The Bernanke “Put” Is Alive and Well

08/27/2007 12:00 am EST

Focus:

Michael Murphy

Former Editor, New World Investor

Michael Murphy, editor of the New World Investor, says chairman Ben Bernanke has adopted the tactics of his predecessor Alan Greenspan in sending a message that the Fed will bail out the markets.

[On Friday August 17th] we all learned that there is a “Bernanke put,” although it is not as strong as, and it's given more grudgingly than, the “Greenspan put.”

In both cases the “put” is that if big financial institutions get in trouble, the Federal Reserve will bail them out. So, if you are a little guy who borrowed money on a subprime mortgage as your one shot to achieve the dream of home ownership, and now your monthly payment is resetting with zero chance of refinancing or selling at your cost, it is time to pack your stuff and get out—you lost.

On the other hand, if you are a big hedge fund, with good Wall Street connections, that overleveraged in subprime mortgages and need a few billion dollars to stay in business and collect your fees,  [Fed chairman Ben] Bernanke will bail you out. You are “too big to fail” as that would introduce “systemic risk” to the financial system.

It really is galling the way that Wall Street portrays itself as the last bastion of cutthroat capitalism, where the free market rewards the strong and crushes the weak. But of course, once they get themselves into a hole, due to their own cupidity, out comes the beggar’s bowl asking for a bailout. And, as seen on Friday, they always get it.

The Bernanke put was cleverly done. Instead of cutting the Federal funds rate, which might lower rates for all the strapped individuals in adjustable rate mortgages, Bernanke cut the discount rate that banks pay to borrow from the Fed by a half a percentage point, or 50 basis points.

The reaction in the stock market was virtually instantaneous. The Standard & Poor’s 500 futures shot up 50 points in less than two minutes. If the Fed had done nothing, those 50 points probably would have been to the down side, hitting the 1326 weekly breakout point.

I’ve seen some talk that the VIX volatility index has to hit 40 before we can say that the downturn is over and a new up leg has begun. That is nonsense. The VIX hit 37.50 Friday and closed at 29.99. Those are high numbers, even for a bear market, and they should help provide enough energy to run the S&P up hundreds of points, if everything else lines up.

As always, we should let the market tell us what it wants to do. Right now, it is saying: “I want to go up.” Don’t be surprised to see little dips back down, testing various minor support levels from the move up. Even a quick, scary decline back to 1404 would not indicate that the Bernanke “put” rally is off course. If [the VIX] comes down slowly or even holds steady in this area, the rally could extend quite far. If it comes down rapidly, indicating that the hot money is getting complacent again, 1530 may be as good as it gets.

Either way, right now you should be fully invested.

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