place, is going to be a painful one and has a ways to go. If you want to be truly market neutral here, you would be long the producers, oil futures, gold futures, and silver futures, while short the Steel producers, copper, and base metal producers in general.

SHORT TRADES

ADI: Has moved way above all of its major averages on consistently declining volume: negative divergence #1. Money Flow turned down on Friday’s new high: negative divergence #2. Momentum Oscillator failed to make a new high relative to the new high made in early December ahead of this consolidation: negative divergence #3. The Secondary Trendline is around $34 while the 10-period daily EMA is at $31. So there are actually two ways to play this: If there is a fall in the market early in the week, pick up a small lot near the $31 level and use the 10-period as your stop. The other way is to short the stock as it approaches the $34 level.

ATHR: This telco play is directly on its all-time highs, which haven’t been broken since November after a series of six tests. This is the seventh (lucky number perhaps)? The only odd thing about my model on this is that it shows money flow collapsing while the stock has been rising for the past several sessions. That could be a false signal due to holiday trading, but it’s worth keeping in mind. On the other hand, all momentum indicators have turned up sharply. I never buy stocks after they’ve rallied several sessions, so a pullback to $30 should be followed by one more attempt at a new high at least. I don’t think we’ll see a break above $35 on this move, so there’s no rush, and if the stock does break above $35, I’d be a seller, legging into my short position and not a buyer, with the intention of covering my short position at or near $35. $30-$31 is a great entry on this stock.

CRM: Although I rarely suggest stepping in front-of a runaway train (i.e. bull market), Salesforce.com appears ready for an extremely short term pullback, ideal for the daytrader. The prior breakout high was 67.72, which directly coincides with the 10d-EMA. But remember, this stock is in a bull market, so when it’s time to close out that short, consider reversing and going long instead of just patting yourself on the back. The actual trade here is on the long side, but the MACD, Doji, and declining volume create three powerful negative divergences.

LONG TRADES

AMZN: Going into the Christmas season, Amazon’s channel checks were bringing back some unbelievable results. In other words, their sales went through the roof. Now we won’t know the extent of the returns they’ll face, but historically, Amazon has been one of those stocks that doesn’t react to the “item returns” line item in their following quarter. The 10p-EMA just crossed the 24p-EMA on Wed. Don’t let the declining volume on Friday fool you, with what appears to the “technician” as a Doji. This is classic chart painting for those that follow technical analysis like it’s their dogma. Friday was a ghost town on Wall Street, so one could have pretty much done whatever they wanted in terms of end-of-day chart painting. That’s why I don’t put too much weight into Technical Analysis as a valid tool in understanding market theory, especially when it comes to the markets’ micro-structure. If anything, it must be used within a much larger plethora of quantitative tools. With regards to Amazon, the stock spent the past 2 months consolidating the move from $92 to $125. Above $140 it’s a potential buy, using the 10p-EMA as your stop.

BCS: As I said before, I’m not a huge fan of Technical Analysis, but that doesn’t mean I’m not going to make myself an expert at it. It’s just another tool in my arsenal. Barclays bank, if it hits $15, will have corrected 40% since its’ October highs. Remember, this is the ADR so it’s thin. Not a daytrading stock at all! I think $15 is a low-risk entry point, perhaps risking $0.70 to make about $3 to $5.

BRCM: Something tells me this stock wants to test $35-$36. For a long position, use the 10d-EMA, leg into your long position, and leg out as it approaches the whole number.

CEO: Something of an anomaly in China, with a P/E of 16 and an EPS $9.57 per share, their 5-year growth rate is phenomenal but their most recent numbers aren’t all that great, but which oil producer didn’t suffer this past year? The anomalies lie in their TTM growth rate of almost 56% while their debt to cover ratio is 2.6 with their peer group being closer to 1.26! I wish American companies were run as tight as CNOOC. Their costs of revenues have shrunk while their income has stayed relatively flat in spite of the dramatic collapse in oil prices. As a long-term position, I would start building a line around the 155-157 level and hold it until at least $200. However, during that time, you should always trade around your core position to lock in Alpha. Here are some ratios for CEO:

CP: Watch the $55 level. Having closed $.25 below it, I’m fairly certain it will bust through $55 in order to clear out the stops resting there, then will fall back down below to nail the ensuing protective stops established on the prior buy through $55. Nonetheless, the stock is in a powerful long-term uptrend which will prevail for the foreseeable future, if not the next several years. For short-term traders, the $55 level will provide for rapid trading on both sides, for the long-term swing/position trader, wait to see what happens. These stocks don’t move like tech stocks, although last year a few did. I actually look at this stock, and the sector, as a growth sector. So for them to have low double digit P/E’s and paying out dividends makes this a solid play, especially with the macro backdrop I mentioned. Lastly, as the Great Sage of Omaha likes to say: “Does it generate cash that ends up in their bank accounts? If it does, I’d like to take a look at the stock”.

CSX: Another railroad breaking into new 52-wk highs. Everything looks good here except the fact that the market broke above the 52-wk high on the day after Christmas, which means a lot of stops were just cleared out and the next step is likely down before ultimately resuming its uptrend. So if you’re a daytrader, feel free to trade the short side and then reverse. All you others out there, keep an eye here and go long when you see the whites of their eyes.

CYOU: Remember this Chinese stock went public May of this year. Once the majority of lock-ups expired, insiders cashed out, as expected. Now, 28-30 has become a major accumulation zone and the stock appears ready to break out. Yes we were on Christmas schedule last week, but the Chinese are communists. First upside target is $40

DRE: Duke Realty bottomed around $12 in March and after regressing back to the $10 level where it should have been if there weren’t a liquidity crisis, the stock seems to be poised for an extended up move. All my models have triggered on this one, which is rare and actually makes me a tad more cautious rather than feeling like I should go all-in. However, the stock has had 7 green sticks in a row, so be patient and buy it on a test or break below $12 and keep legging into the trade until $11.

EQIX: This is the trend followers dream stock. Every single metric is growing at an impressive pace, and the company is throwing off cash by the truck-load, and almost all of it is being plowed right back into the business. Obviously, the stock has the benefit of every single moving average below it, with the most consistent being the 10d-EMA (as always). Since $100 is a whole number which has yet to be tested following the recent break above that level, I’d like to buy it around $100, legging into my position as always.

ESLR: Another potential high flier when it gets wings is Evergreen Solar. The chart below shows a very sensitive and potentially explosive move. However, although I put the odds in the favor of an upside breakout, there is a chance there will be a quick spike down to shake out all the weak hands, so be careful and watch.

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I’m watching the 70.50 level like a hawk in Oil, as are several prominent hedgies I dialogue with on a daily basis. Right now, until Crude breaks above $71, I really like the spread of Short Crude vs Long Nat. Gas. I would lift the short side on a sustained break above $71 in Crude and get long and strong the entire energy complex, including equities.

The Dollar is beginning to weaken across all currencies rather than isolated instances, as was the case throughout the summer, when the Greenback showed strength against many majors. However, it now appears the floor for the US Dollar is being tested and probes are underway to see where the Federal Reserve will likely begin to increase its open market activities along with the US Treasury. It’s too early for a “strong” dollar in this economic bounce. Too many talking heads came out and said the worst is behind us. Which of course means that it’s not.

Keep an eye on Copper. China opened its mouth at the start of summer and swallowed this base metal like a wild boar, which threw off a lot of macro models because Copper is, of course, watched as a leading indicator of economic recovery. However, being that China was behaving like the gluttonous behemoth that it is, it could have just been a strategic build-up of reserves, or a hedge gone bad that needed to be covered. With China, we never know these days. Capitalism being so new to them, they’re like an over-grown kid on a high school football team that’s never played the sport but the coach puts him in there because he’s so big. Clumsy and stupid at times, ultimately very bad at playing their cards close to the chest and equally bad at not giving out the wrong signals and then chasing their own tale ex-poste.

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Lawrence Summers, senior economic adviser to Barack Obama, US president, told the Financial Times recently that the Group of 20 countries should agree to boost government demand. On Monday Christina Romer, chair of the White House Council of Economic Advisers, said: “The more that countries throughout the world can move toward monetary and fiscal expansion, the better off we will all be.” (emphasis mine)

Jean-Claude Juncker, chair of the “eurogroup” of ministers, said: “The 16 finance ministers agreed that recent American appeals insisting Europeans make an added budgetary effort were not to our liking.”

But European ministers are concerned that building up more government debt would threaten the stability of the eurozone and say that they want to assess the effects of spending boosts that have already been passed before considering more. The US Treasury declined to comment on their remarks on Monday.

A new European Union policy paper, due to be approved by finance ministers today, calls the prospects of a return to economic growth next year “highly uncertain”.

Ouch. I do recall hearing this over the audio squawk during market hours, and the market went into a sharp sell-off. These days, that’s more likely to be a bear raid during a vulnerable moment in the tape. Either way, a professional trader should not forget to pay attention to these minor details.

After the powerful bear market rally of the prior two days, gold and bonds are both being bid higher. The Yen is starting to rally. Asian stocks couldn’t pick up on strength in US equities. Market breadth is deteriorating. Watch out below…

JPM- Top name. Target size is 3 boats. Work hard for it. Confirmed/Qualified 12 count.
Assume all insiders have been massive buyers over prior several weeks at unheard of prices. This is where crowd psychology starts to shift, and the beginning of the momentum shift is always the toughest AND most profitable. FOCUS…FOCUS…FOCUS…

MS- #2 in sector. Amazing accumulation all day long.

If SKF < $149 then 134, 127, 123.50. If enough stock not in inventory, look at FAZ short (non-threshold stock)

Homebuilders at lower end of this base. I see this group as a leader over next several quarters. Perfect pscyhology trade: CTX, LEN

OIH/ERX/USO/UNG- Confirmed 9 count with nice looking stick. Entire energy complex poised to readjust for some recovery of demand. Spread between WTI and Brent closing, indicating a market in less distress. Will there be too large of a gap? Note, nat.gas stocks deeply depressed and heavily shorted (CHK, CNX,

FAS/BGU- Wow, this is a first. A confirmed AND qualified 9 count reversal in a triple LONG ETF. Load the boat.

UYG- Red flag on Dow Jones US Fin’l Index. Today was an inside day to Tuesday’s massacre on huge volume. Action should be in commodity and infrastructure stocks; use financials to balance Long/Short book.

BAC- 10 count, unqualified but VERY close. Anticipate qualification if possible.

CME- What a powerful rally all day. Very impressive and shows enormous velocity. Much energy still remains in this rally. Manage Thurs. gap and ride back to $225.

CRM/VMW- Expect big upside gap, but certainly confirmed pivot. Would like to catch some of this move to $35/$26.

JBL- Nice pivot. Back to $8. Also: MRVL, MBI

WYNN- Unqualified 9 count. Watch.

CAT- This could be final pivot I was waiting for. This is the “infrastructure” general.
X- Perfect base built on $30. To $38 first stop.
AKS- Excellent oppty. to pick up under $10. Last call before this ship sails…
ACI- Similar base at $16. Good for pivot reversal to $20. Huge positive divergence in Money Flow during last break to new lows in November.
AGU- Same set-up as ACI.

Look, all correlations are still at 1, so why spread out across so many names when we can just take a massive position in one of these? See if there’s any edge gained from building portfolio versus acute concentration in a few names.

Airlines downgraded on a day like this? What does this remind you of? Back in the days when big boys would downgrade in the face of a rally as large institutional clients have unfinished accumulations in the pipeline at specific price zones. This is cash money to the firms, they need these orders filled or it will decimate their month-end post-trade reporting. Most of the pain taken by American anyway. Others sold off from arbitrage traders.

AAI- Buy this already and stop looking at it. This is silly. Get long and strong.

Got to watch solars. This is their line in the sand where this rally should take off. Positive wires on solar and Obama today and should likely continue.

THUR-
Heavy volume on the sell-off. Market’s spooked by the lopsided gov’t. As expected, but didn’t exploit.
Monitor airlines for entry levels (see below).  Many charts look like gaps from Tuesday were closed. Only problem is volume expanding across the board. So many charts look terrible, I feel like we’re going to revisit the lows. This is all because the Dem’s came 1 senate seet away from a super-majority. Maybe we will become full-blown, open, French style socialists. Who knows.

Short Looks-

AGU, POT, AMX, BAC (maybe), CRM, FSLR, GENZ, GOOG (monitor), ISRG, PCLN, WLP,

Long ideas-

JPM, QID, SDS, SKF, UNG (lower), UYG (S2 around 7.30/.85), V (inside day on declining volume),

AAPL has huge support at 100. Monitor this for market directional clues.

CHINA:

A moment of reckoning for many hedge funds may come at the end of this month, when their exposure to credit default swaps must be “marked to market” to reflect the increased obligations at the end of the third quarter.

Olivant, the investment group run by former Abbey boss Luqman Arnold, revealed last week that its 2.8% stake in UBS was held through an account at Lehman in London which the firm’s administrators are refusing to release.

Oct. 3 (Bloomberg) — Maverick Capital Ltd., Greenlight Capital LLC and The Children’s Investment Fund Management LLP fell more than 12 percent in September as stock hedge funds posted record monthly losses and braced for client defections. Lee Ainslie‘s Maverick Capital declined 19.5 percent and Greenlight Capital, run by David Einhorn, was down 12.8 percent, according to investors in the New York-based funds. Children’s Investment, overseen by Chris Hohn in London, fell 15 percent, based on a preliminary estimate.

Stock hedge funds fell an average of 8.6 percent in September, the biggest one-month loss since Hedge Fund Research Inc. began collecting data in 1990. While that was better than the 12 percent decline by the MSCI World Index, a benchmark for global stocks, industry analysts expect investors to increase their requests to pull money from funds. The poor performance of certain hedge funds will have repercussions in the allocation processes, and it may lead to substantial shifts between hedge-funds strategies and between hedge funds.”

Other managers with above-average losses for the month included Stephen Mandel, whose main Lone Cypress fund in
Greenwich, Connecticut, fell 14.7 percent. New York-based Third Point LLC, run by Daniel Loeb, dropped 11 percent. Officials for the hedge funds declined to comment or didn’t return calls.

Defensive Doesn’t Work

Funds in all investment categories fell 6.9 percent in September, according to Hedge Fund Research’s Global Hedge Fund Index. That’s the worst month for the $1.9 trillion industry since August 1998, when the Russian debt default triggered the collapse of Long-Term Capital Management LP.

Key Problems:

• LIBOR bid only, no offer.
• Commercial paper market shut down, little trading and no issuance.
• Corporations have no access to long or short term credit markets — hence they face massive rollover problems.
• Brokers are increasingly not dealing with each other.
• Even the inter-bank market is ceasing up

The Treasury Tarp plan is an irrelevance if we are at a major funding crisis.

We are indeed at the cardiac arrest stage and at risk of the mother of all bank and non-bank runs as:

-The run on the shadow banking system is accelerating as: even the surviving major broker dealers (Morgan Stanley and Goldman Sachs) are under severe pressure Morgan losing over a third of its hedge funds clients); the run on hedge funds is accelerating via massive redemptions and a roll-off of their overnight repo lines; the money market funds are experiencing further withdrawals in spite of government blanket guarantee.

-A silent run on the commercial banks is underway. In Q2 of 2008 the FDIC reported $4462bn insured domestic deposits out of $7036bn total domestic deposits; thus, only 63% of domestic deposits are insured. Thus $ 2574bn of deposits were not insured. Given the risk that many banks – small, regional and national – may go bust (as even large ones such as WaMu and Wachovia went recently bust) there is now a silent run on parts of the banking system. Deposit insurance formally covers only deposits up to $100000. Thus any individual, small or large business and/or foreign investor or financial institution with more than $100000 in a FDIC insured bank is now legitimately concerned about the safety of its deposits. Even if as likely the deposit insurance limit will be temporarily raised to $250000 by Congress there will still be a whopping $1.9 trillion of uninsured deposits (or 73% of total deposits); thus, a huge mass of uninsured deposits will remain at risk as even small businesses have usually more than $250K of cash while medium sized and large firms as well as any domestic and foreign financial institution or investor with exposure to US banks has average exposure in the millions of dollars. Particularly at risk are the cross border mostly short term interbank lines of US banks with their foreign counterparties that are estimated to be close to $800 billion.

-A run on the short term liabilities of the corporate sector is also underway as the commercial paper market has effectively shut down with little trading and no issuance or rollover of such debt while corporations have no access to long or short term credit markets and they are therefore facing massive rollover problems (over $500 billion of rollover of maturing debts in the next 12 months). Indeed, the market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1 (and down over $200 billion in the last three weeks). Especially banks and insurers were unable to find buyers for the short-term debt: financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent in the last week; but now even non-financial corporations are also experiencing a severe roll-off in the CP market. Discount rates for investment-grade non-financial commercial paper spiked to 599bp for 60 day maturities. More companies are borrowing against or tapping their revolving credit lines. This is largely due to the dislocation caused in the money markets by the failure of Lehman and the subsequent withdrawals from money market funds, which are some of the biggest providers of liquidity in the short term funding/commercial paper. Even the largest corporations are at severe stress: ATT last week was forced to rely on overnight funding for its treasury operations, as lenders were unwilling to provide more long term financing due to fears in money market funds over investor redemption. The CEO said “It’s loosened up a bit, but it’s day-to-day right now. I mean literally it’s day-to-day in terms of what our access to the capital markets looks like,’’ Things are much worse for non-investment grade corporations and for small and medium sized businesses. As reported today by Bloomberg: Almost 100 U.S. corporate treasurers gathered for an emergency conference call yesterday to warn each other that banks are using any excuse to charge
more to renew lines of credit.

-The money markets and interbank markets have shut down as – despite the Senate passing the bail-out bill - yesterday USD Overnight Libor was still at 268bp after reaching an all-time high of 6.88%; the USD 3m Libor-OIS spread widened to record 270 basis points; EUR 3m LIBOR-OIS spread is at record 130bp; the TED spread is at record 360bps (TED was 11bps one month ago); Money and credit markets are dysfunctional also in emerging markets ; and agency bond spreads are also at highs again.

So we are now facing:

- a silent run on the huge mass of uninsured deposits of the banking system and even a run on some insured deposits are small depositors are scared;

- a run on most of the shadow banking system: over 300 non bank mortgage lenders are now bust; the SIVs and conduits are now all bust; the five major brokers dealers are now bust (Bear and Lehman) or still under severe stress even after they have been converted into banks (Merrill, Morgan, Goldman); a run on money market funds restrained only by a blanket government guarantee; a serious run on hedge funds; a looming refinancing crisis for private equity firms and LBOs);

- a run on the short term liabilities of the corporate sector as the commercial paper market has totally frozen (and experiencing a roll-off) while access to medium terms and long term financings for
corporations is frozen at a time when hundreds of billions of dollars of maturing debts need to be rolled over;

- a total seizure of the interbank and money markets.

This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly
scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains
shut down the risk of an economic collapse similar to the Great Depression becomes highly likely.

So what needs to be done?
Even several hundreds of billion dollars in emergency liquidity support to the financial system by the Fed and other central banks in the last week alone have not been enough to stop the seizure of liquidity in interbank markets and the shut down of financing for the corporate sector as counter-party risk is now extreme (no one trusts any more in this crisis of confidence even the most reputable and trustworthy financial and corporate counter-parties).

Thus, emergency times where we are at risk of a systemic meltdown require emergency measures. These include the following six ideas, which are also the key points to be listening for as potential catalysts for sudden market surges to the upside:

-A temporary six-month blanket guarantee on all US deposits (not just those below $250k) combined with a rapid triage between insolvent banks that should be quickly closed and distressed but solvent – conditional on liquidity and capital injections – banks that should be rescued. To stop the silent run on the banking system you do need now such blanket guarantee on all (insured and uninsured) deposit regardless of their size. To minimize lender moral hazard from such action the blanket guarantee needs to be followed by a very rapid triage and shut-down of insolvent institutions to prevent such institutions from gambling for redemption, i.e. acquiring more deposits and making even more risky loans. To limit such moral hazard distortions one can also limit the extended guarantee only to current deposits: i.e. any new deposit above a $100k limit will not be insured.

- Extension of the emergency liquidity support of the Fed (both TSLF and PDCF) to a broader range of institutions in the shadow banking system, especially those directly providing credit to the corporate sector. The TSLF and PDCF are already available to some non banks (the broker dealers that are primary dealers of the Fed). But two of such broker dealers are gone (Bear and Lehman) and the other three are under stress. Goldman Sachs, Morgan Stanley, the other primary dealers and the banks that have access to the TSLF and PDCF (and discount window) have massively used these facilities in the last few weeks; but they are hoarding such liquidity and not re-lending it to other banks, to the thousands of the other members of the shadow banking system and to the corporate sector as they need such liquidity and don’t trust any counter-party. Thus the transmission mechanism of credit policy (the non-traditional Fed liquidity lines) is completely shut down now.

- Some members of the shadow banking system will not receive such liquidity support of the Fed (hedge funds and private equity funds) as – fairly or unfairly – there is no political sympathy for such institutions. This means that the demise of hundreds – and possibly thousands – of hedge funds will occur as redemptions and roll off of overnight repo financing for leveraged investments will cause a massive liquidity – and thus solvency – crisis for such institutions. If hundreds of smaller hedge funds collapse the systemic consequences would be limited (even if in the aggregate hedge funds provide significant financing to the corporate sector). If larger and systemically important hedge funds were at risk of failing the Fed will have to engineer a massive private sector bail-in of such hedge funds (a larger scale rescue a la LTCM) where the prime brokers of such funds are forced to maintain repo exposure to such funds rather than be allowed to shut off such exposure. This is a radical suggestion but the alternative of a Fed liquidity bailout of systemically important hedge fund is not politically feasible given the little sympathy that such funds enjoy in Congress. The refinancing crisis of private equity firms and their LBOs is a longer fuse run as covenant-lite clause and PIK toggles will postpone such financing crisis but make the harder the fall as zombie corporations that postpone restructuring will have a bigger collapse once the financing crisis eventually occurs. But since many of these LBOs should have never occurred in the first place any financing crisis for such buy-outs should be dealt with in bankruptcy court; no public funds should be used to rescue such LBOs and the reckless private equity firms that designed such schemes.

- Direct lending to the business sector from the Fed via extension of the PDCF and TSLF to the non financial corporate sector. This could include Fed purchases of commercial paper from corporations and other forms of financing of the short term liabilities of the Administration to small businesses secured in appropriate ways. Given the collapse of the corporate CP market and the banking system reluctance to provide loans to the corporate sector (credits lines are being shut down) the only alternative to the Fed becoming directly the biggest emergency bank for the corporate sector would be to force the banking system to maintain its exposure to the corporate sector, possibly in exchange for further Fed provision of liquidity to the banking system. The former option may be better than the latter to deal with the looming illiquidity of the corporate sector.

- Have a coordinated 100bps reduction in policy rates by all major advanced economies central bank and, possibly, even some emerging market economies central banks. While this policy rates may not directly resolve the insolvency issues in financial markets and in the corporate sector it may ease liquidity pressures and it would signal that global policy makers are serious about addressing together this most extreme liquidity and financial crisis. Also, some of the radical policy actions that have been suggested here for the US will most likely need to be undertaken also by European policy makers as the liquidity and credit crisis is now becoming global.
- Radically redesign the Treasury TARP rescue plan – possibly after its necessary approval today – to make it effective, efficient and fair. This implies that in addition to a more limited government purchase of toxic assets, you need: a) an emergency triage between insolvent and illiquid and under-capitalized but solvent banks should be made; b) a sharp reduction of the mortgage debt burden of the insolvent household sector; c) and a recapitalization of solvent banks to be done via public injection of preferred shares and matching contributions by current shareholders of the banks. Financial markets have already voted no to this plan (that is flawed in its current form) yesterday when after its passage in the Senate US and global equity markets plunged another 4% while money markets and credit markets seized up even further.

Bottom Line Conclusion:
This credit crisis is both a crisis of confidence and illiquidity and a crisis of credit and solvency. But while the insolvent institutions should go bust we have now reached a point where many financial institutions and now non financial firms may become insolvent because of pure illiquidity; and this would lead to an extremely severe economic contraction similar to an economic depression rather than a mild recession. At this point the US, the advanced economies (and now likely even some emerging market economies) will experience an ugly recession and an ugly financial and banking crisis regardless of what we do from now on. What radical policy action can only do is preventing what will now be an ugly and nasty two-year recession and financial crisis from turning into a systemic meltdown and a decade long economic depression.