Negative.

No matter how bad things get, they would be WORSE BY ORDERS OF MAGNITUDE HAD IT NOT BEEN FOR FRANKLIN DELANO ROOSEVELT. What do we mean? What we mean is: DEPOSIT INSURANCE. For all the nonsense about markets taking care of their own problems, correcting themselves, etc. the bottom line is that such "natural" liquidation comes at a very, very steep price. And what is this price? DEPRESSION AND DEFLATION.

Let us consider briefly the aftermath of previous bubble bursts. One of the most famous of these is the South Sea Bubble of the early 18th century. The expansion of this bubble to insane levels led to a financial collapse and to capital losses which, by some accounts, produced an ECONOMIC DEPRESSION in England which lasted for perhaps 60 YEARS! The collapse of the Mississippi bubble in France led to straitened economic circumstances which may be viewed as the possibly decisive, long-term source of the overthrow of the social and political system of France which occurred in 1789 and during the subsequent years of the French Revolution.

Having considered the banks as loan sharks, we now wish to consider them from a different vantage point: viz., as casinos.

Prudent investment, if it were to be summed up in a single word, could be summed up as:
DIVERSIFICATION. The object of diversification is to insure against the possibility that any one sector or asset loss, in consequence of faulty analysis, bad timing, or unpredictable external shock, will be sufficient to bring down the investor, or even to wreak major damage. Banks, as the custodian of the public's assets, and, in many cases, life-savings, should be held to a very strict standard of PRUDENCE. This, above all, means DIVERSIFICATION.

In fact, the major banks, over the past decade, have demonstrated a recklessness and a wilful disregard of the canons of prudence to a degree which strains the outermost limits of credibility. Instead of DIVERSIFYING their assets, they have CONCENTRATED to a degree which might be acceptable in a high-flying hedge fund where all the participants can easily afford to lose 100% of their investment, but which is far beyond the bounds of acceptability of an institution of public trust whose prudence is the essential prerequisite for a functioning economy and for the financial stability of the nation.

We have been sitting here, reading once again about the plight of the typical credit card holder. We read about folks who have somehow managed to amass credit card debt of $20,000, $50,000, $120,000, and who are now sinking under this mountain of debt. We are also reading about the rate of interest which has precluded these borrowers from escaping the debt-trap in which they have become hopelessly ensnared. Those who have borrowed for the privilege of using plastic as the ENABLER of their impulse buying, of their advertising-induced compulsion to possess all the latest gadgets, the fashionable clothing, meals out, boats, expensive cars, what have you have been paying 22%, 24%, 30% to their friendly credit card issuer. In many cases, the issuer is one of the great, ultra blue chip American banks, which are themselves now in acute financial distress.

These household name lenders seem to us to be usurers. What else can one call lending at 22%, 24%, 30% in an environment where inflation is running at 2% or 3%? This systematic gouging is permitted, if not sanctified, by a Congress filled with lawyers, a president, and regulators supposedly acting as guardian of the economic welfare of the American people.

Today, with the revelation of the latest, most dramatic scheme yet to contain the unfolding real estate/banking system slow-motion crash, Treasury Secretary Paulson has gotten us a 'thinkin. We return, once again, to our start point.

All along, in considering the options available to the government in the event that the credit bubble should burst, we have seen two basic options only. Neither option, in its PURE FORM, is serviceable. Consequently, some combination of the two is likely. However, whatever melange ultimately emerges, the government, and the FED specifically, which must act as the instrument of the government's will, is playing with fire.

Since, with the passage of every day, it seems increasingly clear that the credit bubble either has burst, or is very close to bursting -- a perception, we will admit, which is being fanned by growing signs of panic in Washington -- we must confront the exceedingly distasteful task of assessing the government's options. As noted above, these boil down to 2:

• Option One. Allow the deflation/depression to occur.
• Option Two. Run the printing press a l'outrance.

We detect a new wave of that familiar, happy-happy feeling again. Every manner of "good news" and sunny forecasts are surfacing, seemingly at around the same time.

The current wavelet of optimism -- "structured optimism," shall we ever-so-nastily say -- are comprised of the latest "new" plan to save sinking mortgagees, Mr. Buffett's magnanimous offer to reinsure certain obligations of the drowning muni bond insurers, and intensified Administration reiterations that the economy will avert recession. The topper, we think, is the President's proud assertion that "long-term" the economy is just dandy.

Let us consider first the president's happy long-run prognostication.

We presume that he has forgotten Lord Keynes' celebrated dictum:

"In the long run we're all dead."

As for Mr. Buffett's offer, it is important to read the small print. Mr. Buffett, while grandly asserting that it provides the solution "at the stroke of a pen," did not emphasize that his offer to reinsure certain obligations of the muni bond insurers DOES NOT EXTEND TO THE MORTGAGE-BACKEDS these companies have insured. The mortgage-backeds, of course, are the source of the insurers' distress.

It is frequently useful, we think, to read the analyses and commentary of foreigners about our economy. Often, foreign analysts and journalists have a good deal more perspective than their American counterparts. Apart from those among the former irrevocably hostile to us, the generality of informed foreign observers and opinion-makers have no personal emotional involvement with America's current and prospective economic state.

We feel compelled, at this time, to take note of the continuing flood of vigorous assertions coming from the very highest levels of the Administration and the Federal Reserve that we are going to avert a recession.

We are certain that homeowners will breathe a sigh of relief. Surely, it is most reassuring to those who will have seen the market value of their homes drop 20-50% from the 2005 peak to the bottom sometime in the next few years, and who have seen their equity disappear entirely or move deep into the negative column. Quite a few millions of homeowners, we suspect, will learn first hand what it means to be upside-down in their houses, where their outstanding mortgage debt exceeds the market value of their house.

Why should they mind this mere inconvenience, as long as we avoid a "recession?"

We are also comforted to know that the millions who may wind up losing 20-40% or more of their retirement, even as they watch their home equity evaporate, will understand that the government has been correct: there has been no recession.

Today's news accounts that AIG, the largest property and casualty insurer in the United States, may have "problems" with exposure to derivatives raises anew the question of what we DO NOT KNOW about the true state of financial company exposure to highly leveraged and ultra-high risk speculations which may be ready to explode, or which may have already exploded, but where the sound is being muffled by arcane balance sheet maneuvers.

As every financial market observer worth his salt can tell you, there is always a certain, rather sizable "bezzle" extant. Typically, these "bezzles" only come to light when a general financial panic and market sell-off force their revelation. These financial panics are somewhat akin to the water which buries 95% of a typical iceberg: when the waters recede (ie., when the financial meltdown occurs) the true dimensions and contours of the heretofore concealed iceberg are revealed in all their nakedness.

We were rather astonished by Mr. Paulson's reported February 9th statement in Tokyo, following a meeting of G-7 finance ministers and central bankers. Paulson reportedly said that the global economy faces "downside risks" . He noted that the sell-off in "capital markets" is both "serious and persisting," with consequent increased risk for the global economy. He also noted that the notion that Asian economies had "decoupled" from the American economy was
"a myth." The ritualistic incantation that the U.S. would avert a recession in 2008 we may dismiss as standard pap mandatory for any Treasury Secretary.

Our amazement over Mr. Paulson's remarks derives not from their uniqueness, but from the fact that a man in his position uttered them in public. Mr. Paulson, after all, is not a simple citizen. He is the Secretary of the Treasury. He knows full well that his remarks will be parsed and analyzed ad nauseum, and that they will inevitably carry great weight with the markets and with policymakers. Since he is a very smart man, we must assume that his remarks were made with prior careful deliberation.

We are NOT FORECASTING a waterfall-type decline in the stock market in coming weeks or months. However, we are not precluding it either.

The RISKS have risen for two possible market scenarios, in our view:

• A severe, long-lasting bear market, far exceeding widespread expectations of a repeat of the brief, relatively painless 20% decline of the autumn of 1990;
• The possibility of a waterfall-type decline, a la 1987.

Our growing concern is based upon the continued state of denial of a wide spectrum of "informed" and "professional" opinion about the prospects for the American and global economies, the continued success of the generality of brokers and "financial advisors" in dissuading the mass of investors from selling, and clear signs that the substantial prospects for more significant deterioration in the banking system are being widely ignored.

The principal talking point for the bulls is the relationship between stock valuations and interest rates, i.e., the "Fed model." The price/earnings multiple of the S&P 500 is approximately 17-18x lagging 12-month earnings, as things currently stand. Bulls had been forecasting improved earnings in 2008, and a consequent reduction of the p/e multiple to an even more attractive level, even as competing bond yields continued to drop. A very nice scenario indeed.