The Next Shoe Dropping?

We have been expecting a significant change of direction on April 15 and 16, 2008 in these markets:

Equity indexes, interest rates, currencies, crude and gasoline, and metals.  Currencies are showing already.

The most important direction is that for Treasury interest rates for the next three weeks.  This event will change views and the sentiment of the debt market's relationship between and the equity markets and certain commodity markets.  Industrial production and capacity data from the Fed may be the segue for a new low price level and to the resumption of the equity downtrend.  That is the risk and fear underlying the markets since the Fed's intervention to prevent the debacle centered on Bear Stearns, one month ago.

If the indexes hold up after the Industrial Production data, and then begin to rise late on April 15th from a lateral low on Monday, we will likely enter a partial long position at the closing and fully long on the closing of the 15th or the opening of the 16th.  Late in the month and early in May are the areas of timing clusters for a longer term directional change.  The above is our typical view and strategy for the coming trade. Except for one thing.  Yes, one exception.  Something has been itching to be scratched in the back of our collective minds.  So we began to try to find the cause of the itch.

We looked for some hint of why this turn is going to be so, ... well, seemingly so immense.  We have been sensing something like March 13th -17th government intervention, maybe.  

Maybe the hint is the series of events transpiring over the past few weeks in Jefferson County, Alabama, otherwise known as Birmingham.  A municipal bond failure is the potential.  A bankrupt municipality is not what the U.S. and global economy or markets need. 

The state government of Alabama says it won't bail it out Jefferson County's $5 Billion in debt that is way too complicated to even discuss in a newspaper article.  It will be enough to know that debt service could exceed revenues if restructuring negotiations with the banks, investment banks, bond insurers and other creditors fail to restructure their $847 million variable rate debt (don't ask about the swaps).  They are currently under a 1-week extension to make an interest payment until April 15th! 

If the scenario plays like the Bear Stearns deal, the "panic" low hits on the 15th or 16th, when the ______ (fill in the blank) steps in to back the debt, take over the county government and run their indebted sewer system;  it's the sewer system's $53 million interest payment that is due now.  It's bound to be an onerous, if not an odorous task.  Where's that guy who does the dirtiest jobs in America?

This is a serious concern but is manageable in some way.  If a mini-panic results between the 14th and 15th, the rise off that 'panic low' could be quite powerful early in the move.  That is the positive scenario.  If a bounce ensues into the 15th/16th, and then, the municipality "fails", that would be a very significant "Sell".

We believe a wee bit more than a 50% probability that it will be the former, more bullish resolution - down or lateral into the 15th low, then upward. 

The real questions are these:  Who holds and how much of the Jefferson County debt and its derivatives do they hold?  Does anyone who is big enough (capital and authority) intervene, believe that Jefferson County is "too big to fail" in precarious times like this?

The answer may sound familiar.  There are many municipalities with debt that resembles Jefferson County's all too sophisticated house of cards.  Bond insurers are under the gun here.  They may just shoot themselves to avoid going over the falls with the muni's.  This is another Gordian knot of a hairball, again. 

We want to play the side of "too big to fail" scenario unless the rescue does not show up to play.  Scenarios are fine to consider but the gamers will yield the field to the patient and watchful.  If indeed, an event occurs and is immense in its impact on markets, it won't likely be a domestically contained event.  It may appear to be resolved one day, and then fall apart a day later. 

Kipling again:

IF you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:

Let's hope all working with Birmingham resolve this issue, and soon. 

WBB

April 14, 2008   0600 EDT

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