As Ron Paul spoke during the hearings on Wednesday (around 11:40am EST), the NYSE TICK plunged. Stocks hate Ron Paul. Stocks think he is a disaster for the economy.

As a life-long libertarian, I never “got” Ron Paul. I have never been a fan. He seemed to always just be frantically regurgitating libertarian philosophy. Nothing he has ever said has struck me as creative, innovative, or original. I understand that much of his stuff is written by Gary North, and I while I enjoy reading North, if one of his essays has Ron Paul’s name on it, I just won’t read it.

During the hearings I heard Paul say the dumbest thing that I have ever heard: that real estate is only worth what the market will pay for at any moment. While that is technically true, during a credit crisis it is totally false.

Suppose I have a house that has been worth $100,000 more-or-less for several years. Then, when I decide to sell it, I can only find one buyer who has $20,000 in cash – enough for a down payment. However, when he goes to the bank he cannot get a loan because there is a credit crisis going on.

So, according to Ron Paul, my house is now only worth $20,000 and I should quit my bellyaching and sell it for what the market will bear.

This is the point where I punch Ron Paul in the face.

Real estate values may be a function of available financing, but the idea that the credit crisis will never end is simply foolish.

Now imagine that Hank Paulson comes along and offers me $40,000. Well, maybe I would sell since it is double my best offer. Did Paulson waste the taxpayer’s money? Probably not. He probably made a deal that will turn out to be very profitable once the credit panic ends.

And if Paulson goes up-and-down my street buying up all the houses on the cheap, his actions would likely end the credit crisis. So, in other words, a buyer of sufficient size cannot only buy a lot of houses on the cheap, but he has the power to make himself right by ending the crisis.

Note: Yes, I know the situation is more complicated than this, but I had to dumb it down so that Ron Paul could understand it.

McCain Crash Scheduled for Friday
Doesn’t seem like the best campaign strategy to me, but what do I know?

Voters Are Against the Bailout?
Here is one provision I think should be part of the bill: any voter who lied about their income on their mortgage application to buy a house that they could not afford should be sentenced to five years in prison for economic crimes against the nation, and disenfranchised. And for you voters out there ‘disenfranchised’ means that you don’t get to vote any more.

Of course, if I had lied to my bank about my income on a mortgage application to buy a house that I could never hope to pay for and then got a HELOC and spent the money on an expensive car and ran up my credit cards into the stratosphere and THEN I saw my Congressman on TV talking about bailing out my bank, I would be outraged too. I would call my Congressman and urge him to drop a BOMB on my bank instead.

See how that works? If the financial system melts down, there’s a chance that all my debts go away and I get a free house, car, and boat in the deal. Sure, it might be inconvenient for a while living in poverty in a barter economy, but I have a negative net worth, so what do I care? And once the new bank is built in the smoking crater of the old one, I could pop in and see about getting a new credit card…

It’s Still Quarter-End
Since the big funds control the vast majority of trading each day, it is still up to them whether or not the market crashes. They will attempt to hold things together just to minimize the horror on the quarterly statements that they send out next week.

But can they do it? It’s not impossible. The selling on Wednesday was very light, and that indicates that all the longs that were inclined to barf-up in a panic at this level already did so last week.

Of course, if the big funds are flooded with redemptions, then they may have no choice but to dump stock. I wonder if the brilliant American voters are aware that they crashed the futures and are now firing off redemption requests and are accelerating the crash that they have voted for. Seems like something that they would do…

I would also expect an exodus of foreign money. Any foreigner who has money in the USA needs to have his head examined. His home country might not be much better, but gold comes to mind…

If the selling volume is light after the open, then the big funds might be able to thwart the McCain crash. But I wouldn’t bet on it until I see it. The havoc created by Congress this week did set up a good buying opportunity in front of Thursday’s rally. Perhaps a raging market panic would knock some sense into people and a bill could get passed in a hurry. Taking a small long position at the height of the panic might not be a bad play.

Crisis Averted!
When I first heard that John McCain was suspending his campaign because of the financial crisis, I thought: “Wow, this thing is getting out of control if the presidential campaign has to be shut down.” But I had it backwards.

As soon as Congress heard that McCain was coming to town, they immediately freaked out. I didn’t realize this until Barney Frank spoke after President Bush’s speech Wednesday night. Frank was apoplectic that John McCain was on his way to steal his “Savior of the Economy and Bringer of Justice to Evildoing Bankers” mantle.

The presidential campaign is the big show of course, and the cameras will turn toward McCain if he inserts himself into the process. And Obama might not be far behind. So Frank went out of his way to assure us that Congress practically had the bill all done and didn’t need McCain’s help.

When Frank first came on TV, the S&P 500 futures dropped to 1186, but after he spoke, they jumped up to 1199. The market doesn’t know what’s in the bill, but I think it is just happy that Congress is not going to legislate a meltdown.

Can the Market Rally?
Here the factors in favor of a rally Thursday:

1. The market stabilized on Wednesday
2. The Congressional crisis seems to be over
3. The market is oversold
4. It’s quarter-end mark-up

The big funds probably got a lot of redemptions during the plunge last week, so maybe they won’t have enough cash to bid the market up this time. But I’m thinking that it was probably them bidding under the market on Wednesday, and that would explain why stocks were flat while Congress sent credit markets into a panic.

Also, we have three important economic reports in the morning. Not that anybody is still paying attention to the economy, but the reports aren’t likely to be rays of sunshine. And of course, bailouts have lost their power to spark rallies.

Gun to head, I would be long for a potential relief rally, though I wouldn’t over-stay my welcome.

Watch the comments for updates throughout the day.

Fade the Goldman Gap?
The market will probably open Wednesday with a gap-up on the Warren Buffet/Goldman Sachs news. So, let’s go back and look at what happened when Buffet announced his last investment in financial companies.

On August 24th, I wrote Buffet Buys Banks? a couple of days after I saw Warren Buffet tell Becky Quick on CNBC that he had increased his stake in either Wells Fargo or American Express. If you go back and look at a chart of the XLF, that was when it looked like it was rolling over. But the XLF gathered itself and went on to make new highs, fleeting though they may have been. In fact, the XLF is still above that point.

Whether or not Buffet was the cause of the XLF’s revival, he does indeed have a lot of followers, so I wouldn’t automatically scoff at this Goldman news. Also, the market is oversold, so it is likely to produce a lasting bounce. Of course, “lasting” is a term that is open to question in this market.

Clown Collage? How About Clown Congress?
Whether or not the Paulson Plan is pure evil or white light, I think the Senate on Tuesday gave the impression that they were a pack of ignorant, hostile fools who didn’t care if everybody’s bank account was erased. It was like Senator Schumer starting the run on IndyMac times a hundred. That was the scariest thing that has happened in this crisis so far.

Watch the comments for updates throughout the day.

…or should I say, “Tuesday’s Gambling?”

The 200-up/200-down market has now become the 400-up/400-down market.

This is beyond my stress tolerance. But my nervous facial twitch is gone, so maybe I can place a small bet or two soon.

Watch the comments for updates throughout the day.

A lot of traders are talking about, and betting upon, a new surge in inflation caused by the bailout plan. But I’m not sure that is a done deal. Putting any amount of money into the banking system will not expand the money supply and stimulate the economy at all if the banks don’t increase their lending.

The Fed has already pumped billions into the banking system, and it has simply disappeared into the black hole. It has not stimulated the economy because the banks have not increased lending. In fact, they have decreased lending and the money supply has not expanded.

So, the moral of the story here is that the Fed does not expand money and credit. The Fed pumps money into the black-hole system and hopes that banks will increase lending. That worked in 2003. It is not working in 2008.

Can the banks swallow up another trillion dollars? Maybe they can because not only is the banking system broken, but so is the real-estate market. As long as house prices are falling and deadbeat Americans have no money for down payments, it will be difficult for banks to inject much money into the economy even it they wanted to.

Banks are hoarding capital as revealed by the Libor rate, which is more than 50% higher than the Fed Funds rate. Any new money injected into banks is likely to go straight into the mattress.

I have written about this before here. In that post, there is a link to the True Money Supply which I think is the best measure to use.

I am not betting on a giant tidal wave of inflation just yet. If it comes, it may be awhile.

Maybe I’m crazy to continue doing chart analysis after Dick Fuld detonated his suicide bomb last week sending all asset classes flying in random directions like so much shrapnel, but let’s just see what we have anyway.

The SPY bull-flag intra-day pattern that I first discussed on Sunday has evolved like this (click chart to enlarge):

The purple line marked “A” is the same. That’s the first half of the flag pole. Remember, the flag flies at half mast. Line “B” is the same height, but it is moved down because we measure from the tip of the flag. So, our upper target keeps falling the longer the flag waves.

Now comes the interesting part. I have stretched out the chart so that you can see that the flag, bounded by lines “C” and “D” has formed into a falling wedge pattern.

Falling-wedges are bullish patterns. Make sure to click the link and read up on them if you don’t know what to look for.

Most intriguing is the last bar. Look at the volume. That increase in buying may signal that SPY is about to break out of the wedge to the upside. Your chart may look a bit different depending on how your charting program makes its bars, but if you look at a 5-minute chart, you will see the surge in buying before the close. As I write, the futures are also up a few points.

If I wanted to short here, I would wait until prices pushed line “D” down far enough to erase the wedge. If I wanted to go long, I would wait for prices to break above line “C” with a surge in volume.

The way it breaks is likely dependent upon what Congress does.

Will the market continue to gyrate in wild swings because traders don’t know what the rules of the game are? Are 1% moves in the major indices just noise now, and much larger moves the norm? Maybe we can get answers to these questions today. After a giant up-wave like we had last week, you would expect the market to consolidate in a much narrower range. Let’s see if it can do that.

Watch the comments for updates throughout the day.

Here is a 60-minute chart of SPY from Thursday and Friday showing the bull-flag pattern that has formed (click to enlarge):

The purple lines outline the pattern. If it completes, the target would be $136, which agrees with David’s analysis (see David’s links in the comments of the previous post.)

While flags are not the most reliable of patterns, it is usually not a good idea to fight them until you see them begin to fall apart.

The market is short-term overbought, so I would expect some more consolidation from here. However, longer term, the market is not overbought at all, so technically, there is plenty of room to run up the second half of the flag pole.

This is an intra-day pattern, so it does not carry the same weight as a multi-day pattern. Also, SPY’s volume increased in the last two hours on Friday which is a sign that the flag may unravel. Volume is supposed to remain light in the flag-part of the pattern as longs take profits and traders wait patiently for a pullback to initiate new longs. SPY could correct more than it already has, but volume is still the key.

Another problem is that flags are continuation patterns, not reversal patterns. However, since the Brits announced their ban on the short selling of financial stocks while the US market was still open, we may have a legislated bottom that will not look “normal.”

And finally, knowledge of technical chart patterns has been developed during an era where short-selling has been allowed. Will chart analysis still work while the shorting of stocks in the most important sector of the market is outlawed? I don’t know the answer to that, but I’m sure that there are traders somewhere with experience in the Chinese and Pakistani markets who could tell us.

Since this relief rally is occurring while the economy is contracting, it has to be classified as just another bear-market rally until proven otherwise.

I see a lot of traders around the web getting excited by this ban on short-selling financial stocks. Why don’t we take a look at how well banning short-selling has done in another major market. Here is a chart of the Shanghai index from Yahoo Finance (click to enlarge):

Hmmm…a drop from 6000 to 2000? …doesn’t strike me as bullish…

If anybody knows the history of the ban on short selling in China, please post a comment. After a few minutes of searching I wasn’t able to google-up anything beyond the fact that the Chinese don’t allow short selling.