FORTIGENT, LLC

Economic & Market Update: 

SEPTEMBER 8, 2008

Chip Norton

Managing Director of Fixed Income & Economic Analysis

chip.norton@fortigent.com

“They Were Indeed Too Big to Fail”

Last Week’s Highlights:

Stocks:                                Dow 11.2k – Ready to rally         

Bonds:                                Treasury 10-yr 3.65%- but surge on bailout news

Oil:                                     $106 and dropping

Gas                                    $3.64 – Two months of decline

Dollar:                                $1.42 euro, 108 yen – Dollar Strength continues

Employment                     6.1% - Above expectations

Economics This Week:

Date      Item                                  Est.                     Comment

9/11       Trade Balance                    -$58bil                  Dollar continued to help

9/12       PPI                                     -0.3%                    Finally help from lower oil

9/12       Retail Sales                         0.2%                     A lift from July

On Sunday, the Treasury Department announced the long expected bail out of Fannie Mae and Freddie Mac.  Like it or not, the markets have already begun to react and this week’s equity market open is poised for a very strong rally. 

The debrief is that the Treasury Department said it will invest approximately $100 billion in each of the companies to keep them from going under. Although, that number is speculated to be as much as $200 billion over time. In turn, the US will be issued a new class of senior preferred stock. Treasury will immediately be issued $1 billion of stock from each company, which will pay 10 percent interest. Further purchases of preferred stock will be triggered if quarterly audits find that the companies' capital cushion is below set standards. The government will also receive warrants representing ownership stakes of 79.9 percent in each company. 

Included in yesterday's announced plan is a Treasury program to purchase new mortgage-backed securities from the two companies, starting with a $5 billion purchase this month. The Treasury will also hire independent asset managers to purchase and run the portfolio of mortgage-backed securities. The Treasury also said yesterday it will provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market. The FHFA, which will run the conservatorship, fired Fannie CEO Daniel Mudd, and Freddie CEO Richard Syron. They were replaced by Herbert Allison, former CEO of TIAA-Cref, and David Moffett, who was a US Bancorp vice chairman.

There is no doubt the bail-out is a major step to the resolution of the housing crisis, but the debates over how this impacts the US economy have just begun. The massive bailout will, of course, be paid for via debt financing which most likely simply means more tax burden by all of us.  Add that to the cost of the war on terror and ultimate repeal of the income tax reductions and you have a recipe for less discretionary income for wage earners.

The plan clearly will begin to create stability and start to unwind the liquidity lock in the market and expectations are for lower mortgage rates. However, in the short-run it still does not do anything for the current inventory overhang or price devastation. That will take time and confidence in a very fragile economy. For example, the employment data last week was not encouraging and still points to a long road ahead of rebuilding what has been crushed in the last 12 to 16 months.  Did I mention we have an election in about 60 days as well?

While we enjoy the equity market rally this week, don’t forget to take a minute to remember those who died on September 11, 2001 and those who have given their lives to fight terror since that awful day seven years ago.

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