• Electronic Arts (NASDAQ:ERTS) said it plans to cut 1500 additional jobs. The firm reported second quarter adjusted earnings of 6 cents, a one penny miss, on revenues of $1.15 billion, which slightly topped Street projections of $1.12 billion. The firm forecast 2010 earnings of $0.70-$1.00, topping estimates of 89 cents on revenues of $4.2-$4.4 billion versus estimates of $4.26 billion

• Cadbury (NYSE:CBY) rejected the latest Kraft (NYSE:KFT) bid calling it "derisory"

• Moody's (NYSE:MCO) commented that AIG (NYSE:AIG) will be able to repay its Federal loans

• Wells Fargo (NYSE:WFC) lifted its growth expectations for the semiconductor group following release of third quarter numbers. Intel (NASDAQ:INTC) remained its first pick within the group, with "outperform" ratings also on Micron Tech (NYSE:MU) and Xilinx (NASDAQ:XLNX). Analysts increased 2010 growth expectations of 25% for the industry from 10-20% prior

• Goldman Sachs (NYSE:GS) added Polo Ralph Lauren (NYSE:RL) to its Conviction Buy List, with a price target of $94

• Goldman Sachs (NYSE:GS) also added Kroger (NYSE:KR) to its Conviction Buy List, with a price target of $27

• Goldman Sachs (NYSE:GS) removed Coca-Cola Enterprises (NYSE:CCE) from its Conviction Buy List, but maintained a "buy" rating on the shares

• Tyco International (NYSE:TYC) released better-than-expected third quarter earnings of 61 cents a share, 7 cents above estimates, on revenues of $4.42 billion, slightly higher than estimates of $4.32 billion

• Burlington Northern (NYSE:BNI) CEO advised Berkshire Hathaway (NYSE:BRK.A) is liquidating shares of rival railroads Norfolk Southern Corp. (NYSE:NSC) and Union Pacific (NYSE:UNP) as it readies its purchase of Burlington

• Google (NASDAQ:GOOG) moved further into the market for digital advertising on cell phones with the acquisition of AdMob for $750 million

• Hyatt Hotels (NYSE:H) shares gained 12% on their NYSE debut.  The company sold 38 million shares at $25 per share

• JP Morgan (NYSE:JPM) lifted its price target on Ford (NYSE:F)

• The smartphone marketplace will watch today's launch of Verizon's (NYSE:VZ) much-heralded new "Droid" launch, using Google's (NASDAQ:GOOG) Android operating system

• AIG (NYSE:AIG) reported third quarter earnings of $2.85 ex-items

• Bernstein upgraded General Electric (NYSE:GE) and Amazon.com (NASDAQ:AMZN) shares

• JP Morgan (NYSE:JPM) upgraded Macy's (NYSE:M) shares

• Deutsche Bank (NYSE:DB) upgraded Blue Nile (NASDAQ:NILE) shares, lifting the price target from $30 to $50

The 30-share Dow Jones industrial average finished higher by 51 points, or 0.52%, at 9,829.87. The broad Standard & Poor's 500-stock index gained 7 points, or 0.66%, at 1,071.66 and the technology-laden Nasdaq composite index gained 8.26 points, or 0.39%, to 2,146.30.  Treasury prices rallied after the government’s successful auction of $43 billion in two-year notes.

Meanwhile, dollar continued its downward spiral against other major currencies, sending energy and material shares higher.  Gold and crude prices also advanced.  Gold reached $1014 per ounce, up $12.50, and oil, after a 3.3% plunge Monday, went above the $70 level, rising 2.6% to $71.55.  Volume on the NYSE was a modest 1.27 billion shares, with advancing shares ahead of decliners by a seven-to-three margin.

Among the ten S&P500 industry sectors, seven closed higher, led by financial shares (+2.2%), basic materials (+1.9%), industrials (+0.8%).  On the downside, telecommunication shares fell 0.6%, health care stocks eased 0.3%, and utilities edged 0.1% lower.

Twenty of the DJIA's thirty components finished higher yesterday.  On the Dow average, JP Morgan (NYSE:JPM) was the leading gainer, rallying 4.3% to $46.47 after analysts at Bank of America (NYSE:BAC) lifted their third-quarter earnings estimate on the firm to 49 cents per share from 46 cents per share.  Caterpillar (NYSE:CAT) shares jumped 3.6%, following the expected weak dollar benefit to foreign sales.  Bank of America (NYSE:BAC) rose 2.1% after Rochdale Securities’ Richard Bove raised the shares' price target to $25 from $19 due to the firm's recent moves to exit two federal guarantee programs.  However, rumors that CEO Ken Lewis might resign over the Merrill bonus saga kept the stock’s move in check.  Alcoa (NYSE:AA) rose 2.3% after analysts at Goldman Sachs (NYSE:GS) raised price target on the firm, citing projections for higher aluminum prices.

Analyst upgrades also benefited shares of Macy's (NYSE:M) (+5.1%); Citigroup (NYSE:C) lifted its rating on the shares to "buy" from "hold" on higher revenue expectations.  US Steel (NYSE:X) shares increased 4.6% after Bank of America (NYSE:BAC) changed its recommendation on the stock to "neutral" from "underperform," citing expectations the firm should return to profitability in 2010. Clorox (NYSE:CLX) shares gained 2.6% on speculation of a potential Procter & Gamble (NYSE:PG) bid.  AIG (NYSE:AIG) shares fell 5.4% in a late-session sell-off on talks of a possible secondary offering.  Goldman (NYSE:GS) shares rose 1.7% to $185.52, closing at its highest level since July 2008.

Of key interest today would be the much-expected FOMC policy report, due out at 2:15 ET.  Expectations that the Fed will maintain record low interest rate levels of zero to 0.25% are intact. Most expect the Fed language to support an ongoing accommodative stance.  Moreover, President Obama cautioned that unemployment could even get a little worse in coming months. Therefore, the Fed's $1.75 trillion asset purchase program is likely to remain in place to encourage the recovery's traction.

This morning’s stock futures indicate Wall Street is headed for a higher opening, helped by a rally in global stocks.  Ahead of the market’s open, Dow Jones industrial average futures rose 48, or 0.5%, to 9,766.  Standard & Poor's 500 index futures were up 6.20, or 0.6%, to 1,066.60, while Nasdaq 100 index futures rose 10.75, or 0.6%, to 1,738.50.  Ahead of the FOMC policy statement, trading is expected to remain range bound as traders look for more data before taking the plunge.  

Treasuries were mixed ahead of this week’s $112 billion note auction.  The 2-year rose 1/32 and the 10-year was off 3/32.  The dollar showed some strength, managing a 0.4% advance against a basket of currencies and sending the broad-based DJ-UBS commodity index down 1.8%, as crude prices went below the $70 level.  On the NYSE, declining shares were ahead of those that rose in price by a two-to-one margin on volume of 1.20 billion shares.

Seven of the ten S&P500 industry sectors declined, with health care (+0.6%), tech shares (+0.1%), and consumer services (+0.1%) ending the day in the positive territory.  The tech-heavy NASDAQ was the only outperformer among the major bourses, managing a 0.2% gain to 2138, helped by a Dell (NASDAQ:DELL) announcement to buy Perot Systems (NYSE:PER) in a $3.9 billion all-cash deal. Wal-Mart (NYSE:WMT) rose 1.6% as HSBC Holdings (NYSE:HBC) initiated coverage on the stock with an "overweight" rating and a price target of $61. Baird upgraded Celgene (NASDAQ:CELG) shares to "outperform," citing upside from strength of its Revlimid drug. Celgene shares closed up more than 5%.  General Electric (NYSE:GE) shares also rose, bucking the trend of both its financial and industrial counterparts, as Morgan Stanley (NYSE:MS) raised its price target on the stock $19, noting the company's improved risk profile.

Leading the indices lower yesterday were financials (-1.0%), oil and gas (-0.9%), commodities (-0.7%), as well as industrials (-0.6%) and consumer goods (-0.6%).  The Dow Jones industrial average, which was down 94 points in the morning session, closed down 41 points, hurt by its financial components, with American Express (NYSE:AXP) down 2.9% and Bank of America (NYSE:BAC) retreating 2.2%. Bank of America (NYSE:BAC) said it agreed to pay $425 million to terminate a tentative loss-sharing agreement with the government that had been established to facilitate its purchase of Merrill Lynch. However, the firm skipped a deadline to provide documents regarding that merger to a House panel.   Shares in AIG (NYSE:AIG) spiked 22% after a report from the Government Accountability Office noted the company is seeing stabilization following the government's bailout measures.  However, the report said it remains unclear when AIG would be able to repay those funds.

A $2.33 decline in crude prices also hurt share of commodity-related companies even as the greenback showed some resistance against a basket of currencies.  Alcoa (NYSE:AA) shares lost almost 1% after Macquarie warned of an unfavorable aluminum demand/supply outlook over the next six to twelve months.  Caterpillar (NYSE:CAT) declined 1.8% after reporting its global machinery sales plunged 48% in the three months to August.

• Morgan Stanley's (NYSE:MS) CEO John Mack will be replaced before year-end by current co-president James Gorman

• Abbott Labs (NYSE:ABT) announced that it bought the 90% of Evalve that it does not already own for $410 million

• Bank of America (NYSE:BAC) cut its rating on Electronic Arts (NASDAQ:ERTS) to "neutral"

• Wells Fargo (NYSE:WFC) lowered its rating on AIG (NYSE:AIG) to "underperform" asserting the firm currently is trading "significantly" above book value

• National Semiconductor (NYSE:NSM) reported fiscal first quarter earnings of 13 cents a share, 6 cents above estimates on revenues of $314 million

The 30-share Dow Jones industrial average rose 56 points, or 0.6%, to 9,497.34 and the S&P 500 index added 9 points, or 0.9%, to 1,025.39, its highest close in 11 months.  The tech-heavy NASDAQ added 19 points, or 0.94%, to close at 2,037.77 points. On the New York Stock Exchange, advancing issues outpaced those that declined three to one on volume of 1.32 billion shares.  However, a jump in the CBOE Vix volatility measure, which rose 1.4% to 25.62, added a note of caution to the upbeat mood.

Dollar’s plunge to an 11-month low was also due to a Monday release from the United Nations, which again called for less dependence on the greenback as the premier global reserve currency. Indications that China would diversify some of its interests into gold also hurt the dollar, although the size of China's reserves mitigates against much impact.  Nevertheless, the news helped gold prices.  This morning's news indicated Barrick Gold (NYSE:ABX) is planning to raise up to $3.5 billion through a new share offering priced at $36.95 per share.

Yesterday, General Electric (NYSE:GE) was the leading gainer on the DJIA after being upgraded by JP Morgan (NYSE:JPM).  Costco (NASDAQ:COST) advanced 2.3% after two brokerages upgraded the stock. Among tech issues, IBM (NYSE:IBM) retreated 0.3% after it was downgraded; however, the firm noted it is "well ahead" of its 2010 earnings target of $10-$11 per share.  Advanced Micro Devices (NYSE:AMD) surged 14.6% as Barclays Capital (NYSE:BCS) upgraded the shares to "outperform."  AIG (NYSE:AIG) shares slumped 10.5% after Credit Suisse (NYSE:CS) downgraded the stock to "underperform," noting "little to no value for common equity" remains.

Nine of the ten S&P industry groups recorded gains Tuesday , with oil and gas (+2.7%) and basic material shares (+2.1%) leading the list of gainers.  Only healthcare shares registered declines, declining 0.3%.  Crude prices spiked $3.31 to $71.33 on expectations today's OPEC meeting will see no change in the production levels.  Moreover, Goldman Sachs (NYSE:GS) maintained a favorable long-term view on the group, saying there is an "increasing evidence of a stronger-than-expected recovery in global industrial activity."  Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM) shares gained 2.2% and 2.1%, respectively.  Among basic material issues, Alcoa (NYSE:AA) rose 3.5% to $12.60.

In today's Presidential appearance before a rare joint session of Congress, President Obama will attempt to resuscitate his healthcare reform package and counter the groundswell of centrist opposition, which has driven his ratings to a low 52% point.

• AIG (NYSE:AIG) was downgraded to "underperform" at Credit Suisse (NYSE:CS), with its price target lowered to $15 from $30, and 2009 estimate cut to a $13.98 loss, with 2010 initiated at an estimate of $5.70

• Smithfield Foods (NYSE:SFD) reported a fiscal first quarter loss of 56 cents a share, three cent under expectations versus last year's 17 cent loss, on revenues of $2.7 billion, off estimates of $2.8 billion

• Kraft (NYSE:KFT) advised its will continue to pursue its unsolicited offer for Cadbury (NYSE:CBY), after Cadbury rejected the firm's $16.7 billion cash and stock bid

• Airbus turned positive, projecting an air passenger volume rebound. In 2009 passenger volume is estimated to drop 2%, in 2010 to climb 4.6%, and in 2011 to soar 7%

• Goldman Sachs (NYSE:GS) upgraded Red Hat (NYSE:RHT) to "buy," and raised the price target to $28 from $18

Today, we're fortunate to have Simon van Norden, Professor of Finance at HEC Montréal (École des Hautes Études Commerciales), as a guest blogger.

"Once you've seen one financial market crisis...you've seen one financial market crisis."

-- Attributed to Federal Reserve Board Governor Kevin Warsh by former US Treasury Assistant Secretary for Economic Policy Phillip Swagel in The Financial Crisis: an Inside View, March 2009, p. 4.

The financial crisis has set a lot of records so far; it's certainly the worst US banking crisis of my lifetime. Some, as suggested by the above quote, see such crises as unique events; each one is singular and there's not much to be learned about how to handle one from looking at past crises. For example, there's no precedent that I know of for a banking crisis involves the failure of the biggest counterparties for credit default swaps.

I think a much smaller number of people see the crisis differently; they think of it as another potato, a big one. No two potatoes are exactly alike in size and shape, but they all taste pretty much the same and you can use the same recipe for most of them. For that reason, it's interesting to see to what extent the current crisis behaves like other crises, even if it has some unique features.

I think there's some interesting parallels between the current crisis, the Savings and Loan (S&L) crisis of the 80s and 90s, and the Long-Term Capital Management (LTCM) Crisis of 1998. But before I talk about that, let me talk about what a "typical" banking crisis looks like.

The Basel View of "Typical" Banking Crises

If we set the way-back machine to 2004, a time long before terms like ARM, CDS, and AIG entered common conversation, we can see what people thought a typical bank crisis looked like. That's the year the guys in Basel who worry about such things published "Bank Failures in Mature Economies." They looked at the main banking crises in developed countries from 1980 to 2000 and asked themselves what they saw. To be sure, they saw some differences, but they also saw some patterns. Here's part of their main conclusions (note that "credit risk" is Banker for "bad loans").

Most of the widespread [banking] failures required some amount of public support, sometimes in very large amounts. All of the episodes that involved large amounts of public support were caused by credit risk problems. ...The widespread banking crises that involved credit risk were remarkably similar. A period of financial deregulation resulted in rapid growth in lending, particularly in real estate related lending. Rapidly rising real estate prices encouraged more lending, abetted by lax regulatory systems in many cases. When economic recessions occurred, inflated real estate prices collapsed, leading directly to the failures. (BIS, 2004, p.66)

That sounds a lot like what the US (and some other countries) experienced immediately afterwards. There had been some financial deregulation, which was followed by a period of very rapid growth in real-estate-related lending. Rapidly rising real estate values encouraged more lending. The biggest difference seems to be the last point; the recession did not cause real estate prices to collapse; they had peaked by 2006 and fell before the recession started. We could probably also argue about whether it was financial deregulation or "financial innovation that avoided regulations" that helped fuel the increase in real-estate lending. However, in this view the boom and bust cycle in real estate, the subsequent fallout for the banking sector, and the need for a major publicly-funded bailout is not remarkable; we've seen this kind of story before. In fact, Reinhart and Rogoff have gone so far as to tabulate what happens to government debt in the aftermath of a banking crisis. They find that real government debt increases by an average of 86% in the three years after the start of a crisis. So regardless of how you feel about the US government's spending during the crisis, it seems less remarkable when compared to what typically happens in a banking crisis.

Three American Financial Market Crises

More support for the view that banking crises follow similar patterns can be found by comparing the last three US banking crises; the S&L crisis of the late 80s and early 90s, the collapse of LTCM and the most recent crisis. The S&L crisis closely followed the pattern described by the BIS report quoted above; financial deregulation, followed by a rapid growth in real estate lending, creation of local speculative bubbles in real estate prices, and the failure of institutions as bubbles burst (For descriptions of the S&L crisis, see BIS (2004) or the GAO 1996 report). The General Accounting Office put the cost of the S&L bailout to US taxpayers at $132.1 billion, or a bit under 2% of GDP (United States General Accounting Office (1996) "Financial Audit: Resolution Trust Corporation's 1994 and 1995 Financial Statements," Table 3 and author's calculations). That may seem small compared to the size of TARP or this year's projected federal deficit, but it was shocking at the time.

At first glance, the LTCM crisis appears quite different; no bank failed (LTCM was a hedge fund), its failure was unrelated to real estate investment or credit risk, and the crisis was resolved at no cost to the taxpayer. However, the LTCM crisis showed that, as a result of deregulation, a systemic crisis could start outside the regulated banking system. Another GAO study noted:

The LTCM case illustrated that market discipline can break down and showed that potential systemic risk can be posed not only by a cascade of major firm failures, but also by leveraged trading positions. LTCM was able to establish leveraged trading positions of a size that posed potential systemic risk primarily because the banks and securities and futures firms that were its creditors and counterparties failed to enforce their own risk management standards. (US GAO (1999) p. 29)

The same report noted:

• Gaps in [US Government agencies'] regulatory authority limits their ability to identify and mitigate systemic risk (US GAO (1999) p. 24)
• Regulators did not identify weaknesses in firms' risk management practices until after the crisis (US GAO (1999) p. 16)
• Monitoring did not reveal the potential systemic threat posed by LTCM (US GAO (1999) p. 17)

and provided a variety of proposals (some of which are mentioned below) to reform the financial system by reducing systemic risks.

The success of those reforms can be judged by role of similar factors in the most recent US banking crisis. An important factor in the latter has been the role of trading in derivative securities, primarily mortgage-based securities and credit default swaps (CDS). Again, government oversight of this market was limited due to faith in the market's ability to manage its exposure to risk, and was further weakened by divided responsibilities between multiple agencies. Regulators and private lenders alike were again unaware of major firms' exposure to losses on derivative securities; this time even the heads of major financial institutions were not aware of the extent of their own exposures. Again, this was in part due to the lack of transparency, lack of clearing and high leverage afforded by trade in Over-the-Counter (OTC) derivatives (particularly those traded at Bear Stearns.) Again, weaknesses in firms' risk management practices became apparent only in hindsight. Again, major financial firms that were not regulated as traditional deposit-taking banks took on highly-leveraged positions and posed major systemic threats to the banking system. These included several investment banks (such as Bear Stearns, Goldman Sachs, Lehman Brothers, and CitiGroup) and the insurance company AIG.

Conclusion

Looking at recent events from this perspective, I still see the size of the losses as breathtaking, but the causes and dynamics seem much more familiar. What bothers me is that some of the suggested solutions sound pretty familiar too; make derivative trading more transparent, improve coordination among the regulators, give regulators more power to control systemic risk in new places, and so on. Despite that, not only was there another crisis, but it was much larger than the two previous crises combined.

This post written by Simon van Norden.

On Tuesday, the Dow Jones industrial average, after gaining over sixty points in the morning, nose-dived 185.68 points, or 2%, to 9,310.60.  Since Friday, the index has lost 270 points, or 2.8%.  The S&P 500 fell 22.58, or 2.2%, to 998.04, while the Nasdaq composite index fell 40.17, or 2%, to 1,968.89.  Treasuries, which usually benefit from a fall in stocks, could garner only moderate gains.  Volume picked up on the NYSE where 1.63 billion shares exchanged hands as declining stocks beat those that advanced five to one.  The market’s measure of volatility, the CBOE Vix, shot up 12.1% to 29.2.  

The decline in stocks was broad based as all but one DJIA component ended in the red.  Only Wal-Mart (NYSE:WMT) showed some resistance, edging up 0.2%.  Financial stocks took a beating, hurt by analyst comments and rumors of a bank failure.  Leading the Dow average lower was Bank of America (NYSE:BAC), which slipped 6.4% to $16.46.  American Express (NYSE:AXP) slid 5.4% to $31.98 while another Dow component JP Morgan Chase (NYSE:JPM) retreated 4.1% to $41.67.  Citigroup (NYSE:C), though not in the Dow average, was another notable loser as its shares lost 9.2% to $4.54.   

A Sanford Bernstein downgrade sent shares of AIG (NYSE:AIG) down 20.6%.  The plunge wiped off much of the recent gains in AIG stocks.  Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) lost 17.6% and 17.0%, respectively, as traders decided to book profits after the recent advance in the shares. Wells Fargo (NYSE:WFC) shares dropped 4.8% even as the company announced plans to repay government bailout funds "shortly," without selling shares; the firm received $25 billion in TARP funds.  E*Trade Financial Corp. (NASDAQ:ETFC) slid 15% to $1.50.

This afternoon’s release of the FOMC minutes could be of interest, as investors weigh its wording for recovery and growth expectations, as well as sign posts of exit strategy plans.

• AIG (NYSE:AIG) and its former CEO and CFO have reportedly agreed to terms of binding arbitration in settling claims from shareholders regarding lost investments due to financial restatements

• Apple (NASDAQ:AAPL) will host a September 9, music-themed media event in San Francisco, expected to include a new iPod line, with a Beatles' catalogue available on its iTunes store

• Sony (NYSE:SNE) will distribute Google's (NASDAQ:GOOG) Chrome browser on its Vaio PCs

• Media reports said Bank of America (NYSE:BAC) is planning to repay part of the $45 billion in government aid recovered from TARP, beginning with a $20 billion repayment.  The move would remove its status as a recipient of "exceptional aid," allowing certain government oversight measures to be lifted

• EBay (NASDAQ:EBAY) is expected to announce plans to sell its Skype Internet calling division to private investors.  The company has said it wants about $2 billion for the unit

• Wal-Mart (NYSE:WMT) began website sales of merchandise not carried in its stores in a revenue-sharing exchange similar to Amazon.com's (NASDAQ:AMZN)

• Citigroup (NYSE:C) said its sold $1.3 billion in credit-card assets to an undisclosed buyer.  Terms of the sale were also not revealed

• Credit Suisse cut its Nokia (NYSE:NOK) rating to "underperform" from "outperform," and removed the company from its focus list.  The firm also cut its estimate for 2010 by 28%. Credit Suisse expects Nokia to lose smart phone market share next year

• Robert W. Baird upped its price target for Wells Fargo (NYSE:WFC) to $33 from $30

The Shanghai Composite Index, which had declined nearly 3% on Friday, plunged 6.7% to 2,697.  Hong Kong's Hang Seng retreated 1.9%. In Japan, the Nikkei 225 stock average, which was up 200 points earlier in the session, fell 41.61 points, or 0.4%, to 10,492.53.  In Yesterday’s landslide victory, the Democratic Party of Japan came to power ending an almost half-a-century rule by the Liberal Democratic Party.  The yen strengthened, helped by the election results.

This morning’s U.S. stock futures show Wall Street is headed for a lower opening.  Dow Jones industrial average futures fell 59, or 0.6%, to 9,477. Standard & Poor's 500 index futures fell 5.70, or 0.6%, to 1,021.70, while Nasdaq 100 index futures fell 11, or 0.7%, to 1,631.50. 

On Friday, U.S. stocks closed mostly lower after a report showing a drop in consumer confidence offset a rally in technology stocks that was fueled by better-than-expected results from Intel (NASDAQ:INTC) and Dell (NASDAQ:DELL).  Also, Apple (NASDAQ:AAPL) announced that it entered into a deal with China Unicom to launch the iPhone in the country.  The rally in tech shares was also helped by signs of a bottoming in the personal computer market after Intel (NASDAQ:INTC) raised its third quarter sales forecast to at least $8.8 billion from its prior forecast of $8.1 billion.  The firm also raised its outlook on gross margin expectations.

The Dow Jones industrial average lost 36 points, or 0.4%. The S&P 500 index retreated 2 points or 0.2%. The Nasdaq composite added 1 point, or 0.1% and rose to its fresh 2009 high, closing at the highest point since October 1.  Trading was light as most traders remained out of the market due to the summer vacations.

Among the S&P500 industry groups, financials led the gainers rising 1.2% during the week; consumer services shares rose 1.2%, followed by technology shares (+0.8%), industrials (+0.1%), and telecommunication stocks (+0.1%).  The week saw financial stocks recording huge gains, helped by advances in AIG (NYSE:AIG), Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE).

Among the week's losers, basic material and consumer goods shares fell 0.8%; utilities declined 0.7%; oil and gas shares dropped 0.3%, and health care issues retreated 0.2%. 

Gains in retail stocks helped shares of consumer services companies record some gains.  Luxury jeweler Tiffany (NYSE:TIF) reported better-than-expected earnings for the quarter, and also raised its full-year guidance. Housing shares showed some strength, helped by a report on new home sales, which revealed a more-than-expected, 9.6% advance in July.

• AIG (NYSE:AIG) shares jumped 11% yesterday. In an interview, new CEO Benmosche calmed fears of a fire sale of the firm's assets, instead pointing to a measured approach to retaining the company's diversified base, noting that in a year the company will be said to be performing well

• Microsoft (NASDAQ:MSFT) announced a $71 cut on its highest-priced Xbox 360 in Europe and US markets after Sony (NYSE:SNE) cut price of its PlayStation 3 last week

• General Electric (NYSE:GE) is reportedly seeking bids for its security business, with interest said to be forthcoming from United Technologies (NYSE:UTX) and Tyco (NYSE:TYC). The firm hopes for bids of about $2 billion

• Guess? (NYSE:GES) beat second quarter estimates with earnings of 64 cents a share, ahead of Zacks expectations of 44 cents a share, on revenues of $522.4 million, beating
estimates of $480 million.  The company raised its quarterly dividend 25% to $0.125; guidance for the current quarter was set at 46 cents to 49 cents per share on sales of $465 million to $485 million

• The US Navy awarded a $2.4 billion contract to Northrop Grumman (NYSE:NOC) for work on nuclear-powered aircraft carrier, USS Theodore Roosevelt

• Toll Brothers (NYSE:TOL) reported a third quarter loss of $2.93 a share, worse than the Zacks projections of a $1.40 per share loss, on revenues of $461.38 million, compared with estimates of $414 million. The firms expects lower fourth quarter sales

US stock futures point to a moderately higher open on Monday.  Dow Jones industrial average futures rose 34, or 0.4%, to 9,523. Standard & Poor's 500 index futures rose 3.30, or 0.3%, to 1,028.50, while Nasdaq 100 index futures rose 2.00, or 0.1%, to 1,637.50.

The Dow Jones industrial average gained 156 points, or 1.7%, closing above 9,500 for the first time since November 4.  The S&P 500 index added 19 points, or 1.9%, closing at the highest point since October 6.  The tech-heavy NASDAQ composite index added 31.68 points, or 1.59%, to 2,020.90, its highest close since October 1.  On the New York Stock Exchange about four stocks rose for every one that fell.

Speaking at an annual Fed conference, Bernanke noted that "After contracting sharply over the past year, economic activity appears to be leveling out, both in the US and abroad," adding prospects for a return to growth in the near-term “appear good."  However, he sounded a note of caution, warning that lending is not back to normal, and that the difficulty consumers and businesses are having obtaining loans will be a challenge.    

All ten S&P 500 industry sectors closed higher on Friday, led by gains in basic materials (+2.7%), oil and gas (+2.6%), industrials (+2.3%), and financials (+2.1%).  Year-to-date technology stocks have been the best of the lot managing gains of 40.4% and are followed closely by basic material shares (+40.1%), financials (+13.2%), industrials (+11.1%), and consumer goods (10.4%).  On the year only telecoms (-4.2%) have suffered declines.

A rise in energy stocks sent shares of Exxon Mobil (NYSE:XOM) up 2.5% to $69.92 and Chevron (NYSE:CVX) rose 1.6% to $69.73.  Shares of healthcare companies also advanced with Pfizer (NYSE:PFE) surging 5.5% to $16.64 and Merck (NYSE:MRK) gaining 5.1% to $32.56.  Among financial issues, AIG (NYSE:AIG) jumped 35% to $32.85 after the company said it will be able to pay back the government.  Game Stop (NYSE:GME) plunged 13% after the company reported earnings that were below analysts’ expectations.    

However, notable risks remain to the fragile economy.  A Sunday Financial Times piece quoted economist Nouriel Roubini as saying there remains a "big risk" of a double-dip recession, although Roubini currently sees a "U-shaped" recovery. 

The Dow Jones industrial average declined 39 points, or 0.4%, the Standard & Poor's 500 lost 3 points, or 0.3%, and the tech-heavy Nasdaq composite retreated 18 points, or 0.9% after disappointing data on private payrolls and the services sector dented some optimism.  However, the Commerce Department reported an unexpected 0.4% rise in orders for manufactured goods in June.  On the NYSE, volume was a moderate 1.53 billion as decliners outpaced advancing shares by 8 to 7

Treasuries fell, with the 10-year declining 19/32 and the corresponding yield rising to 3.762%. Commodity prices rose, with crude prices up 55 cents to $71.97 per barrel, rebounding from initial declines posted after weekly inventory stats showed a larger-than-estimated build of 1.67 million barrels.

Seven of the ten S&P industry groups declined.  Financials again were the leading gainers on the S&P 500, rising 2.9%, as investors assessed the favorable impact of gains in mortgage applications and expectations that loan losses may have reached their peak. On the DJIA, Bank of America (NYSE:BAC) rose 6.5% and was the leading gainer in the Dow average. American Express (NYSE:AXP) added 5.8% and JP Morgan (NYSE:JPM) increased 3.9%. American Express (NYSE:AXP) reported a 5.8% increase in credit card defaults, representing a smaller pace for the second straight month, due in part to a lower-than-anticipated number of bankruptcies.  This morning, Keefe, Bruyette & Woods analysts noted that Bank of America (NYSE:BAC) may report slight losses in the third and fourth quarter before turning profits in 2010.

Procter & Gamble (NYSE:PG) slid 2.8% after the company reported an 18% decline in quarterly profit.  World’s second-largest video game publisher Electronic Arts (NYSE:EA) fell 6.8%.

On the S&P 500, troubled-insurer AIG (NYSE:AIG) shares rallied 62.7% as Radian's (NYSE:RDN) $231.9 million quarterly profit helped sentiments.  Radian's (NYSE:RDN) shares surged 83%.  AIG is expected to report quarterly results on Friday.  Fannie Mae (NYSE:FNM) rose 29.8% and Freddie Mac (NYSE:FRE) jumped 31.1% on news of the impending resignation of the director of the Federal Housing Finance Agency. Citigroup (NYSE:C) trading action marked a one-day, single-stock NYSE record Wednesday as 347 million shares traded. The firm launched its $2.5 billion 5-year note sale.

Leading the decliners on the S&P 500 were telecommunications (off 1.6%), health care (-1.3%), oil and gas  (-1.1%), utilities, consumer goods and technology (-0.9%), industrials (-0.8%), consumer services (-0.5%).  Helped by a rise in commodity prices, only basic material shares showed some strength, adding 0.6%.

As expected, the Bank of England held benchmark interest rates unchanged at 0.5%; however, it also expanded its asset purchase plan $84 billion. Meanwhile a Chinese central banker indicated interest rates could go up, advising of plans to "fine tune" credit policy. As global rate talk swings between hawkish and accommodative, risk assumptions may sway as well, with the more hawkish tone suggesting brighter recovery prospects near at hand.

An unfavorable weather is expected to have hurt retailers' comparable sales results last month, with Costco's (NASDAQ:COST) sales down 7%, Big Lots’ (NYSE:BIG) declining 2.4%, Stage Stores’ (NYSE:SSI) declining 11.9% and Limited Brands’ (NYSE:LTD) decreasing 7%.

• Goldman Sachs (NYSE:GS) downgraded shares of IBM (NYSE:IBM) to "neutral" from "buy"

• Infosys Technologies (NASDAQ:INFY) beat estimates by 8 cents, posting fiscal first-quarter earnings of 55 cents a share as revenues fell 2.9% y/y to $1.12 billion.  The company expects second quarter earnings of 50 cents to 51 cents a share and full-year earnings of $1.97 to $2.00

• Barclays (NYSE:BCS) upgraded KLA Tencor (NASDAQ:KLAC) shares to "overweight"

• General Motors (NASDAQ"GMGMQ) exits bankruptcy today

• Nissan Motor (NASDAQ:NSANY) CEO Ghosn warned 2010 is likely to prove "as difficult as 2009," with Europe expected among the slowest areas to recover worldwide

• Credit Suisse (NYSE:CS) upgraded Western Union (NYSE:WU) shares to "outperform" from "neutral"

• Citigroup (NYSE:C) warned AIG (NYSE:AIG) investors may have little left after the US government is paid back. JP Morgan (NYSE:JPM) has opted for a public determination of its warrants' valuation in order to pay back government borrowings

• BMO Capital noted mildly positive data for May from Las Vegas Strip gaming revenues

• AIG (NYSE:AIG) is reportedly in early talks with rival MetLife (NYSE:MET) to sell its Alico unit, which could bring in as much as $15 billion

• Credit Suisse (NYSE:CS) raised its rating on KB Homes (NYSE:KBH) to "outperform"

• Bank of America/Merrill (NYSE:BAC) upgraded Goldman Sachs (NYSE:GS) to "buy," on expectations of better-than-estimated second quarter earnings, due out next week. Analysts upped the price target from $144 to $175, increasing estimates for 2009 and 2010 as well

• Among same-store-sales numbers: Less-worse numbers were posted by Zumiez (NASDAQ:ZUMZ), with a 19.3% decline versus estimates of a 20.4% drop. Worse-than-expected results were posted by Limited (NYSE:LTD) down 12% versus estimates of a 7.9% drop, and Wet Seal (NASDAQ:WTSLA) with a 11.1% drop versus estimates of a 8.7% decline

• Walgreen (NYSE:WAG) increased its quarterly dividend 22% to $0.1375

• Paccar (NASDAQ:PCAR) halved its quarterly dividend payout from 18 cents to 9 cents

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Here are highlights from Thursday's Analyst Blog:

Consolidated Banking, Maybe?

Clearly the cobbled-together oversight from various federal agencies was ineffective to contain the current financial crisis that all but swallowed the U.S. last year -- institutions such as but not limited to Citigroup (C), Bank of America (BAC), JP Morgan Chase (JPM) and AIG (AIG) -- and it remains in fairly close proximity to do so again.

Several weeks ago, U.S. Treasury Secretary Timothy Geithner sent to Congress a proposal to potentially to overall the current supervision of financial markets. While much is still up in the air, it is now expected as early as mid-June 2009 that the Obama Administration will make a formal recommendation to Congress for the creation of a single banking regulator to oversee the entire sector. It would be hoped that if such a proposal were sent to Congress it woud be finalized by the end of the year to help resolve the current quagmire.

Currently, a disconnected grouping of state and federal regulators oversee financial institutions throughout the country. It is not anticipated that the Obama Administration will propose the elimination of this so-called "Dual Banking System."

The new regulator would serve as primary regulator for the nationally chartered banks and thrifts, serve as a secondary oversight for the more than 5,000 state-regulated banks and the primary regulator for the nationally chartered banks and thrifts, and help to streamline supervision of banks and make it harder for banks to game the system by shopping for the lightest form of oversight.

UTStarcom - Big Opportunities

We expect UTStarcom, Inc. (UTSI) , a provider of IP-based telecom equipments, to receive further demand for its IPTV solutions as mobile TV systems become increasingly popular in China and India due to nationwide deployments of 3G wireless networks.

UTStarcom's transformation from a mobile handset developer to an IPTV and optical transport solutions provider has been favorably implemented.

Moreover, the company's current valuation is below its net cash position. At the end of the first quarter, the company had approximately $2.41/diluted share of cash position with no outstanding debt.

On the other hand, the markets for IPTV solutions and intelligent switching products are highly competitive and this, together with global economic weakness, may hinder efforts to improve the company's earnings power.

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Zacks Equity Research provides the best of quantitative and qualitative analysis to help investors know what stocks to buy and which to sell for the long-term.

Continuous coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.

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About Zacks

Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Leonard Zacks. As a PhD in mathematics Len knew he could find patterns in stock market data that would lead to superior investment results. Amongst his many accomplishments was the formation of his proprietary stock picking system; the Zacks Rank, which continues to outperform the market by nearly a 3 to 1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter; Profit from the Pros. In short, it's your steady flow of Profitable ideas GUARANTEED to be worth your time! Register for your free subscription to Profit from the Pros at http://at.zacks.com/?id=4580.

Visit http://www.zacks.com/performance for information about the performance numbers displayed in this press release.

Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.

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Visit: www.zacks.com

* A Washington Post article said the administration if preparing to send General Motors (NYSE:GM) into bankruptcy as soon as next week: however, Treasury officials advised the June 1 deadline will remain

* AIG (NYSE:AIG) CEO Liddy announced plans to leave the company as soon as a replacement is found

* Citigroup (NYSE:C) announced likely savings of over $1 billion from technology savings this year

* Johnson & Johnson (NYSE:JNJ) announced plans to purchase Cougar Biotech (NASDAQ:CGRB) for $1 billion, or $43 per share

* Sears Holding (NASDAQ:SHLD) reported earnings of 38 cents per share, ex-items, versus last year's 43 cent per share loss, and up from Street estimates of an 88 cent loss

* Gap (NYSE:GPS) announced first quarter earnings of 31 cents per share, one cent above Street estimates, versus 34 cents a year ago, on inline revenues of $3.13 billion

* Campbell Soup (NYSE:CPB) reported third quarter earnings of 48 cents per share, versus Street estimates of 42 cents and up from 43 cents a share a year ago, despite a sales decline of 10% to $1.7 billion. The company said it expects full year adjusted earnings growth of 5-7% from 2008

In the absence of major economic posts or corporate earnings, Friday is expected to be a quiet trading day.  Stock futures, nevertheless, are pointing to a higher open with Dow Jones industrial average futures up 52 points at 8,347. Standard & Poor's 500 index futures are up 6.20 at 894.90 and Nasdaq 100 index futures are up 9.50 at 1,377.00.

Financials showed some strength yesterday, edging up 0.2%, helped by an improved credit scenario.  Among DJIA components, JP Morgan (NYSE:JPM) and Citigroup (NYSE:C) rose 1% and 0.8%, respectively.  Wells Fargo (NYSE:WFC) added 2.4% and AIG (NYSE:AIG) was up 1.1%.  The 3-month Libor declined to an all-time low of 0.66%.  Fifth Third Bancorp (NASDAQ:FITB) shares declined 9.9% after the company announced plans to sell up to $750 million new shares.  Regions Financial (NYSE:RF), which priced an offering of 400 million shares of its common stock at $4 each, plunged 16% yesterday.

With investors remaining jittery, the CBOE Volatility Index, or VIX, jumped to 32.7.  Earlier this week, the measure had declined below 30 for the first time since September.

Industrial shares went sharply lower as the FOMC lowered prospects of a US recovery this year and raised its unemployment projections.  Caterpillar (NYSE:CAT) fell 4.7% and United Technologies (NYSE:UTX) dropped 1.9%.  Crude oil prices declined 1.6%, on weak demand concerns, sending the oil and gas industry sector shares off 3.0%.  Basic material shares fell 3.2%.  Largest U.S. aluminum producer Alcoa Inc. (NYSE:AA) declined 4.1% to $9.10. Schlumberger (NYSE:SLB) dropped 5.6% to $51.94. Farm equipment maker Deere (NYSE:DE) slid 6.2% to $41.57. 

* After the close Thursday, AIG (NYSE:AIG) reported a quarterly loss of 97 cents a share, worse than consensus projections of a loss of 6 cents a share but better than $1.41 a year ago

* Satellite provider Dish Network (NASDAQ:DISH) reported better-than-expected first quarter earnigs 70 cents per share, beating estimates of 56 cents versus 57 cents a year ago, on inline revenues of $2.91 billion, up 2.1% year-over-year. The company also said it lost 94,000 subscribers during the quarter

* Listed among the nine US banks which do not need additional capital, BB&T (NYSE:BBT) announced its plans to sell $1.5 billion common shares, in its efforts to help repay TARP funds. The company also said it plans to cut its third quarter dividend 68% to 15 cents. Capital One Financial (NYSE:COF) announced plans to sell 56 million common shares; Principal Financial (NYSE:PFG) reported plans to sell 42.3 million shares to raise at least $1 billion. US Bancorp (NYSE:USB) announced its plans to sell $2.5 billion in common shares

* American International Group (NYSE:AIG) faces a congressional hearing on Wednesday. According to media reports its "Project Destiny" internal review calls for multi-year restructuring needs

* AT&T (NYSE:T) announced plans to purchase $2.35 billion in assets from Verizon (NYSE:VZ)

Ed Yardeni is president of Yardeni Research  Inc., a provider of independent investment strategy research and data. He has worked as chief investment strategist at Deutsche Bank, Prudential Equity Group and Oak Associates. Yardini has also served as chief economist for C.J. Lawrence, Prudential Securities and E.F. Hutton.  

His resume also includes working as an economist with the Federal Reserve Bank of New York. He also held positions at the Federal Reserve Board of Governors and the U.S. Treasury Department.

Earlier this week, IndexUniverse.com's Murray Coleman caught up with the market-oriented economist and investment analyst Thursday afternoon to find out his take on macrotrends going forward.

IndexUniverse.com: Does this rally have legs?

Ed Yardeni:  I think it does. It has already traveled a fair distance. I think 1,000 on the S&P 500 is likely. We're probably going to take-out the Jan. 6 high for the year fairly soon, which was 934.70.

IU: Do you see more bumps in the round?

Yardeni: Yes, but they're the same bumps we've seen in the bear market. The banking system still has its issues as evidenced by the most recent stress test given by the government. And unemployment is still a concern. But there's a sense that these problems might not stop the economy from recovering after all.

IU: Do you see a pullback coming, though?

Yardeni: I don't try to be a technician. But sure, there could be a pullback. Remember, though, that we're coming back from a huge fall. What is encouraging is that stock prices in many industries are gaining back their losses from the September 2008 levels. That's when Lehman and AIG really hit the fan and panic took over.

IU: What sectors seem the best-positioned at this point?

Yardeni: Being defensive doesn't make much sense with a global recovery in sight. So I think materials and industrials should do well. The price of oil has done well recently. It should continue to rise. In the next six- to 12-months, prices could get up into the $75-$80 per barrel range. The metals and mining as well as specialty chemicals also look attractive now. Diversified chemicals still appear rather sluggish and I don't see a lot of upside in that industry.

IU: Do you think gold has more room to run?

Yardeni: Not necessarily. Gold and the trade-weighted U.S. dollar have been flight-to-safety plays. We've seen more interest in risk-taking lately. If that continues to be the case, the trade-weighted dollar and gold may go nowhere fast. I'm not enthusiastic about either one at this point.

IU: How about emerging markets?

Yardeni: They've had a great run and I think they'll continue to outperform from here. We started to see at the beginning of this decade a great global boom. That was interrupted by the credit crisis, but it looks like global growth might be resuming again. China, India and Brazil look best at this point. Asia will be the region that really leads the global economy out of this recession, more so than the U.S., Japan or Europe.

IU: How do you see Europe?

Yardeni: It's going to be a slow-growth story. They don't have much going on over there in terms of domestic demand. The demographics are against them with an aging population. And on the whole, they tend to have a more conservative consumer base. Other than in Spain, the U.K. and a scattering of other countries, Europe hasn't seen the kind of housing boom in recent years as the U.S. underwent this decade. Eastern Europe seems to continue to be mired in some of the credit excesses they've been through in recent years.

IU: What do you see taking place in those markets where housing did spurt before the credit crisis?

Yardeni: Now that we've seen the housing bubble burst, economies that used to have very active real estate markets -- such as Spain, the U.K. and Ireland -- are going to slow even more.

IU: Which markets appear in relatively better shape in Europe?

Yardeni: France and Germany have been heavily reliant on exports. But they should show better strength than other European countries because a global recovery will provide a lift to their exporting capabilities. That should put them in a better relative position than Spain, Ireland and the U.K.

IU: What sort of chance to do you see for a turnaround in Japan?

Yardeni: Not much. The main hope for Japan is strong growth in China. They've got one of the worst demographic situations of any industrialized economy. And they don't have any real serious domestic demand. They're working on their second lost decade. Japan stands to lose much of their economic influence in the next decade.

IU: What about the U.S.?

Yardeni: This is going to be the first global recovery not led by the U.S. Our economy will recover, but it will be lackluster and take some time to complete. The good news is that the U.S. remains a very dynamic economy. We've still got plenty of entrepreneurs who are going to make money even with the government playing a larger role in the private sector. But even once employment growth builds, we still could be looking at a recovery about half the strength of what we've seen in the past.

IU: What other types of investments are you recommending to institutional investors these days?

Yardeni: Corporate bonds, junk bonds and leveraged loans all look interesting. If you can get involved in funds that invest in companies benefitting from TALF, those would seem to be an attractive way to invest right now. That's assuming that you think that we're on a course heading towards a global recovery. I certainly do, which makes me believe that some sectors considered at the moment to be more risky look very attractively priced. This would seem to be a good time to take advantage of some of those opportunities.

U.S. markets felt the jitters yesterday as the anxiety over the pending stress test results somewhat offset Bernanke's optimistic view that the U.S. economy is on track for a recovery.  The Fed Chairman's testimony before the joint congressional economic committee, nevertheless, helped equity markets end the day relatively flat.  The S&P 500 declined 0.4% but managed to hold above 900. The DJIA dropped 0.2% and NASDAQ eased 0.4%. Volume on the NYSE was a moderate 1.5 billion shares as declining issues outpaced advancing stock 8 to 7. The market's volatility index, the CBOE Vix, eased 1.18 to 33.36. Today's premarket report of ADP private sector employment for April came in at a less-than-feared 491 K jobs lost, short of the 643K anticipated, and sharply lower than last month's 742K, sending futures into positive territory this morning.

Tuesday showed a dent in investor confidence even as President Obama told Congress the Administration is not seeking additional funds for banks.  And a Reuters report suggested AIG (NYSE:AIG), though expected to report a first quarter loss, will not need additional bail-out funds.  Financial shares declined 1.4% during the session.  On the DJIA, however, the financial component action was mixed as Bank of America (NYSE:BAC) and Citigroup (NYSE:C) shares rose 4.4% and 3.4%, respectively, and JP Morgan (NYSE:JPM), and American Express (NYSE:AXP), declined 2.7% and 2.6%, respectively.  Some media reports suggested Citigroup (NYSE:C) is considering the sale of its 16.7% interest in China Construction, which would help the company raise $8 billion.  Another development saw new standards being imposed for those planning to return TARP funds.  Those planning to return the funds need to provide evidence of their ability to issue non-government-backed debt. While Goldman Sachs (NYSE:GS) and JP Morgan (NYSE:JPM) have already done so, Morgan Stanley (NYSE:MS), has yet to issue non-government bonds.

The general mood, nevertheless, is that the industry is unlikely to head into another tailspin given the improving economic conditions.  The 3-month dollar Libor fell below 1% for the first time ever yesterday, suggesting the industry's optimism about each others' solvency.  Fed Chairman Bernanke, in his testimony, told Congress that banks will be able to meet funding needs through "issuance of new capital or through conversions and exchanges, or sales of asset and other measures."

Kraft Foods' (NYSE:KFT) better-than-expected earnings yesterday underscored improving consumer outlook.  However, Avon Products (NYSE:AVP), off 8.5% joined the list of firms reporting disappointing earnings. Order cuts from US automakers General Motors (NYSE:GM) and Chrysler were blamed for a wider-than-expected loss at AK Steel (NYSE:AKS).  DR Horton's earnings (NYSE:DHI) also disappointed and its shares declined 8.5%.

* Google (NASDAQ:GOOG) reported better-than-expected first quarter results due to improved margins on cost-saving measures. Revenues, though down 3% from the previous quarter, was up 6% from a year ago, marking the firm's first-ever sequential quarterly drop caused by the recession's impact on consumers' clicking activity and advertisers' fees paid per click. The company's conference call which suggested further sensitivity to the general economy, stressing the likely impact of seasonality on second quarter returns, bothered investors

* Citigroup (NYSE:C) reported its first profit in over a year on investment banking strength, as net income rose to $1.6 billion during the first quarter. On a per share basis, however, the firm reported a loss of 18 cents, resulting from a 24 cent loss on the conversion reset of preferred shares, which was narrower than the expected 34 cent loss and the $1.03 loss a year earlier. The Company also delayed its exchange offer

* Economic bellwether General Electric (NYSE:GE) reported better-than-expected first quarter earnings of $2.9 billion, or 26 cents per share, as revenues declined 9% to $38.41 billion. The showing compared with estimates of 21 cents and revenues of $39 billion

* Mattel (NYSE:MAT) reported a loss of $51 million, or 14 cents per share, versus the prior year's loss of $46.6 million or 13 cents a share. Analysts had expected a 13 cent loss

* Lincoln National (NYSE:LNC) received a Moody's Investor Service (NYSE:MCO) debt and financial- strength ratings downgrade amid warning that further cuts are possible if the company fails to get government aid

* GlaxoSmithKline (NYSE:GSK) and Pfizer (NYSE:PFE) plan a joint venture combining HIV drug operations, with Glaxo (NYSE:GSK) to wind up with an 85% and Pfizer a 15% interest

* AIG (NYSE:AIG) said it plans to sell its US car insurance operations to Zurich Financial Services for $2 billion

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Here are highlights from Thursday's Analyst Blog:

Pfizer to Trim Animal Health Biz

Yesterday, Pfizer Inc. (PFE) announced that it may have to sell a portion of its animal health business in order to gain regulatory clearance for its proposed purchase of Wyeth Pharmaceuticals (WYE). On January 26, 2009, Pfizer announced that it planned to buy Wyeth for about $68 billion.

The merger would create a company with combined revenue of about $71 million, according to Pfizer's estimates. We forecast revenue from the combined animal health businesses would equal about $3.8 billion in 2009 before any divestitures, making it the largest in the world. Schering-Plough (SGP) had held that title since its purchase of Organon BioSciences in November 2007. Schering's animal health sales were almost $3 billion in 2008.

China Mobile a Buy on Stimulus

China Mobile (CHL) reported 2008 annual results today along with encouraging 2009 expectations based on the Government of China's estimated economic stimulus program of 4 trillion yuan ($586 billion). The company believes the domestic stimulus plan will stimulate demand for telecommunications and information services with the active promotion of homegrown innovation.

From a financial perspective, total 2008 revenue reached RMB $412 billion, up 15.5% from 2007. Net profit to shareholders for full year 2008 increased 29.6% to RMB 112 billion and the dividend payout ratio was approximately 43%. Total subscriber count exceeded 457 million with net subscriber additions averaging over 7.3 million per month. The company plans to maintain its dividend payout ratio at 43%. We reiterate our Buy rating.

AIG Execs, Give It Back!

Apparently the contracts that were signed by AIG (AIG) with its executives in its Financial Products unit -- the part of the company that wrote all the Credit Default Swaps and sank the company and almost sank the world financial system -- are iron clad. So says Treasury Secretary Tim Geithner and AIG CEO Ed Liddy (installed at only $1 a year after the mess had been made).

I'm a finance and economics guy, not a lawyer, but it does strike me that there are probably several grounds on which the contracts are at least ambiguous enough that the company should have avoided paying them. If a company knows it is in financial trouble, it cannot strike sweetheart deals with some parties that transfer the assets of the company to them at the expense of other interested parties. This is the essence of the idea of fraudulent convenience.

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About Zacks Equity Research

Zacks Equity Research provides the best of quantitative and qualitative analysis to help investors know what stocks to buy and which to sell for the long-term.

Continuous coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.

Zacks "Profit from the Pros" e-mail newsletter provides highlights of the latest analysis from Zacks Equity Research. Subscribe to this free newsletter today: http://at.zacks.com/?id=2677

About Zacks

Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Leonard Zacks. As a PhD in mathematics Len knew he could find patterns in stock market data that would lead to superior investment results. Amongst his many accomplishments was the formation of his proprietary stock picking system; the Zacks Rank, which continues to outperform the market by nearly a 3 to 1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter; Profit from the Pros. In short, it's your steady flow of Profitable ideas GUARANTEED to be worth your time! Register for your free subscription to Profit from the Pros at http://at.zacks.com/?id=4580.

Visit http://www.zacks.com/performance for information about the performance numbers displayed in this press release.

Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.

Contact:
Mark Vickery
Web Content Editor
312-265-9380
Visit: www.zacks.com

One of the reasons this is so outrageous is that the promise of such bonuses was in fact one of the very factors that caused our current problems, creating incentives for managers of AIG to get out of solid insurance underwriting and into hedge fund gambling. If anyone had supposed that AIG had "learned its lesson", this report seemed to dash that hope against the wall like a plate of china.

Some may argue that AIG's hands were tied by contracts the company offered employees in the spring of 2008 promising that 2008 bonuses would be 100% of 2007 bonuses. Or that the inability of the Treasury Secretary to override these bonuses was cemented by the following clause in the American Recovery and Reinvestment Act signed into law on February 17:

The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

Fox News blamed the above de facto AIG exemption on Senator Christopher Dodd (D-CT), suggesting a possible connection to the fact that Dodd was the largest single recipient of 2008 campaign donations from AIG. But Jane Hamsher documents that the words above were inserted after the bill left the senate and went to conference committee. Hamsher proposes instead that pressure from Treasury Secretary Timothy Geithner and National Economic Council Head Larry Summers played a role in those words' appearance in the final bill.

I have yet to find a clear account with actual names of the representatives and senators who thought prohibiting restrictions on bonuses promised before February 11 was a good idea. But somebody put that clause in, and the claim that the legislators all are shocked-- shocked-- to find this is part of what they voted for is, if nothing else, Exhibit 9,247 for the case that legislation needs to be sufficiently short that everyone can be expected to read it.

But more shocking yet, at least if we measure these things in dollars and cents, is the amount of taxpayer funds that have gone to compensate AIG's counterparties for bets those counterparties never should have been allowed to make.

Source: Capital Chronicls

On Sunday Larry Summers offered this explanation for the bonuses:

We are a country of law. There are contracts.... Binding contracts were entered into long before the government put any money into AIG. We're not a country where contracts just get abrogated willy-nilly.

But here's the point. AIG may have entered into contracts with its managers and its counterparties, but the U.S. taxpayers did not. A precondition for infusion of taxpayer funds has to be sufficient restructuring of pre-existing commitments to ensure that any new funds delivered achieve their purpose rather than simply prolong the problem.

If Geithner and Summers feel they lack the legal authority to ensure that kind of constructive receivership status for recipients of bailout dollars, then they should have delivered proposed legislation to Congress providing such authority on day one.

Or, given that we missed that deadline, maybe they'd consider giving us a plan that works tomorrow.

Technorati Tags: macroeconomics, economics, credit default swaps bailouts, AIG

Part of this miscalculation can be attributed to misguided quantitative models that were used to assess those risks. The key inputs for those models were assumptions about underlying default rates and their correlations across different borrowers. Default rates and correlations were quite low up until 2005, because rising home prices made default a decidedly inferior option to refinancing for even the least credit-worthy borrower. But the rising home prices were themselves caused by the huge flow of capital for lending to this market, sucked in by the illusion of safety. When the flow of credit stopped and house prices began to fall, the same forces operated impressively in reverse, now leading otherwise credit-worthy borrowers to default in increasing numbers.

But I would argue that another factor contributing to the illusion of safety was severe distortions in the markets for derivative contracts based on those underlying mortgage-backed securities. The seller of a credit default swap promises to make a payment to the buyer in the event that the security against which the contract is written goes into default. From the perspective of the buyer, a CDS is like an insurance policy against default. Some institutions might be interested in buying such contracts even if they did not have long positions in the securities against which the CDS was written, as a hedge against risks of other related investments.

And who would want to be on the sell side of these contracts? Insurance giant AIG was one big player. At first blush, you might think this could be a reasonable role for such an institution, since from the point of view of the buyer a CDS could function much like an insurance policy. But from the point of view of the seller, this is a very different product from conventional insurance. Selling more fire insurance policies helps the insurer to diversify, because fires across different communities have little correlation. But there is a common risk factor at the core of recent housing market developments. By selling a bigger volume of CDS, AIG was simply taking a bigger lopsided position on a single one-sided bet. And AIG lacked the financial resources to make good on those contracts in the event that the housing downturn became as severe as it has now proved to be.

But that raises a separate question. Could it make any sense for AIG to sell and someone else to buy a promise on which AIG in fact could not deliver? From the point of view of AIG-- at least the specific players within AIG running these operations-- one could argue that the answer is yes. In selling the CDS, they were receiving huge payments. As Forbes reported last September:

A big part of the reason was most likely that AIG's financial products unit, run by Cassano since 1988, was a veritable money machine, pouring $6 billion of riches into AIG's coffers from 1988 until 2005.... According to The Times, compensation ranged from $423 million to $616 million for Cassano's group. That would be about 20% of the unit's revenue, meaning Cassano was being paid like a hedge fund manager.

This understanding of AIG's incentives may have been what prompted Federal Reserve Chair Ben Bernanke to sound off last week:

if there's a single episode in this entire 18 months that has made me more angry, I can't think of one, than AIG.... AIG exploited a huge gap in the regulatory system.... There was no oversight of the Financial Products division. This was a hedge fund, basically, that was attached to a large and stable insurance company, made huge numbers of irresponsible bets-- took huge losses. There was no regulatory oversight because there was a gap in the system.

So let's grant that Cassano and his cohorts may have had ample incentive to sell the product. But who would buy? Though he may not have been thinking of AIG and its counterparties in particular, Bernanke aptly described one potential answer in his remarks today on financial reform to address systemic risk:

In a crisis, the authorities have strong incentives to prevent the failure of a large, highly interconnected financial firm, because of the risks such a failure would pose to the financial system and the broader economy. However, the belief of market participants that a particular firm is considered too big to fail has many undesirable effects. For instance, it reduces market discipline and encourages excessive risk-taking by the firm.

Could AIG's counterparties have been thinking that their payments would come not from AIG but from the Federal Reserve and taxpayers? If that's what they thought, some of them at least would appear to have been correct. Gretchen Morgenson reported this weekend:

When A.I.G. couldn't meet the wave of obligations it owed on the swaps last fall as Wall Street went into a tailspin, the Federal Reserve stepped in with an $85 billion loan to keep the hobbled insurer from going bankrupt; over all, the government has pledged a total of $160 billion to A.I.G. to help it meet its obligations and restructure operations....

Edward M. Liddy, the chief executive of A.I.G., explained to investors last week that "the vast majority" of taxpayer funds "have passed through A.I.G. to other financial institutions" as the company unwound deals with its customers....

On Wall Street, those customers are known as "counterparties," and Mr. Liddy wouldn't provide details on who the counterparties were or how much they received. But a person briefed on the deals said A.I.G.'s former customers include Goldman Sachs, Merrill Lynch and two large French banks, Societe Generale and Calyon....

How much money has gone to counterparties since the company's collapse? The person briefed on the deals put the figure at around $50 billion.

To the extent that the buyer and seller of the CDS were making a bet for which the taxpayers were implicitly picking up the downside, the CDS market, rather than helping institutions effectively manage risk, would have been a factor directly aggravating systemic risk.

I raise this issue not to be yet another voice clucking that we need to get tougher on AIG or others in order to prevent moral hazard, though that is one reasonable inference to draw from the discussion above. But the issue for me has always been not to exact retribution or instill market discipline, but instead the very pragmatic question of how to use available resources to minimize collateral damage. I accept the argument that a complete failure of AIG would have unacceptable consequences. The relevant question then is, what combination of parties is going to absorb the loss?

The concern I wish to raise is that any reasonable answer to that question would include Goldman Sachs, Merrill Lynch, Societe Generale, and Calyon, to pick a few names at random, as major contributors to this particular collateral-damage-minimization relief fund. But if they are to contribute, the plan must be something other than doling out another $100 billion every few months to try to keep the operation going a little longer, but instead requires seizing this bull by the horns. Split AIG into a core business we want to protect-- with enough equity to be a viable operation, and a hefty fraction of the existing management team fired-- and a derivatives business that's going to be systematically liquidated in large part by abrogation of outstanding contracts.

Then there's the domino effect to consider. What do we do when this brings down the next player who can't continue operations without those payments AIG (or the taxpayers) were supposedly going to deliver? I say, we implement the parallel operation there.

That's my proposal for how to dismantle the derivatives house of cards. One trillion at a time.

Technorati Tags: macroeconomics, economics, credit default swaps bailouts, subprime, credit crunch

* Global demand rose 18% to 1,133.4 metric tonnes from 963.3 tonnes a year earlier.

* In dollar terms, the jump in demand was even bigger. Dollar demand for gold reached an all time quarterly record of $32 billion in the third quarter, a whopping 45% higher than the previous record … set in the second quarter.

* Identifiable investment, which includes purchases through exchange-traded funds and of bars and coins, climbed 56% year over year to 382.1 tons.

Hank Paulson has just about burned through $300 billion, and it's not clear what the public has got out of it. Perhaps things would be worse without the bailout but they're certainly no better. Wall Street banks have not significantly stepped up their loans to small businesses, college students, car buyers, or distressed homeowners. Much of the auto industry is on the verge of bankruptcy. And the rate of foreclosures is rising.What happened to all the money? About a third has gone into dividends the banks are paying their shareholders. Some of the rest into executive salaries and bonuses. Another portion toward acquisitions designed to raise share values. Another chunk for bailing out giant insurer, AIG. That's not what taxpayers bargained for.

“We shouldn’t worry about the deficit next year or even the year after,” the U.S. president-elect Barack Obama said on 60 Minutes over the weekend.

We were afraid that Barack’s message of “change you can believe in” was going to make it harder to take issue with politics as usual in Washington. But now we see he already drank the Kool-Aid and we…

Constant readers know I’ve gone back and forth on this:  In September I figured the bailout bill smacked of making things up as he went along.  But on Monday I took note of the phone conversation he had two months before Washington Mutual collapsed, in which Paulson told WaMu’s CEO he ought to sell out to JPMorgan Chase (NYSE:JPM) because his company was in big trouble.

I guess it’s possible Paulson knew bad things were going down, but he still didn’t know what to do about it.  And this morning, the making-things-up-as-he’s-going-along thesis seems inescapable.  I mean, really: The bailout bill was predicated on…

Monday’s activity showed another decline in gold open interest…down 2,312 contracts. Tuesday’s sell-off brought another o.i. decline in gold of 906 contracts. Without doubt, yesterday’s activity will show a further decline…

Earlier today, the Secretary of the Treasury stood in front of an audience of Wall Street reporters and gave the country an update on the Trouble Asset Relief Program (TARP) and his team’s efforts to shore up the nation’s economy. What he had to say is taking some investors by surprise.

Most importantly, Paulson noted he would not use the TARP to buy the troubled assets of the nation’s financial institutions (like the name of the program implies). Instead, the Treasury Department will…

1.) They’re Riskier Than Other Investments

While this was once true, if you’ve been following the economy recently, you know that’s no longer the case. In an age when blue chips like AIG (NYSE:AIG) or Lehman Brothers can swing just as wildly as the crankiest penny stock, even the big names are no sure thing.

To be fair, penny stocks are far from risk-free. But it’s that risk that brings with it the reward potential penny stocks are known for.

********************************

The “Black Market” Secret Used by Famous…

First comes word that Hank Paulson rewrote tax law without Congress’s say-so, giving the banks a $140 billion tax windfall.  Now one could argue the tax law Paulson circumvented was a dumb idea, but even mainstream analysts who don’t fuss over the plain language of the Constitution say Treasury overstepped its bounds here.  I hope conservatives who hailed the “unitary executive” philosophy of Team Bush might be rethinking things by now… but I doubt it.

Meanwhile, Paulson and Ben Bernanke have gone back on their promise to disclose just who’s…

This from The Daily Reckoning Australia

Now to the big subject of the day: Inflation. You’d think evidence of even bigger deficits in the U.S. is clearly inflationary. But not everyone thinks so. The new prophet of doom, Dr. Nouriel Roubini, says at least four factors are setting up what he calls “Stag Deflation” (as opposed to the stagflation of the 1970s, where you had no growth and rising prices).

Roubini’s four…

This from The Daily Reckoning:

Let there be no mistake; the U.S. has now transformed itself into a great socialist society by using taxpayers’ money to buy-out private companies. In my view, this ridiculous measure is a slap in the face of capitalism and will further promote reckless and dubious practices. Essentially, by bailing out the behemoths (Fannie Mae, Freddie Mac and AIG [NYSE:AIG]) and allowing the smaller fish (Lehman Brothers) to fail, the U.S. establishment is…

The most interesting news item recently was found on the cover of the Financial Times newspaper, where we learn that a guy named Lahde “made tens of millions of dollars from betting against the financial and property sectors during [the] past two years”, and he now wanted to thank “the low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA” who made it all possible…

“Broad should be a lot poorer this year. Worth $7 billion last fall, the insurance and housing maven saw his 46.6 million shares of AIG - received a decade ago when he sold his SunAmerica to the insurance giant for $18 billion - drop 70% between last summer and August 29, the day we priced the Forbes 400 (they’ve fallen much further since). That decline erased $2 billion from his personal balance sheet. But Broad’s net worth fell only $300 million. One reason: the soaring value of his 2,000-piece art collection. Comprising mostly contemporary pieces by artists like Jeff Koons, his collection was recently appraised…

I don't think so.

Once news leaked that the JoI editorial board would be meeting at the NASDAQ MarketSite and ringing the closing bell ... well, faith in America's markets was restored.

And why not? Indexing and ETFs are a bright spot in the otherwise dark cloud hanging over the financial markets right now. The trends being driven by ETFs—including lower costs, greater transparency and more diversified portfolios—are trends that will help American investors over the long term.

In fact, more than one JoI board member suggested that the current financial crisis may well accelerate the movement of investors into ETFs and index funds. We've seen that happen before when the markets hit a rough patch (think after the Internet bubble). Investors suddenly realize that picking individual stocks and shooting for 50% annual returns is a recipe for disaster. Some of them turn to sound index-based strategies and build diversified, low-cost portfolios that will help them in the long haul.

Similarly, the transparency of ETFs is appealing to those who have lost faith in Wall Street. A lot of active fund investors got burned this year holding funds that (unbeknownst to them) had stakes in AIG, Fannie Mae or Lehman Brothers. With ETFs, you know what you're buying.

There are still some issues in the ETF market, and there was a frank and substantive discussion of those issues at the board meeting today. We touched on credit/counterparty risk, the need for continued investor education and the recent trading issues in fixed-income ETFs. Of the latter, most people say that the problem with fixed-income ETFs lies with the index pricing and not the ETF pricing; in fact, they say the ETFs are acting as the best price discovery mechanism for the illiquid bond markets right now.

One thing that jumped out at me about the meeting was the large media interest. There must have been a dozen or more reporters attending the open-door part of the meeting. Clearly, the influence of ETFs and index funds is widening.

Kudos to NASDAQ doing a great job hosting the meeting. From the excitement of ringing the closing bell to excellent meeting facilities and great food (including extraordinary—and extraordinarily large—cookies), it was first-class all around.

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Traders are reacting quickly to the ever evolving events, which has included the bankruptcy of Lehman (LEH), the government takeover of AIG (AIG), the closing of a Putnam money market fund, an infusion of liquidity by several central banks and a proposal for a massive bailout of financial firms. Not to mention that short-selling has been banned on nearly 800 financial stocks here in the U.S.

In describing the week's events to David Gaffen, who writes the excellent MarketBeat blog for the Wall Street Journal, I opined, "Throughout the year there's been so many people saying this is bottom, and we hear about (the major financial firms) throwing in everything including the kitchen sink, but now we're finding they're throwing in the dishwasher, the refrigerator, and who knows what else."

Treasury Secretary Henry Paulson's and Fed Chairman Ben Bernanke's latest response to the financial crisis is the creation of a new entity that would purchase a significant amount of the distressed debt plaguing many financial firms. The assumption is that if the toxic debt can be moved off of corporate balance sheets, calm will be restored to the financial system.

Taxpayer money could be used to fund this entity, which is why the proposal is being brought before Congress. And, since this is an election year, it is highly likely that some type of bailout for homeowners at risk of defaulting on their mortgages will be included.

Rest assured, the decisions being made right now will be criticized in the future. But in a crisis situation, fast action is often better than no action. Give Bernanke and Paulson credit for being creative.

At the root of the credit crunch is a psychological problem - lenders don't trust borrowers. The entire financial system is based on the expectation that both parties engaged in a transaction that will meet their obligations. When counter-parties don't trust each other, deals don't get done and loans don't get made. It was a lack of trust that caused Bear Stearns to collapse so quickly, and it is a lack of trust that has created questions about the viability of Morgan Stanley (MS) as a stand-alone firm.

Strategies for the Current Environment

I wish I could tell you that a bottom was established earlier this week and that a rebound in the markets is underway, but there are too many variables at play.

What Thursday did show everyone is the importance of maintaining an allocation to stocks. Anyone who did not have money allocated to stocks at lunchtime on Thursday missed out on the big rally. The biggest rallies happen very quickly and without any forewarning.

Therefore, it is important to continue to focus on the long-term. Over time, stocks have consistently created more wealth than any other investment vehicle. A diversified portfolio will weather bear markets and will thrive in bull markets.

Investors looking to use the current environment to get back into the market should consider researching shareholder friendly companies such as CSX (CSX) and Smith International (SII). Both pay dividends and are buying back stock.

I would warn that the risks of investing in MBIA (MBI), PMI Group (PMI), National City (NCC) and Zions Bancorp (ZION) remain high. The latest proposal is still under discussion, and therefore we don't know how it will affect those or many other financial firms.

Read the full analyst report on LEH

Read the full analyst report on AIG

Read the full analyst report on MS

Read the full analyst report on CSX

Read the full analyst report on SII

Read the full analyst report on MBI

Read the full analyst report on PMI

Read the full analyst report on NCC

Read the full analyst report on ZION

The speed and intensity of the rally demonstrated the importance of maintaining an allocation to stocks. The biggest rallies often happen without much forewarning.

Therefore, it is important to continue to focus on the long-term. Over time, stocks have consistently created more wealth than any other investment vehicle. A diversified portfolio will weather bear markets and will thrive in bull markets.

Our Strategy for the Focus List

In managing the Focus List, we treat each stock pick as an investment, not a trade. We are willing to move quickly when conditions change, but day-to-day swings in the market are not going to change our management style. Our plan is to continue to find fundamentally sound stocks with rising earnings estimates that are trading at attractive valuations.

In accordance with this objective, we will be adding ReneSola (SOL), Smith International (SII) and Sohu.com (SOHU) to the Focus List. All three stocks are trading at an attractive valuations and have rising earnings estimates.

SII provides a complete range of oilfield drilling products and services, from the rig floor to the drill bit. A sizeable portion of its business is tied to long-term projects in the Eastern Hemisphere, which historically has provided less volatile revenue streams. Smith International is also a shareholder friendly company, having both raised its dividend and repurchased stock. Zacks Equity Research analyst Sheraz Mian recently upgraded SII to a long-term buy.

SOHU is the leading Internet search engine and web portal in China. The company has been experiencing rapid growth in both revenues and earnings, but recent weakness in the Chinese stock market has made shares of this company a bargain. SOHU trades at just 18x projected 2008 earnings of $3.55 per share and is a Zacks #1 Rank ("strong buy") stock.

SOL manufactures solar wafers and supplies many of the major manufacturers of solar cells and modules. Unlike many other alternative energy companies, ReneSola has been profitable. Equally important, the company's earnings are projected to rise approximately 60% next year to $2.16 per share. SOL is a Zacks #1 Rank stock trading at just 10.6x projected 2008 profits.

The Focus List does not have any exposure to the industries in which these companies operate. Therefore, adding these companies will improve the diversification of the portfolio, which in turn reduces its volatility.

Regulatory and Market Events

I'm going to reiterate what I said on Zacks.com concerning the week's events and new regulatory proposals.

Traders are reacting quickly to the ever evolving events, which has included the bankruptcy of Lehman (LEH), the government takeover of AIG (AIG), the closing of a Putnam money market fund, an infusion of liquidity by several central banks and a proposal for a massive bailout of financial firms. Not to mention that short-selling has been banned on nearly 800 financial stocks here in the U.S.

In describing the week's events to David Gaffen, who writes the excellent MarketBeat blog for the Wall Street Journal, I opined, "Throughout the year there's been so many people saying this is bottom, and we hear about (the major financial firms) throwing in everything including the kitchen sink, but now we're finding they're throwing in the dishwasher, the refrigerator, and who knows what else."

Treasury Secretary Henry Paulson's and Fed Chairman Ben Bernanke's latest response to the financial crisis is the creation of a new entity that would purchase a significant amount of the distressed debt plaguing many financial firms. The assumption is that if the toxic debt can be moved off of corporate balance sheets, calm will be restored to the financial system.

Taxpayer money could be used to fund this entity, which is why the proposal is being brought before Congress. And, since this is an election year, it is highly likely that some type of bailout for homeowners at risk of defaulting on their mortgages will be included.

Rest assured, the decisions being made right now will be criticized in the future. But in a crisis situation, fast action is often better than no action. Give Bernanke and Paulson credit for being creative.

At the root of the credit crunch is a psychological problem - lenders don't trust borrowers. The entire financial system is based on the expectation that both parties engaged in a transaction that will meet their obligations. When counter-parties don't trust each other, deals don't get done and loans don't get made. It was a lack of trust that caused Bear Stearns to collapse so quickly, and it is a lack of trust that has created questions about the viability of Morgan Stanley (MS) as a stand-alone firm.

The Markets

The S&P 500, and other major averages, set new lows for the year, only to bounce right back into their previous ranges. Trading this week was not driven by technicals, but rather speculation and reaction to news events. I expect more of the same next week as we start to learn the details of the proposed bailout.

The VIX shot well above 30 this week, signaling an elevated level of fear. Recently, spikes above 30 have signaled short-term bottoms. Given the ban on short sales and the proposed bailout, it's very possible that another bottom has been set.

Charles Rotblut, CFA, is the Senior Market Analyst for Zacks.com. He can be reached at crotblut@zacks.com.
"SII" Free Stock Analysis: Buy? Sell? Hold?
"SOL3" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

While the strategic rationale for BAC to buy MER is pretty obvious - it weds the biggest retail bank to the biggest retail brokerage firm - what possessed BAC to pony up that sort of price is far from obvious.  They could have had LEH for maybe $0.05 a share if they wanted it.  If they had waited a week they could have probably picked up MER for $10 a share.  I would not be shocked to find out that there was some sort of inducement from the government for them to step up the price, so there would be some "good news" for the markets today. 

Meanwhile, it appears that the biggest insurance company, AIG (AIG) in the world turned down capital-raising offers from several private equity firms and is now going hat in hand to the Fed. 

Apparently the rule of law means nothing on Wall Street now.  There is NOTHING in the Federal Reserve Act that would allow a non-Depository financial institution that is not even a Primary Dealer (and even that is stretching it big-time - but was the basis the Fed was part of the Bear Stearns [BSC] bailout/shotgun wedding) to have access to the Fed window, and certainly not to the tune of $40 billion which is reportedly what they are looking for. 

This is crazy. There is no Fed window anymore.  A window implies that it is something that could be open and shut, so that access to it could be controlled.  This is no window, it is a gaping hole in the side of the wall.  To the extent it is still a window, it is like all the windows of the J.P. Morgan Tower in Houston. 

There is much to look at and explore.  Ten major banks have each come up with $7 billion to fund something that looks like a second, private Fed window.  As I write this the Dow is down 300 points.  If we close at these levels, count it as a victory. 

People thought that the demise of BSC was then end of the credit crisis, it was not.  Then the conservatorship of Fannie Mae (FNM) and Freddie Mac (FRE) was going to be the bell that rings signaling the end of the credit crunch (big financial crunches have historically come to a climax when someone or something big goes under, like Continental Illinois Bank, Mexico, LTCM). 

I doubt this is the end, either; there is still much more trouble ahead.  In the meantime, hunker down and for God’s sake make sure you do not have more than $100,000 in any single bank.  There are going to be a lot of bank failures still, and the FDIC insurance fund is running dangerously low. 

It appears that the next domino to fall may be Washington Mutual (WM).  Its insured deposits alone far exceed the size of the FDIC fund.  If it goes under there will have to be an emergency infusion of funds from the Fed or the Treasury.  If that didn’t happen, then the next bank failure would result in insured depositors not getting their money back.  That would lead to a run on virtually every bank in the country - shades of 1931. 

Thus, I am very confident that such an infusion would be made.  But - oh what the heck, what’s another $100 billion or so added to the budget deficit?  Dick Cheney assures us that deficits don’t matter anyway.

On a macro-level, what is going on is a massive deleveraging.  Deleveraging is by its very nature deflationary.  Money goes to money heaven when it happens.  The Fed is trying to offset this by pumping as much liquidity into the system it can.  Under normal times that is how you go about creating inflation. 

Once upon a time, only depository institutions, plain old-fashioned commercial banks were allowed to borrow from the Fed, and then only using T-Notes or T-Bills as collateral.  Then Investment banks were allowed in, and the collateral was expanded to Agency debt.  Now it appears that even insurance companies can go to the window and use any investment-grade debt (and we know just how on top of things the Rating agencies have been about quickly reflecting the true financial conditions ) as collateral. 

Heck, they are now even allowing equities to be used as collateral.  What is next, a beanie baby collection as collateral?  Down that road leads to hyperinflation (i.e. the United States of Zimbabwe).  Theoretically, it would be possible to precisely offset the deflation with this induced inflation, resulting in stable prices.  However, with the lags inherent in monetary policy even in the best of times (usually 6-9 months) and incomplete data collection, that will not be easy. 

The best comparison I can make is that the Fed will have to thread a needle while sitting in a car going 70 mph down a poorly maintained dirt road, and they only get one chance.  Stay away from the Financials.  This is not over, folks.

Read the full analyst report on LEH

Read the full analyst report on MER

Read the full analyst report on BAC

Read the full analyst report on AIG

Read the full analyst report on FRE

Read the full analyst report on WM