Daily Insight

U.S. stocks rallied in the afternoon session, erasing a 1.7% decline that occurred right off the bat, as transportation and industrial shares turned mid-day on lower oil prices. A late-session move in financial shares also helped the indices advance. Speculation that Lehman may have found a buyer boosted those shares.

As the chart below illustrates, the S&P 500 jumped 3.1% from the session’s nadir, which had the index below the July 15 multi-year low just 30 minutes into trading.

Oil hit the $100 per barrel handle, closing the day at $100.97 and the Dollar Index ended above 80, which is a level I’ve been looking to as an escape from the danger zone – hopefully we hold onto this rally.

One has to assume oil and gasoline prices will rise from here as Hurricane Ike is headed for Houston, meaning it will track through the western edge of Gulf of Mexico production infrastructure and halt a lot of refinery operations.



Market Activity for September 11 2008
On Lehman, the news has changed a bit from yesterday afternoon as it is now being reported the Fed and Treasury are assisting the search for a buyer of the securities firm. At the top of the list, reportedly, are Bank of America, Barclays and HSBC. Supposedly, the government will not provide financial assistance, thankfully; if they get involved in one more deal we may have to start learning French.

This situation is not like Bear Stearns as Lehman is a much smaller firm and other firms have gone out of their way to say they continue to trade with Lehman. It is far from the Fannie/Freddie situation as those were government sponsored organizations. Further, the money markets don’t seem quite as worried this time around as volatility remains more mild as witnessed by the Ted Spread – the price difference between three month futures contracts for U.S. Treasury bills and three-month LIBOR (rate at which banks can borrow from one another). In short, the spread is a measure of risk aversion. A higher reading means investors and banks run for safety and a lower reading means risk-aversion has waned.

The spread has widened, but as you can see not nearly as much as prior events during this whole mess.


On the economic front, the Labor Department reported that initial jobless claims fell 6,000 to 445,000 in the week ended September 6. The four-week average, which removes volatility, remained statistically unchanged at 440,000.

The level of claims remains elevated for the seventh-straight reading (above 430,000 during this stretch) and since the past couple of readings remain at these levels we can no longer blame the increase on the government’s plan to extend benefits – which increased the number of people available for claims and extended the period one can remain on the dole.

As a result, we should expect monthly job losses to remain in the 60,000-85,000 range, but we’ll need the next two weeks worth of claims data to have an appropriate feel for how the September job losses will turn out.

(I will repeat a comment made last week. When viewing the chart below keep in mind that civilian employment is 12 million stronger than it was 10 years ago and 32 million stronger than it was 20 years back. So not only do claims remain below the levels of the last two recessions, but adjusted for the increase in jobs it’s even lower. The current level of claims is obviously unwelcome news, but we feel the need to provide some context in light of the hysterical comments we all hear.)


In a separate report, the Labor Department reported that import prices fell 3.7% in August (that’s on a month-over-month basis) and decelerated to 16% on a year-over-year basis from a 17-year high of 21.6% in July.

A couple of things:
First, it is obviously good to see the figure decline – which was expected as we discussed yesterday on oil’s plunge from its peak and dollar strength. The petroleum products segment of the report declined 12.8% in August.
However, the ex-petro reading was not much changed on a year-over-year basis from the previous reading, up 7.5% vs. 8.0% for July. Further, industrial supplies ex-petro and ex-total fuels (two separate components) were essentially unchanged from the previous reading as well. The first is up 22% YOY and the latter 19.8% on the same basis. Those numbers were 23.3% ands 20.3% in the July report.

Point is I personally remain concerned inflation has become embedded and this data – in addition to others we’ve cited over the past couple of months – may suggest costs in areas outside of energy have not come down much. Overall, the decline in energy is very helpful, but we’ll have to wait for the September reading to get a better overall picture.

I believe my thought on inflation is a minority view, but I just see too much data that gives me question -- the NABE price survey (large business), the NFIB price survey (small business), the Cleveland Fed’s Trimmed-Mean CPI (which does not just arbitrarily take out food and energy but 16% of the most volatile components), core intermediate good within the producer price index and the ISM and NAPM price indices (manufacturing sector) all give me concern on the inflation front.



In another release, the Commerce Department stated the trade gap widened in July to $62.2 billion from $58.8 billion in June. In real terms, the trade gap still widened, although it has narrowed significantly over the past year. Real exports rose 2.0% in July as imports increased 2.2%.

For all of those who desire a narrower trade gap, we’ve often cautioned be careful for what you wish – the U.S. trade gap narrows during times of economic weakness. A wider gap shows U.S. growth is hitting on all cylinders as imports outpace exports.

The nominal (not adjusted for prices) trade gap will narrow big time when the August reading is released, reflecting a large decline in oil prices. The real trade gap may not change that much.


Today we have another morning of big data releases as August producer prices, retail sales and business inventories for July come out at 7:30CT.

Have a great weekend!

Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks rose as investors snapped up energy shares that are trading at their cheapest levels in 18 months (and beyond that the lowest multiples in many years) and FedEx stated current-quarter profit would exceed their forecast, helping industrial and transportation shares.

In addition, Texas Instruments maintained their third-quarter earnings guidance, helping to assuage some concerns over tech-industry revenue growth, which sent the NASDAQ Composite higher.

That said, the benchmark indices did come off of intra-day highs, but closed on the plus side nonetheless.


Market Activity for September 10, 2008

Energy share led the advance, rising 4.12%. Basic material, information technology and industrial shares also performed well.

The news of the day was Lehman’s earnings report in which they stated a third-quarter loss of $3.9 billion as they wrote-down the value of mortgage and commercial real estate assets by $5.6 billion. The firm will also sell a majority stake in its asset-management unit, spin off its commercial real estate holdings and cut the dividend in an attempt to shore up capital and regain investor confidence – which didn’t seem to work yesterday at least as the shares were down 6.9%.

Oil

The weekly energy report showed crude-oil inventories dropped 5.8 million barrels – supplies were forecast to decline 3.5 million. Stockpiles are now eight million barrels below the five-year average. In the meantime, refinery production dropped also as operating rates fell to 78.3% (has been averaging 88%) due to Hurricane Gustav.

Crude prices fell, nevertheless, as demand for fuels (averaged over the past four weeks) declined 3.8%, according to the Energy Department; that is a significant easing. As the chart below shows, the Federal Highway Administration has miles driven down 4.7%.


The Dollar

The greenback is on fire as we’re seeing the more traditional flight-to-quality dollar trade during the current environ of risk aversion. The ECB (European Central Bank) has raised their benchmark interest rate over the past year even as economic activity has weakened – further damaging growth prospects. (Unions have much more clout in the EU – thus they are very able to push wages up as costs rise, increasing the phenomenon of wage-push inflation, something we don’t need to worry about here in the U.S. as our labor market is more free and flexible.)


That said I do believe our central bank has gone too far with its easing campaign – 3.00% fed funds would be more appropriate in my view – but the freer labor market dynamics here in the states has granted us more flexibility with policy.

We were without an economic release yesterday. Well, we did get mortgage applications for the week ended September 5, but that isn’t a major release. Those apps rose 9.5%, following a 7.5% increase in the prior week. Hopefully, we see this trend continue – fixed mortgage rates will fall next week and that should help to some extent.

This morning we get back to it as all eyes will be on initial jobless claims and import prices. The trend in jobless claims is not looking particularly good, so I wouldn’t expect an inspiring number. Then again, maybe we will see some easing in claims as the government’s program that extended benefits wears off.

Import prices should fall – on a month-over-month basis – as the dollar continues to strengthen (that reduces our cost of imports) and lower oil prices will have a large effect on the reading. Still, ex-petroleum import prices are up 8% year-over-year, so we may not see the overall easing that we’re all hoping far.

We’ll also get the July trade balance and the Treasury’s monthly budget statement. The budget deficit has widened this year as the rebate check scheme combined with weak growth has sent revenues lower, yet spending has jumped. That’s too bad because we had driven the budget deficit down to the low level of 1.2% of GDP last year. In any event, the 2008 fiscal deficit is on schedule to come in at $450 billion, or 3% of GDP, which is manageable – the long-term average is 2.5%.

This morning the NYSE will schedule a moment of silence at 9:46 ET – the time American Airlines Flight 11 crashed into the North Tower of the WTC seven years ago.



Brent Vondera, Senior Analyst

Daily Insight

Stocks slid yesterday led by energy, basic material and financial shares as the Dow erased just about all of Monday’s gain and the S&P 500 was pushed back to a level that is just above the July 15 multi-year low – the index endured its steepest drop since Feb 2007.

Financials led the declines, falling 6.6% yesterday, as a 45% drop in Lehman Brothers shares led the index that tracks these stocks lower.

Energy shares fell 6.4% as the decline in oil continues to punish these shares. I guess many have forgotten that these firms will continue to post strong profit results – oil trades at $103 per barrel for goodness sakes. These stocks trade between 5-8 times earnings and are posting high double-digit profit growth.

In fact, there are a number of stocks and entire sectors that trade at attractive valuations, it’s just investors must have a great deal of patience and resolve during times such as these.

Market Activity for September 9, 2008

Oil touched $102 per barrel yesterday, before closing at $103.26 – down 2.90% -- as concern over a global economic slowdown has increased in recent days.

OPEC’s spokesman -- contradicting yesterday’s comments from the Saudi Oil Minister who stated inventories are “healthy” and the market is “well balanced” – is saying this morning that there is a “huge oversupply” and they’ll cut production by 500,000 barrels per day. They have obviously succumbed to pressure from Iran and Venezuela – two of whom are at the least proxies for a Russian voice within the cartel. In reality, Russia should have been granted membership this indecorous group long ago as they run things much like a mafia anyway..

And one more point on crude and the market, I doubt anyone would have thought stocks (as measured by the S&P 500) would be down 3.3% (and barely above the multi-year low set on July 15) as the price of oil has plunged 31% since July 3 and the dollar has rallied big time -- even if the current price of crude remains elevated. But while it looks like all hell has broken loose we have to acknowledge to some extent that heretofore commodity-heavy hedge funds are causing some adjustments.

Hedge funds were riding the commodity gravy train, and who could have blamed them; the Fed’s easy money policy was signaling to those with a traders’ mentality to do just that. But now that the CRB is off by 24% and oil down heavily from the peak, the unwinding of those trades are causing havoc.

Look, we are not out of the woods yet, and maybe quite a way from it; there are a plethora of uncertainties out there – as we talk about nearly each day – and a number of them are capable of creating troubles at any time. But we could also find, a few weeks out, that stocks begin to climb as investors turn their attention to attractive long-term valuations and away from focusing on the anticipation of a potential train wreck.

On the economic front, the Commerce Department reported wholesale inventories rose 1.4% in July and as expected sales declined; they slipped 0.3% in July.

This decline in sales is very normal as activity was robust over the previous four months – up 26% at an annualized rate.

Further, sales were largely hurt by petroleum sales. Excluding petro, merchant wholesaler sales climbed 0.8% in July and are up 12.8% over the past six months at an annual rate – 12% three-months annualized.

We’ll note that machinery sales were also weak, falling 3.7% in July. However, this segment had been on fire, up 22% annualized over the previous three months, and these big-ticket items are volatile. One has to expect a decline in machinery sales after this activity. I suspect they’ll bounce back as the energy industry continues to hum and incentives to increase business equipment remain in effect through year end.

With regard to the impact on GDP, the rise in wholesale inventories – twice as much as expected – offers good evidence business-retail inventories will be stronger-than-estimated (we get that number next week) and we may see this result in another upward revision to the Q2 GDP report.

The inventory-to-sales ratio did move up but remains at an extremely low level historically, as the chart below illustrates.

Important point, automotive inventories alone rose 2.3% in July, but last week’s auto sales data showed inventories were trimmed substantially due to incentives that helped August sales activity. I’d look for wholesale and overall business inventories to move back to a record low when the August number is released, which provides a strong indication the production needed to rebuild stockpiles will keep overall economic growth positive.


In a separate report, the National Association of Realtors stated pending home sales for July fell 3.2%, breaking a very nice trend that had this figure up 32% at an annual rate over the previous three months. Pending sales in the West plunged 10.6% and 7.5% in the Northeast. The South region was unchanged from the prior month and the Midwest posted an increase of 2.8%

Mortgage spreads, until the past couple of days, remained historically wide and this hasn’t helped the housing market. After the Treasury Department’s decision to take the mortgage GSEs into conservatorship that has changed as spreads have narrowed and mortgage rates will fall substantially next week. Still, this won’t solve things as those that put little-to-no money down, or do not have a meaningful down payment will find little help outside of the FHA program.

The big issue with housing is a speculative bubble has been burst in many regions and the decline in prices will simply run its course until the overhang of home supply is absorbed. Once buyers get a sense that prices have bottomed, sales will begin to ramp up in a consistent manner. It will just take time, there is nothing the government or anyone else can do about it.

What can be done for the economy as a whole is for Congress and the next administration to reduce tax rates on incomes and business, make permanent increased current-year write-down allowances and bonus depreciation schedules, and keep the rates on capital and dividend returns unchanged at the least. This will do three things:
One, it will restore investor confidence and thus drive equity prices higher.
Two, it will keep the boost we’ve seen in capital spending over the past few months alive, which will boost GDP and drive future productivity gains via the new equipment.
Three, it will lead to job creation as small business is this economy’s largest job creator – remember than two-thirds of those in the top federal tax bracket is small business. All three of these factors will have a beneficial effect on housing, over time.

It will also help if the Fed learns from this harsh lesson not to recklessly push interest rate to levels that encourage the behavior that led to the housing excesses we are now watching correct. Keeping fed funds at 2.0% or below for the three years that ran November 2001 – November 2004 was a grave mistake. Hindsight is 20/20, but we were calling for the Fed to raise rates at the end of 2004, as longer-term readers may recall, as it was evident the economy was running on most cylinders by the end of 2003.

We’re without an economic release today, but will get back to it tomorrow with the July trade balance, August import prices and initial jobless claims.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks climbed yesterday, on the view that the government takeover of the mortgage GSEs (government sponsored entities) will stabilize the global financial system battered by half a trillion in write-downs since August 2007.

The market actually held onto most of the early session’s gains – although it didn’t look that way by midday as the chart below illustrates – all sectors but energy and basic materials enjoyed a nice day with financials, consumer discretionary and industrials jumping between 2.4% and 4.7%.


Market Activity for September 8, 2008

Advancer whipped decliners on the NYSE by a 30-to-1 margin and volume was pretty strong as 1.7 billion shares traded on the Big Board.

The S&P 500 is still 19% below the October 9 all-time high, but we’ve bounced back to 4.5% above the multi-year low set on July 15 – it will be important to remain above that mark. Even if we do, investors will likely need to lean on patience as the next short-term event is Hurricane Ike and longer-term the election.

Oil prices have moved back to the $104 per barrel handle this morning (for the first time since April) on news the Saudi Oil Minister stated inventories are “healthy” and the market is “well-balanced” at the cartel members’ meeting. OPEC is expected to keep production unchanged. While this is a big plus, weather-related events do threaten the welcome trend in crude prices. If Hurricane Ike maintains its current speed it is expected to keep south of major oil production facilities in the Gulf of Mexico and we could test $100 per barrel. If it does not, all bets are off.

On the economic front, the Federal Reserve reported that consumer credit rose half as much as expected in July rising $4.6 billion for the month, which represents the smallest increase this year – the financial press will focus on this point.

However, while the media will cite stricter lending conditions, leading one to believe credit is hardly available, we’ll note a reading of this nature is not unusual especially following several months of strong increases – which was the case in the prior six months of the year. What helped to drag the figure lower was the slump in July auto sales as gasoline prices jumped and consumers shunned SUVs and trucks.

For sure credit standards have tightened, but is this a bad thing? – especially in light of the fact that there have been little-to-no standards at all over the previous couple of years. I saw one report quote someone as saying the consumer is “stuck between a rock and a hard place,” but it is not because the availability of credit has disappeared, but more because real income growth has been hurt by accelerating rates of inflation and the ancillary effects of higher energy prices, even if those costs have come down of late.

Credit spreads have widened, thus the cost of money is higher than it otherwise would be with benchmark interest rates at their currently low levels but this latest report on consumer credit showed the cost of money actually fell for car loans – the average interest rate for new car loans fell to 3.31% in July from 5.49% in June as dealers offered incentives. For those with strong credit scores sub-1% financing is available. The loan-to-value ratio rose, not exactly a situation that takes place in an environment with which credit is scarce.

While financial institutions have become more cautious from an overall perspective, things have hardly progressed to the point that we need to worry credit has dried up and thus the economy will grind to a halt as a direct result.

In fact I would take a more optimistic view – and I’m not being Pollyannaish here as you all know I’ve got my concerns – as we’ve seen the consumer credit-to-disposable income ratio ease slightly even as the Fed continues to subsidize debt via their easy money policy. It’s saying something when this figure flattens out or dips slightly even as interest rates remain historically low – it’s a long-term plus that credit standards have become more reasonable.

So we have the media that is not happy when credit expands “too much,” for fear the consumer is spending beyond his/her means. Yet, when the borrowing figures rise less-than-expected, that isn’t good either. I would say the economy is adjusting to the realities of the economic environment just fine overall, even if is unpleasant during such periods as stocks struggle to gain ground and these adjustments make for trying times.

Mortgage Spreads Narrow

The temporary government take-over of Fannie and Freddie certainly helped stocks yesterday, as it also helped to bring mortgage rates lower. The yields on Fannie Mae mortgage-backed securities fell 40 basis points, narrowing to 150 basis points over the 10-year Treasury – that spread was 190 basis points on Friday and widened to 212 basis points in early August. This means the 30-year fixed mortgage rate will come down to a level that more closely mirrors the historic average, relative to Treasury rates. When these rates adjust to this reality next week we’ll be able to provide a chart of this picture.

Looks Like We Have a Race

Game on in the race for the White House as both the polls and pay-to-play Intrade has either McCain pulling away or the race narrowing.

Polls (of likely voters) show McCain is up by 5-10 points over Obama. But forget these polls; they can be wrong up to the final day as we found out in 2004. Pay-to-play Intrade betting has McCain gaining momentum, making a game of it. Obama remains in the lead according to this source, but the McCain surge is significant and one person is directly responsible – Sarah Palin.

The charts below show you pay 46 cents and get a buck if McCain wins. Pay 53 cents and get a buck if Obama wins.

Hard telling how things will play out, but the important thing with regard to the market and economy is that this tightening has helped ease the worry over tax rate changes, even if just slightly. This new surge, if you will, has caused the Obama campaign to state they may just defer their plan to raise taxes on income, capital and dividends. While politicians say a lot during a campaign, and do something entirely different when in office (no matter the party), this change may give investors a little solace – now that gives me something to believe in.

This morning we get pending home sales for July and wholesale inventories. Pending home sales will likely show a decline as the figure has jumped 32% at an annual rate the past three readings.
On wholesale inventories, we’ve got to expect the underlying sales data will slip after four months of huge sales growth that has sent the inventory-to-sales ratio to an all-time low. Merchant wholesaler sales jumped 26% at an annual pace over the past four readings and one should expect a pull-back in sales as a result.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks didn’t take kindly to the large increase in the unemployment rate as the benchmark indices began the morning session down roughly 1.5% across the board. However, the market reversed course in the afternoon as people realized, while the economy has lost jobs for eight-straight months, the losses remain mild relative to the typical labor-market downturn.

In addition, most of Thursday’s decline a significant move, was in anticipation of this employment report as the jobless claims data offered an indication losses would continue. Point is most of the damage due to this event occurred on Thursday.

Also, possibly helping to spark the reversal was a report from Barton Biggs – a well-known market strategist – that stocks are “pretty close to a bottom” and can mount a “powerful” rally from here. Although, we’ve heard this from Mr. Biggs before, only then to see stocks make new multi-year lows. (This is not meant to disparage Biggs, whom I admire, just stating the fact.)

Market Activity for September 5, 2008
The chart below shows the strong rebound from the day’s low point – up 2.00% from that intraday bottom.


Financial, consumer staple and basic material shares led the rally – financials were up 3.23%, consumer staples added 1.00% and materials 1.13%. The worst-performing group was utility shares, down 1.75%.

On the economic front, the Labor Department reported the economy shed 84,000 payroll jobs in August, which was a bit higher than expected but meaningfully less than the whisper range of between a 100,000 -110,000 decline.


That said the previous months’ job-loss figures were revised up. Prior to these revisions the monthly job-loss average year-to-date was 66,000. That average has moved to minus 75,000 per month due to these adjustments.

Again, the economy lost 84,000 payroll positions in August – according to the initial estimate at least – as the majority of these losses where in manufacturing and business services. Manufacturing, lost 61,000 and business services shed 53,000. (I’ll note, most of the manufacturing decline came from the motor vehicle and parts segment of goods-producing industries as auto-land employment declined 39,000 last month.)

Interestingly, construction lost only 8,000, which is a major improvement relative to the past few months – we’d averaged a decline 41,000 monthly construction jobs prior to this report year-to-date. The bright spots remained education and health services, adding 55,000 combined (38,000 pick up from health services and 16,000 in the education sector).

The unemployment rate jumped to 6.1% from 5.7% in July and is higher by a full 1.7 percentage points since hitting a multi-year low of 4.4% in March 2007. Although, I think it is safe to say that that low-point for unemployment was a bit artificial as it was the former (as opposed to the current easing campaign) very easy monetary policy stance by the Fed that led to housing-industry excesses and the big jump in construction employment as a result. It is more appropriate in my view to gauge the current increase in unemployment to the 5.00% level reached prior to those excesses totally taking hold – which is still a significant rise that amounts to roughly 1.6 million in jobs losses – this includes the self-employed.

The civilian labor force (those currently employed or looking for work) rose 250,000 in August, while household employment declined 342,000. So, we had 250,000 new entries – those looking for work – which is why the unemployment rate shot up to 6.1% as the labor market lost jobs in addition to those new entries. To add, much of the rise in the unemployment rates over the past few months was due to the teenage segment of the report. Not so in August as it was all adults.

(Just to clarify for new readers, there are two reports that encompass the monthly jobs figures. One is the establishment, or payroll, survey. This is the number you see in the headlines and this is where the 84,000 jobs lost in August came from. It is a survey of 400,000 businesses. The second is the household survey, this is the figure that is used to calculate the unemployment rate – it’s a survey of 60,000 households and includes the self-employed.)


Average hourly earnings accelerated to 3.6% on a year-over-year basis, from 3.4% in July. This is quite helpful and good to see a slight acceleration. Another positive from the report, and not touched by most, was the percentage of private companies adding jobs rose to 48.9%, the highest in many months. Not sure this is the start of a trend, but it’s something to watch for indication the labor market scenario may flatten out in the coming months.

What does this job’s report say for monetary policy? It increases the likelihood Bernanke and Co. will actually cut their benchmark fed funds rate – that’s right, I said cut. This would prove to be a very large mistake if in fact they do so – in my personal opinion --, but their flawed Phillips Curve models will point them in that direction with the unemployment rate jumping to 6.1%. (For additional perspective, the current unemployment rate matches the 30-year average, but the Fed will take notice to the jump from 4.4% last year and possibly think they have a green light to reduce rates without sparking inflation. Not saying this will happen, just that it wouldn’t surprise me if it did.)

The economy is not in terrible shape even though these jobs reports are less than encouraging. A number of sectors continue to show nice progress and from an overall perspective just look at business sales (a chart we show regularly), which remain on an upward trajectory rising 6.5% year-over-year. What we are seeing within the labor market is a housing and auto sector drag that is causing firms to cut jobs within goods-producing industries – that’s where the pressure is coming from.

However, for the auto-sector at least, the latest auto report showed incentives are clearing inventories and leading to a mild increase in sales – even if they remain depressed from a historical perspective. There is evidence however, that auto production will extend upon August’s increase (the data we saw on Wednesday has changed my mind in this regard). Housing will remain weak for sometime, but a little boost from the auto sector will do a lot to keep manufacturing activity near or slightly above the expansion/contraction cut line. Many segments within the industrial sector remain upbeat. The Fed’s models though will likely push them in the wrong direction in my view at this time. We shall see.

Fannie and Freddie

The big news of the weekend came from Hank Paulson and the Treasury Department, stating the two housing GSEs Fannie Mae and Freddie Mac would be placed in conservatorship – which means the government, via the Federal Housing and Finance Agency (FHFA), will take them over and shore them up until the housing market stabilizes. This was not triggered for fear of imminent collapse – both have capital that is above the requirement, but further housing-sector losses would test that capital position in time and this was the furthest point from the election, yet after the conventions, to take such action. Prior to this, Paulson’s hope was that simply talking of a government backstop would calm markets; alas, that strategy only made things worse.

The terms of the plan will be to eliminate dividends on common shares and at least suspend dividends on the preferred. Interest and principal will continue to be paid on the subordinated debt and one would expect over the next few days for mortgage-backed bonds to perform well.

The Treasury will extend their credit facility to both Fannie and Freddie to $100 billion each in order to make sure they maintain a positive net worth. The Treasury will also receive $1 billion of senior preferred stock and 10% interest on the stake. As a condition, the two GSEs will have to shrink their portfolios, not to exceed $850 billion as of December 31, 2009 and shall decline 10% per year until it reaches $250 billion. (Currently, Fannie’s portfolio stands at $758 billion.) The point of the December 2009 timeline is that this is a relatively safe bet the housing woes will have run their course by this point. Longer-term this will be a very good thing because if they are currently too big to fail, then the logical solution would be to shrink these behemoths. I do believe this plan to shrink their portfolios must first be approved by Congress, so it’s not official just yet.

Stock futures are up big on the news so the effort by Treasury will result in at least short-term market strength.

Have a great day!

Brent Vondera, Senior Analyst