End-of-Day Market Update

From Merrill Lynch: "When all was said and done, the Tsy rates were unchanged...Does the market realize that the Secondary MBS rate at 5.12% in near the all-time low..." From JPMorgan: "Interestingly, we have entered a new era where the government will target the mortgage rate directly for policy, rather than just short rates. This comes after a long period of rate cuts which had had very little impact on mortgage rates." From Credit Suisse: "The mortgage market was failing because of the fear that insolvent GSEs would become massive net sellers. The Treasury’s GSE bailout fixes this problem."

From LEHC: "The Treasury noted that “(b)ecause the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking.” On the face of it, this statement might suggest to folks that the GSEs will be managed in a fashion where they take less risk. However, Treasury also noted that “the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.” The latter statement suggests that the “new” management may be encouraged to “roll back” some of the GSEs’ recent increases in guaranty fees. Most folks, though, note that it would be really strange public policy if the government placed the GSEs into conservatorship because of safety and soundness issues directly related to a deterioration in the credit conditions of the mortgage market, continuing declines in home prices, and “alarming high” levels of mortgage delinquencies, and then had the companies take on more mortgage credit risk via loosened underwriting guidelines!"

From Bloomberg: "Washington Mutual Inc., the biggest U.S. savings and loan, tumbled as much as 24 percent after ousting Chief Executive Officer Kerry Killinger and disclosing that regulators stepped up scrutiny of the lender's operations. WaMu signed an accord with the Office of Thrift Supervision that calls for the Seattle-based company to reduce risks and overhaul procedures, according to a statement today. Alan Fishman, 62, of Meridian Capital Group, a New York-based commercial mortgage broker, replaces Killinger, 59, who was CEO for 18 years."

From Citi: "Flows seemed unaffected today by the government takeover of Fannie and Freddie. ABCP spreads remained the same, with more and more issuers focusing on issuing paper in to 2009. The best ABCP names continue to trade at libor flat to plus 5 across the curve. Top tier corporate names, such as Johnson and Johnson, continue to trade as far as three months out at Fed funds type levels, but they are no longer 25 to 50 bps through discos, but rather back to roughly flat. Not much premium has been placed on quarter end as of yet, but the libor curve is still exceedingly steep from one to two months(20bps)which doesn't really make much sense..."

From Bloomberg: "U.S. fixed mortgage rates dropped about a quarter of a percentage point this morning after Treasury Secretary Henry Paulson announced the federal takeover of Fannie Mae and Freddie Mac. It may be the beginning of a trend...The average U.S. rate for a 30-year fixed mortgage is 6.08 percent today, down from 6.26 percent last week, according to Bankrate Inc...The federal bailout of the mortgage giants may temper the slide in home prices, Pacific Investment Management Co.'s Bill Gross said in an interview today...It is not without risk, though. ``If the government needs to borrow so much money for the bailout that Treasury yields start to rise, they could begin to compete with mortgages and have the opposite effect,'' Shaugnessy said. ``I think the plan will work, but if it doesn't we'll see rates going up.''

From Bloomberg: " U.S. stocks climbed, adding to a rally across Europe and Asia, on speculation the government takeover of Fannie Mae and Freddie Mac will stabilize the global financial system battered by $507 billion in credit losses. Citigroup Inc., Wachovia Corp. and Bank of America Corp. added at least 6.6 percent after Treasury Secretary Henry Paulson said the government will provide short-term funding to mortgage lenders Fannie and Freddie. KB Home and D.R. Horton Inc. jumped more than 12 percent, sending a gauge of homebuilders to a four- month high. A rally in banks from Germany to Japan sent the MSCI World Index up 2.1 percent, the most since April. The Standard & Poor's 500 Index gained 25.48 points, or 2.1 percent, to 1,267.79, its steepest advance since Aug. 8. The Dow Jones Industrial Average rose 289.78, or 2.6 percent, to 11,510.74. The Nasdaq Composite Index increased 13.88 to 2,269.76. Almost three stocks climbed for each that fell on the New York Stock Exchange... All but one of the 30 companies in the Dow advanced. About 1.7 billion shares changed hands on the NYSE in the busiest trading session since July 23. Treasury 10-year notes gained amid speculation the seizure of Fannie and Freddie won't reverse a U.S. economic slowdown. The dollar increased to the highest in almost a year against the euro. The rally pared the S&P 500's decline this year to less than 14 percent as the index heads for its first annual loss since 2002...The S&P 500 Financials Index rallied 4.6 percent, postingits best gain since Aug. 5 and reaching its highest level since June 19. The rally in banks came even as Oppenheimer & Co. analyst Meredith Whitney slashed her third-quarter earnings estimates for Goldman, Lehman Brothers Holdings Inc., and Merrill, citing a decline in trading volume and share sales."

From Lehman: "How many times have we seen this movie before? First, there is some "good news" released which is on the surface bearish for treasuries, and the market gets plastered. But then the market turns around and rallies sharply, sucking in newly set shorts in the process. Treasuries sold off pretty hard after the close on Friday when the first headlines about a Treasury plan for the GSE’s hit the tapes. While news tidbits around the plan surfaced Friday night and Saturday, the Treasury announcement itself came on Sunday, and it looked both aggressive and comprehensive. (I assume that you have seen the details of the plan ad infinitum by this point, so I won’t waste your time with them here.) Treasuries plunged at the Tokyo open, with 5 year yields rising by another 20 basis points on the top of the 10 bp selloff that came after the 3 PM close Friday. (Mortgages, of course, were doing considerably better, and by day’s end were on the order of 50 basis points tighter to treasuries.) Five year yields got as high as 3.20%, but started to grind lower around the London open, and prices arced higher for the next 12 hours, eventually getting back to 2.95%, or 5 basis points LOWER than where they went out Friday afternoon. Go figure. Volumes were high today...The yield curve flattened today, and the five year sector was a huge underperformer overnight, cheapening by almost 5 basis points to 2s and 10s on the move lower. That move came after a 5 bp richening last week. The sector did recover along with the market but still finished between 2.5 and 3 bp cheaper on the day."

From UBS: "After this weekend's GSE bailout headlines, Treasuries traded dramatically cheaper during the early pre-dawn hours, with front end yields more than 25bps higher versus Friday's close. As the day wore on, however, Treasuries gradually recouped their losses, likely on the back of convexity buying resulting from the mortgage basis' large move. We saw 2-way flow on curve trades (2s5s and 5s30s in particular), along with fast money selling in the 2-year sector. TIPS breakevens finished 2-5bps wider across the board, but were much wider earlier in the day before nominals recovered. Today's volume was 172% of the 30-day average, and the highest level in nearly six months. Equities celebrated the GSE announcement, with the Dow up by 347 points within a few minutes of the open. Left out of the party were Fannie and Freddie, both of which dropped more than 80% to the ignominy of penny-stock status...the Treasury today announced a $12B re-opening of the 10-year note, $1B more than the last re-opening...Swaps saw receiving in the belly, and swap spreads collapsed in on the back of agency and MBS tightening. Agencies saw light buying in 2- and 5-year paper, along with small selling in 10-years. After this weekend's GSE announcement, agency debt tightened 35bps in 2-years, 30bps in 3- to 10-year space, and 23bps in the long end. Versus swaps, the outperformance amounted to 27bps, 25bps, and 20bps, respectively. GSE sub-debt, which had taken a beating recently over uncertainty about their standing after any government intervention, benefited especially handsomely after this announcement. Although volume was light, front end sub-debt has tightened roughly 350bps versus Treasuries, and longer-maturity paper is about 250bps better. Mortgages saw convexity buying along with large scale rolling. There was servicer and fast-money buying in the morning, fast-money selling after lunch, and servicer buying later in the afternoon. Mortgages opened 40bps tighter to Treasuries and stayed within a few basis points of that all day. Today's moves in agency and mortgage spreads easily should easily set a record for the largest one-day moves of all time."

Three month T-Bill yield fell 7 bp at 1.70%
Two year T-Note yield unchanged at 2.30%
Ten year T-Note yield fell 2.5 bp to 3.67%
30-year FNMA current coupon fell 41 bp to 5.21%

Dow rose 290 points to 11,511
S&P rose 10 points to 1282

Dollar index rose .56 points to 79.49
Yen at 108.2Euro at 1.413
Gold fell $1 to $802
Oil rose $0.25 to $106.5