Explaining Thursday's Rally

CNBC reported Thursday that Treasury Secretary Henry Paulson is trying to set up a government facility that would help banks and brokers clear bad mortgage-related paper from their books much like the Resolution Trust Corp. did in 1989. This is exactly the plan that Cramer’s been calling for on Mad Money.

The news came late in the trading day, but it was enough to send the Dow surging 410 points before the closing bell. The RTC-like facility would buy the very mortgage-backed securities (MBS) that have been at the epicenter of the housing and credit crises that struck in August 2007. This would free financial institutions from the enormous weight that’s been dragging them down, our report said, and most likely boost the housing sector because banks would be free to lend money again.

But this is only part of the solution, Cramer said. There are other important moves the federal government needs to take before we’re out of this mess. He laid out his plan during Thursday’s show.

Federal Reserve Chairman Ben Bernanke and Henry Paulson need to announce they’re buying actual mortgage bonds. Not those made up of home-equity loans, Cramer said, because he doesn’t trust them coming from the struggling brokers and banks, but pure mortgage bonds. Pay 30 cents on the dollar and then hold them until housing turns around.

Cramer said he’s confident homeowners will pay to stay in their homes, but he just thinks it’s going to take about 18 months to pan out. Once it does, these government-owned MBS will regain at least part of their value, probably more. Also, the 30 cents on the dollar figure offers a floor for other investors who want to follow Washington’s lead and start buying the mortgage-backs in hopes of eventually turning a profit.

If Hank Paulson can bailout Fannie Mae, Freddie Mac and AIG, then why not the American homeowner?

Cramer likes the plan because nobody knows how much this bad paper is worth. And the government’s stepping it imposes value. The trend so far has been to price at zero, which destroys a bank’s balance sheet, or to overestimate, which ruins a bank’s credibility, and sometimes the bank itself (think Lehman Brothers).

As for the moral outcry, meaning why save the holders of this paper if they brought this trouble on themselves, Cramer blames the real problem on mark-to-market accounting. If these banks didn’t have to value their MBS on the last price at which they traded, we wouldn’t be in this trouble. (Never mind the fact that MBS trade in an illiquid market that barely exists right now.) It’s not that mark-to-market accounting is fundamentally wrong. But it is causing problems in this environment. If the Fed started buying this distressed debt at 30 cents on the dollar, those problems could disappear, Cramer said.

Cramer also wants Ben Bernanke and the Federal Reserve to bring interest rates down to 1%. Alan Greenspan did in 2003, and things are a whole lot worse now than they were then. Even better: All the central banks of the world should cut rates, forcing Uncle Ben into line.

Lastly, in terms of regulation, Cramer thinks credit-default swaps must be regulated. And he wants to bring back the uptick rule, which prevents a stock from being sold short until it first ticks up in price. The SEC did finally take some steps to bar naked short selling, but Cramer urged the feds to go one step further. These moves would lend this market some much-needed stability.

So what’s the bottom line for investors watching at home? Today’s rally was founded on a rumor. It’s not the dependable we’ve-found-a-bottom rally we need. So take the opportunity to sell some of your holdings into this strength. Take some money off the table. That way you have some cash ready when he hit the next decline. And believe we will have another decline. The key here is to be ready for it.

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