Yeah.

Folding.

As in "The financial system is folding."

I know, I know, The Fed will save us.

Really?

How come they haven't already?

Perhaps it is because they can't? Because they really don't set interest rates, but rather follow the market? Because they know you can't "fix" someone who has borrowed too much by lending them even more money?

Today Jim Cramer and Larry Kudlow, on their respective shows, floated an even more outrageous proposal - to effectively steal at gunpoint several firms in the United States and fold their assets and liabilities into the public debt.

Yep.

The Monoline insurers, specifically - Ambac, MBI, etc.

Why?

If you remember at the end of the year in my "Year In Review" I talked about how, in fact, there is only so much "spread", or potential profit, in a particular debt issue, and that "spread" is determined simply by the risk of the issue.

To reduce it to simple terms, if you have a certain risk of not paying your loan back then that commands a higher interest rate than a "risk free" loan - that is, US Treasuries (loaning the Federal Government is generally thought of as being "without risk".)

The chimera (read: FRAUD) is that you can "lay off" this extra risk and not pay for all of it.

For the sake of argument let's say that the "risk difference" is 200 basis points over Treasuries on a given transaction for a given duration.

If you don't want the risk the only way you can lay it off is to give someone ELSE the entire 200 basis points! If they take the "liability" for less than 200 basis points then you have bamboozled them, and if they only reserved 100 basis points (for example) eventually they will go bankrupt because the true risk is twice as high!

It cannot be otherwise.

But if you do that, then why not just buy Treasuries? After all, why go through this entire exercise if indeed it doesn't make you any money?

The obvious answer? YOU WOULD NOT DO SO!

But these banks and other institutions did.

What we have here is a giant con game.

What has to happen here?

Simple: Those institutions that have managed to con others into taking risk for less than its actual price need to eat the consequences, and what better way to make them do so than to let the monolines all blow up!

Now there will be those who say that "we can't allow that".

To which I say "horsecrap!"

We not only CAN allow it, WE CAN'T PREVENT IT!

There ARE solvent banks in this nation - banks who made PRUDENT loans.

There ARE others who can step in the place of Citigroup, Lehman, Merrill and others.

Why don't Kudlow and Cramer suggest that these banks simply issue enough capital stock equal to their current outstanding, diluting all their existing stockholders by half, and use that cash?

Preposterous? Like hell it is.

Let's look at a few of these banks and their market caps, all in billions.

Merrill Lynch: 44.40
Lehman: 28.32
Morgan Stanley: 47.65
Goldman Sachs: 82.19
Citibank: 121.79
Bank America: 159.65

Total: $484 billion dollars

Gee, we have a $150 billion problem according to Cramer and Kudlow? It would seem to me that the root cause of this problem, the securitization of loans by the above firms (and a few others not included) which were all performed on the basis of improperly laid-off risk, inured to the benefit of these firm's market cap! Therefore, if we are to TAKE capital at gunpoint to solve this problem we should take it from THOSE WHO STOLE IT IN THE FIRST PLACE!

Why isn't this being proposed?

Because this isn't a $100 or $200 billion problem. Its much worse than that, and they know it.

And while they might try to "paper it over", if the government actually tries to step in the interest rate on the 10 year will go north of 10% - way north, perhaps as high as 20% - essentially immediately.

That will squick the Federal Government instantly - Bernanke and Paulson know this by the way, which is why it won't happen. Oh, and so do a good number of the members in The House and Senate. I'm sure they've been briefed and "get it" - although you'll never hear them admit that.

These realities are why you're hearing palliatives on the TV like sending everyone a $600 check.

THAT they can do.

Fix this? Can't. Those who are screwed will be cut adrift.

There is no other choice.

Got debt? You're in trouble - maybe ocularly screwed blind.

Got cash? Real, unencumbered cash? You'll be doing quite well.

Hope you're in the second group, and not the first, because its too late to change where you are in this regard at this point.

Remember, the market is closed Monday - have a great long weekend, and I'll see you Tuesday!

Here's your technical!