Morning Update

RTC2?

We will provide more details about the government plan as they're announced, but what we know at this point is that officials are considering the establishment of a fund to purchase failed assets in a plan that echoes the structure of the Resolution Trust Corporation (RTC) that was structured during the savings and loan crisis in the late-1980s. As Treasury Secretary Hank Paulson said last night: "What we are working on now is an approach to deal with the systemic risk and stresses in our capital markets. As we've said for some time, the root cause ... is the real estate correction and what's going on in terms of the price declines in real estate. We're coming together to work on an expeditious solution, which is aimed right at the heart of this problem, which is illiquid assets on financial institutions' balance sheets."

The cost is expected to be as much as $500 billion and the purchases would cover both private-label and government-guaranteed mortgages.

The plan would have two parts, the largest involving the private-label mortgage securities (underwritten by Wall Street). Financing would occur through the sale of Treasuries and the plan does require Congressional approval. The idea at this point is for the government to hold the securities until maturity (the average mortgage has a life of about seven years). The second part would involve ramping up the already-approved purchases of government-backed mortgage securities (Fannie Mae and Freddie Mac).

The administration is contemplating hiring a private investment manager to run the mortgage vehicle, but there's a lot yet we don't know, including the amount of mortgage securities to be bought, from whom the government would accept them, and at what price would they be purchased. The thought is the purchases would be at steep discounts and that there's some likelihood the government could eventually make money on the deal.

Market likes the news so far

The first surge came yesterday afternoon on news that the Financial Services Authority (FSA) has temporarily banned short-selling in the United Kingdom, as well as by an announcement that the New York attorney general began a probe into short-selling of Lehman, Goldman and Morgan Stanley shares. And then the markets sprinted to a finish on the aforementioned government plan. The financials were the big winners yesterday jumping by nearly 12%.

Short-selling of financials halted

The stocks of both Morgan Stanley and Goldman Sachs dropped precipitously through mid-day yesterday, and Morgan Stanley's CEO John Mack's railed on a perceived "bear raid" (and abusive tactics) on his stock. It may have contributed to the announcement last night that the Securities and Exchange Commission is halting short selling of 799 financial companies until October 2 of this year. At its low point intraday yesterday, Morgan Stanley's stock was down 70% on the week, before a significant rebound that's carried through to the pre-open this morning. This decision is not without controversy so expect to hear many debates on the subject in the days to come.

Credit market still seized

What few safe havens were considered to be left, including gold and oil, rocketed higher over the last several days, but gave up some ground yesterday. Three-month Treasury bill yields imploded to 4 basis points earlier in the week (yes, that's 0.04%), but have rebounded a bit to a current 0.85%. Believe it or not, T-bill yields this low are not unprecedented ... but you do have to go all the way back to the 1930s to find another time the yield was below 10 basis points. According to Birinyi Associates, from November 1930 to February 1941 the yield remained below 10 basis points, with the all-time low of 1 basis point hit in January 1940. The extremely low yield reflects a massive flight to safety which pushed up the price of Treasury bills (yields and price move in opposite directions).

Money market funds now protected

The other breaking news overnight was the plan to use as much as $50 billion from the country's Exchange Stabilization Fund to temporarily protect investors from losses on money-market mutual funds. This comes after two money market mutual funds "broke the buck" (their net asset values dropping below $1) earlier this week. It led to a record $89.2 billion being pulled from money market funds on Wednesday; equal to 2.6% of total money market assets.