Today's Tidbits

Reaction to Paulson’s Sub-Prime Mortgage Plan
From Morgan Stanley: “Treasury Secretary's Paulson's speech reinforced the sense that the Treasury is trying to move aggressively to address the problems associated with the reset of ARMS. These measures include the reset modification program that was unveiled last week, as well as pending FHA and GSE reforms. The only new proposal in the speech is aimed at allowing state and local governments the ability to issue tax exempt debt to help finance mortgage refi's. Tom Keays of our tax exempt group points out that one state -- Ohio -- has already done a small taxable deal aimed at providing such assistance. As seen in the attached article, these bonds were taxable because the federal govt has explicitly prohibited tax exempt issuance to fund refi's. This is the change that Treasury is now proposing. However, Treasury does not have the statutory authority to do this themselves, they will need to get a bill through Congress. Given the controversial nature of the subprime issue, it might be difficult to get a clean piece of legislation that is acceptable in a timely manner. So, while this proposal might eventually become law and trigger some tax exempt issuance that will be used to aid homeowners facing a reset, it's probably not going to happen anytime soon.”
From Deutsche Bank: “Treasury Secretary Paulson spoke at a housing conference overnight, touching on the much talked about mortgage restructuring deal that the Treasury is trying to broker behind the scenes. According to Paulson, the "Treasury is pursuing a comprehensive plan to help as many able homeowners as possible to keep their homes", with the focus on those borrowers "with steady incomes and relatively clean payment histories". This seems easier said than done. Needless to say, deciding exactly who will be helped will not be easy (the focus seems to be on those mortgage holders who can afford to pay the introductory rates, but not the higher rates to which they are about to be reset). Beyond that, the details of the scheme remain scarce. It appears clear that a key part of the plan will be the freezing of mortgage interest rates for a period. In addition, Paulson has proposed letting state and local authorities issue tax exempt bonds to help refinance subprime borrowers. With the pressure on to find a `solution' ahead of the wave of mortgage rate resets due early next year, Paulson professed that he is optimistic that he will have something to announce by the end of this week. However, market price action suggests that investors are skeptical that the plan will make much difference.”

Falling Corporate Profits Increase Recession Risk
From Bloomberg: “U.S. corporate profits are in a recession, and the entire economy may not be far behind. Slower sales and higher energy and labor costs are forcing companies from Bear Stearns Cos. to Pitney Bowes Inc. to reduce spending and hiring. Their efforts to keep earnings from eroding even further raise the risk that the economy, already weakened by the steepest housing slide since 1991, may shrink sometime next year… Corporate profits, as measured by the Commerce Department, fell at an annual rate of $19.3 billion in the third quarter from the second, as domestic earnings dropped by $41.2 billion.The drag from sagging U.S. sales and huge writedowns offset robust earnings abroad, fueled by the weak U.S dollar. The fourth quarter may be an even bigger bust… Profits for the Standard & Poor's 500 companies fell almost 25 percent on a per-share basis in the third quarter, the biggest year-over-year decline in almost five years. David Wyss, S&P's chief economist, expects their earnings to fall as much as 30 percent in the fourth quarter as companies take more writedowns for bad investments. Excluding such extraordinary items, operating profits may fall as well, he says. Consensus estimates compiled by Bloomberg indicate S&P 500 operating profits may rise just 1.1 percent in the current quarter. That's down from the 8.8 percent increase analysts foresaw a month ago. Operating profits fell 2.5 percent in the third quarter, the first drop in more than five years…In the last expansion, profit margins began contracting in late 1997; there was no recession until March 2001. What's troubling this time is that much of last quarter's damage came in the financial sector, where operating earnings fell 25 percent, as banks and brokers were hurt by losses from subprime mortgages and related investments. Analysts' estimates compiled by Bloomberg indicate the industry's profits this quarter may decline more than 25 percent…Bank of America, JPMorgan Chase & Co., Bear Stearns, Citigroup Inc., Lehman Brothers Holdings Inc. and Morgan Stanley have announced some 25,000 job cuts so far this year…The biggest hit to the economy from fading financial profits may come from tighter lending standards. The Federal Reserve reported last month that banks were making it harder for businesses and consumers to borrow.”

Ten Year Treasury Yields Below Inflation Rate is Very Unusual
From Bloomberg: “For only the fourth time since Gerald Ford's presidency, oil is threatening to push the rate of inflation above 10-year Treasury yields…Yields on 10-year notes fell as low as 3.79 percent last week, within a third of a percentage point of the consumer price index. Every time inflation has exceeded what investors get paid to own Treasuries, bonds have plunged. That happened from August 1973 through August 1975, when Ford addressed the nation with his ``Whip Inflation Now'' speech, and from January 1979 to October 1980, the end of Jimmy Carter's term…The only other time inflation outpaced yields was in October 2005, when oil climbed 8 percent in a week in the aftermath of Hurricane Katrina. Treasuries fell the next two months. During the 1970s the 10-year note's yield, which moves inversely to its prices, rose to 12.4 percent by 1981 from 5.89 percent at the end of 1971. Normally, yields average 3.8 percentage points more than inflation, based on trading since 1987. Even if the relationship just reverts back to the 2.2- percentage-point average in the first half of the year, investors in 10-year notes would lose 0.8 percent…Investors have sought Treasuries as a haven from widespread losses in mortgage markets even as consumer prices climbed 3.5 percent through October, the most since August 2006. U.S. government debt has returned 9 percent this year, including reinvested interest and price gains, the most since gaining 11.5 percent in 2002, according to Merrill Lynch & Co. data. The combination has left the Federal Reserve with the dilemma of either cutting interest rates next week for a third time since September to prevent the housing slump from pushing the economy into recession or keeping rates steady to fight inflation. ``You've got to be thinking inflation is falling by a dramatic amount'' to buy bonds at their current yields,…”
From Merrill Lynch: “November was a volatile month in the stock market and we saw a flight to safety and stability with the large caps down the least at 4.26%, followed by the mid caps at -4.78% and the small caps at -7.18%.”

From RBSGC: “Freddie Mac retained portfolio dropped by $10 bn in October while Fannie Mae added $8 bn. Freddie's retained portfolio declined to $703 bn and was mostly accomplished by the sale of the more liquid PCs and structured securities. According to Freddie Mac, the increase in sales reflects activities to maintain a regulatory capital surplus over the 30% mandatory target capital. Additionally, the third quarter reported loss of $2bn to provide a higher provision for credit losses continues to bother us. In effect, they are getting rid of the better rated -more liquid bonds to cover for losses in their subprime book (approximately $105 bn AAA rated backed by subprime loans). Fannie Mae, on the other hand, added to their retained portfolio reaching $732 bn. Clearly, their exposure to subprime is less ($44 bn) and is in somewhat of a better position, in our view.”

From Bloomberg: “The U.S. budget and trade deficits are narrowing in tandem for the first time since 1995, when the currency gained 8 percent as measured by the Federal Reserve's U.S. Trade Weighted Dollar Index…improvements in the deficits may provide a respite for the dollar after it tumbled 12 percent this year…A depreciating dollar has helped American exports rise to records in each of the past seven months, the longest streak since 2000. The trade deficit narrowed to $56.5 billion in September from the record $67.6 billion in August 2006, data compiled by the Commerce Department show…The budget deficit for fiscal 2007 ended Sept. 30 shrank to $162.8 billion, according to Treasury data. It is the smallest shortfall since $158 billion in 2002, and down from $413 billion in 2004, according to the Treasury…Both Buffett, the world's third richest man as measured by Forbes Magazine, and Gross, who Forbes says is worth $1.2 billion, have said they're bearish because interest-rate cuts by the Fed dim the allure of U.S. assets…The dollar lost 40 percent of its value against the euro during its five-year slide as widening deficits raised concern over the capability of the U.S. to attract foreign money. Former Fed Chairman Alan Greenspan said in November 2004 that overseas investors will eventually tire of funding the current-account gap and may channel money into other currencies. Plus, Buffett and Gross may turn out to be right if the worst housing market in 16 years pushes the economy into recession, further diminishing the dollar's appea. Corporate profits, as measured by the Commerce Department, fell at an annual rate of $19.3 billion in the third quarter from the second, as domestic earnings dropped by $41.2 billion.”

From Dow Jones: “General Motors Corp. posted an 11% drop in U.S. November sales, while Ford Motor Co. posted an increase of less than 1% as both U.S. auto makers said first-quarter output will be below year-ago levels, as difficulties in the U.S. market continue into 2008. Japan’s Toyota Motor Corp. posted a 0.3% rise….Despite a holiday clearance sale to spur demand, GM said sales of light trucks fell 15% to 156,196, while car sales fell 4.5% to 105,077. Sales of pickup trucks and SUVs are lower, generally, amid high gas prices and the housing-market downturn.”

End-of-Day Market Update

From UBS: “Treasuries rallied across the board after news that Moody's may review over $100B in SIV debt for possible downgrade, and the 2s30s curve steepened nearly 10bps… TIPS saw selling of breakevens which narrowed across the board, with January 2009 breakevens coming in nearly 11bps… Janet Yellen of the San Fran Fed waxed dovishly late in the day when she said that she's "re-thinking" her growth forecast due to the data since Oct. 31st. She sees a serious risk of sustained sluggish spending. We do too… [swap]spreads widened across the board, particularly in the front end, where 2-year spreads blew out by 8.5bps to close back near 100bp. Agencies saw buying scattered across the curve, richening to Libor by 3bps in the short end and 1bp out back. Meanwhile, the FHLB announced $3B of a new 3-year issue. Mortgages opened 4 ticks tighter, but after real money profit taking in the midst of the Treasury rally, MBS ended up 10 ticks wider to Treasuries- substantially cutting much of Friday's gains in the Basis.”

From RBSGC: “Prices certainly moved towards the upper end of the most recent range (use LAST Monday as the reference point) and the curve edged up towards it's recent steepness with 2s/10s looking at 100 bp…Today's volumes were below average…”

From Deutsche Bank: “Libor rates remain under upward pressure, financials are dragging equities modestly lower, the Dollar is modestly weaker, US bond yields are lower and the curve is a little steeper. Comments made by Boston Fed President Rosengren generally supported the bond market. Rosengren noted that ".the foreclosure crisis will get worse before its gets better," and predicted that the economy would grow "well below" potential over the next two quarters before strengthening gradually next year.”

Three month T-Bill yield fell 13.5bp to 3.01%.
Two year T-Note yield fell 11.5bp to 2.88%
Ten year T-Note yieldfell 7bp 3.87%
Dow fell 57 to 13,315
S&P 500 fell 9 to 1472
Dollar index fell .19 to 75.95
Yen .74 to 110.5 per dollar
Euro rose .003 to 1.467
Gold rose $8 to $791.5
Oil rose 1 to $89.71
*All prices as of 4:20pm