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May 2010

Who Will Bail Out the Bailer-Outers?

"At every inflection point of the financial crash, governments stepped in and announced that they had solved the problem. The crisis began in July 2007; central banks stepped into provide liquidity in August, and the Fed cut interest rates in mid-September . The consensus then held that the crisis was over and that bank stocks were cheap. Then came the Bear, Stearns failure in March 2008, in which the remnants of the firm were sold to J.P. Morgan. Financials briefly soared, and the analyst consensus was that bank stocks were cheap—just before Lehman Brothers' failure in August 2008. The Bush administration announced a $700 billion bank bailout in September 2008, and financials rallied, before crashing again in early 2009, amidst rumors of a general bank nationalization. More bailouts followed, and this time, an extended rally.

Each bailout requires more leverage, and puts at risk a larger and larger compass of the financial system. The central banks with their combined muscle crushed all the short positions in the market this morning. But time is against them; and now that the market has had a peek behind the curtain, things will never be the same."

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