Washington Mutual And Bail-Out Fail

U.S. stock futures are pointed to a sharp sell-off this morning, after the proposed $700 billion bank bailout package stalled and Washington Mutual was seized by regulators in the country's largest-ever bank failure.

Yesterday, there was optimism that the bank bailout package would be passed. U.S. stocks rose higher, despite General Electric issuing a profit warning and reports that orders for durable goods had dropped. The Dow industrials closed up 197 points, the S&P 500 added 23 points and the Nasdaq Composite rose 30 points.

The bank package began to unravel, however. A White House meeting blew up in acrimony, with House Republicans refusing a demand from Democrats to come back to the table. The Democrats now insist they will not bring the package to a vote unless Republicans support it.

Adding more fuel to the conflagration, federal regulators seized Washington Mutual and sold it to J.P. Morgan. WaMu was the second biggest originator of "Option ARMs," which were marketed to borrowers via low introductory rates and included various payment options. Those loans often included the option to pay only interest, which caused the borrower's debt to grow with each payment, resulting in negative amortization. When housing prices began to fall just at the time rates were adjusting higher on those loans, borrowers began defaulting at alarming rates, leading to enormous losses for WaMu and others who had extended the credit or purchased securities based on that extended credit.

Make no mistake about it. Our nation's credit market is in crisis. Right now the financial markets are clinging to the hope that politicians can set politics aside and put together a sound bail-out plan. With the Democrats and Republicans at each other's throats in advance of the upcoming election, they may very well invest more time blaming each other for the crisis to win votes rather than working with each other for the good of the country.

With crisis comes opportunity, however. There is a great deal of volatility pushing option prices higher. These markets are no place for the amateur, but if you can avoid the whipsaws and sell-offs there is money to be made.

Mind your risk, and trade well.

Christopher Smith
TheOptionClub.com