How to Make 191% Gains as Wall Street Swallows a Poison Pill – Again!

I could start out today’s column by telling you all about how official unemployment is at a 26-year high at 9.5%. I could go on at length as to how unofficial unemployment may very well be double that and we’d never know. Washington regularly moves entire cadres off the unemployed list, once they are satisfied that they have no hope of finding employment.

I could reference the latest report from the American Bankers Association, which warns that adding 6 million to the unemployed rolls has driven consumer loan delinquencies to an all-time high. The ABA notes that the number of borrowers behind 30 days or more has risen to 3.22% while the amount of money that is overdue has risen to 3.35%.

The credit card situation is even worse: 4.75% of all accounts are now delinquent, as compared to 4.52% in the previous quarter. And the balances on those delinquent accounts is up 108 basis points to 6.60% of the value of all outstanding bank card debt.

I suppose I could list the seven banks that the FDIC has closed in July. Or all 52 that failed in 2009. Or even the 80 financial institutions that have been shuttered since the crisis began back some 19 months ago.

“We misread how bad the economy was.” – Vice President Joe Biden

It would not be difficult at all to go on like this at great length.

My desk is awash in such depressing reports. I am literally drowning in ugly economic statistics. Even the spinmeisters in Washington are conceding that its “green sprouts” are shriveling up. Turns out, the situation is considerably more dire than anyone predicted, and the stimulus is not working.

Of course, Washington’s solution is to borrow even more, spend even more, regulate even more, and keep interest rates at zero for the foreseeable future, because in the end, it’s the only trick they know.

But all that generalized economic pain and degradation is not what I wanted to bring to your attention today. Rather, I wanted to point out a specific news item I have found, buried on page six as it were, that has the hairs on the back of my neck standing on end.

Bad Medicine Indeed

Remember all those awful mortgage-backed securities that were blamed for laying Wall Street low in the first place? The toxic assets that the TARP fund was supposed to buy up, except that no one could figure out how to price them or break them up, so they are still rotting away in Wall Street’s dank basement?

Guys in New York got fired for inventing them, right? Heck, guys in Asia got shot for buying them! And it seems like no one can figure out what to do about these ugly tar babies.

As the evil genius in the old serials used to say: “Maybe yes – and maybe no.”

This brings us neatly to our friends at Morgan Stanley (MS:NYSE), who are in a bit of a pickle. They would dearly like to go back to the good old days of million-dollar bonuses. In order to do that, they have to ditch their Washington nannies by paying off some $10 billion in TARP loans.

The Fly in Their Pudding

Problem is, this massive payout would cause them to come up short for the third quarter in a row, to the tune of some -32 cents a share. (Or maybe even -50 cents a share: depends on whom you ask). And then there’s all those “shriveled brown shoots” of economic overhang.

Investors want to know how the heck the bright boys at MS are gonna fill a hole like that. And if they don’t get a good answer but soon, they are going to cut MS shares in half.

But these folks are America’s best and brightest, right? So they have come up with a really cool solution. They are going to pedal off $130 million in collateralized debt obligations or “CDOs.”

Sorry about that. Let me give you a moment to wipe up the coffee you just spit out your nose.

Didn’t Kill Us the First Time, So Why Not Try It Again?

Here are the details on the scam (courtesy of a trio of investigative reporters at Bloomberg). The bonds were the result of some sort of squirrelly deal between Goldman Sachs (GS:NYSE) and a private New York outfit called Greywolf Capital Management.

As is, the horrid things were worth zilch. That is, after all, why the world’s biggest institutions have taken $1.47 trillion in write-downs and losses on CDOs and their ilk.

But with a cut here, a snip there and a little paint, and Shazam! Now you’ve got $87.1 million in AAA-grade bonds and $42.9 million in bonds Moody’s has labeled “Baa2,” a polite Wall Street euphemism for “toilet paper.”

What! You say you don’t have any faith in this magical transformation? Don’t feel bad. Neither does anyone else.

You Can’t Fix Stupid, But You Can Sell It Short

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Here is your Technical Chart for Morgan Stanley (MS:NYSE), showing the breakdown signal as traders began to head for the exits. It generously posits support at $22.63 and $20.26. A rebound off either of these levels could still be construed as bullish in the long term.

However, should this short-term drop build some real strength, a genuine fall from grace could see MS shares hit $16.12 with relative ease. And I should like to point out that a 37% drop like that could power select put options up to 191% gains.

Yours truly,

Adam Lass

P.S. At the upcoming Chicago conference in August, I will be charting out the future of the entire U.S. market, and offering up forecasts – and option plays – for each sector. Anyone who remembers the 2007 and 2008 conferences, where I warned of the coming crash and gave a dead-on target for the bottom, knows just how invaluable these sessions can be to stock and option investors alike.

Other Related Topics: Banks , Economic Growth , Editor Adam Lass , WaveStrength Options Weekly

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