MarketView for July 28

Stock prices were pummeled once again on Monday, sending the key equity indexes tumbling as fears rose on Wall Street that the credit and housing markets have yet to see the light at the end of the tunnel.  Mixed quarterly earnings results and a rise of more than 1 percent in the price of crude oil only added to the downward pressures as worries over inflation and consumer spending took their toll.

Furthermore, the news that federal regulators seized two more failed banks late last week also helped to sharpen the sell-off in financial shares. The Office of the Comptroller of the Currency said late on Friday it closed First National Bank of Nevada and First Heritage Bank NA of California.

Among the hardest-hit were Merrill Lynch, down more than 11 percent; Citigroup, off over 7 percent and Lehman Brothers, down more than 10 percent. Lehman hit the skids after a Merrill analyst said the firm may post a third-quarter loss and face a round of fresh write-downs on its residential mortgage portfolio. Another major loser in the financial sector was insurer American International Group; down 12 percent. The S&P financial index shed 4.6 percent.

Shares of mortgage finance companies Fannie Mae and Freddie Mac also fell, reversing gains seen after Congress, over the weekend, approved a rescue plan for the housing market. Fannie Mae's stock slid 10.7 percent, while Freddie Mac's stock was down 6.7 percent.

Verizon saw its shares fall 2.5 percent after its second-quarter results showed further weakness in its land line telephone business. On the NASDAQ, Apple were the largest drag, falling 4.8 percent, while Kraft Foods Inc was a bright spot, gaining 4.9 percent posting a stronger-than-expected quarterly profit.

Crude Rises

The price of crude oil was sharply higher on Monday, settling up $1.47 per barrel at $124.73, after militant attacks slashed Nigerian oil production and Iran stirred up tensions once again by suggesting it was rapidly expanding its nuclear program. Those emotions also sent London Brent up $1.32 per barrel at $125.84. The gains were limited somewhat by fresh evidence that high prices were shrinking demand in the United States, a trend that has contributed to a record sell-off in oil prices since the mid-July peak.

A militant group in Nigeria's Delta region said Monday it attacked two Royal Dutch Shell pipelines, thereby halted some production due to the incident but declined to say how much. The incident in Africa's biggest oil exporter followed the kidnapping of eight foreign oil workers last week.

Developments in Iran also provided some support. The country has more than 5,000 active centrifuges for enriching uranium, its president said, suggesting a rapid expansion of nuclear work. President Mahmoud Ahmadinejad's announcement was likely to annoy major powers which have offered Iran a package of economic and other incentives to suspend its enrichment activities.

Oil's gains were trimmed somewhat after fresh evidence that surging oil prices and an economic slowdown in the United States were cutting into demand from the world's biggest consumer nation.

The U.S. Transportation Department reported that the number of miles driven in May fell by a record 3.7 percent from last year, making it the largest decline ever for a month that usually sees increased traffic due to Memorial Day vacations and the start of summer.

The data reinforced concerns that oil prices had become unsustainably high after a six-year, 600 percent rally driven partly by an economic boom in China. Data from the Commodity Futures Trading Commission released on Friday showed that speculative funds were shifting to a net short position, a bet on falling prices, for the first time in 17 months.

Traders will have their next glimpse at U.S. oil stockpiles on Wednesday, when the U.S. Energy Information Administration issues its weekly report. The report is expected to show a decrease in inventories of crude oil after Hurricane Dolly delayed some imports along the Gulf Coast last week.

Now It’s Covered Bonds

The Treasury and the nation's four biggest banks on Monday said they will kick-start a market for an investment product known as covered bonds to support home financing in the latest effort to spur a slumping housing market. Covered bonds are secured by pools of assets like home loans.

However, unlike mortgage securities, which pass all the risk to investors, covered bonds collateralized with mortgages would continue to perform even if the mortgages backing them default, assuming the issuing bank remained solvent because covered bond loans stay on the balance sheet of the bank that issues the bond, so they are obligations on the bank. In other words, the issuer retains control of the assets that back the loans, which will be high-quality home mortgages in good standing.

Covered bonds are widely used in Europe but have only become attractive in the United States since the segment of the mortgage securitization market driven by investment banks dried up last year. In a move designed to help develop the market for the investment instrument, the Treasury Department released a set of "best practices" for covered bonds.

"The key to the U.S. economy making a major improvement will be turning the corner on housing finance and on the housing correction," Treasury Secretary Henry Paulson told a news conference. "We're not going to be able to do that unless we have availability of mortgage financing, and this is an attractive resource for mortgage financing."

The U.S. housing market has traditionally been supported by mortgage-backed securities, which involves bundling loans into securities and selling them to investors worldwide. Financing, however, has dried up since the wave of foreclosures spawned by the collapse of the subprime mortgage market last year.

"I think there'll be some issuance very soon," Paulson said. "There's not 100 percent certainty that it ever will become very significant but this is an innovative tool and we think it's one that we think is very promising."

Covered bonds are not totally new in the United States, but have been a small factor in the nation's $11 trillion home mortgage market that Paulson thinks can become bigger with the backing of the four big banks.

A Bank of America official said that, given time, covered bond issuance might reach $1 trillion, enough to be considered significant part of the mortgage market.

Whatever it amounts to, Paulson made clear that any new source of mortgage financing was welcomed given the seriousness of a housing downturn that is rated the worst since the Great Depression.

Two weeks ago, the Federal Deposit Insurance Corp. had offered guidance specifying how investors would get their collateral if an issuing bank failed, and the Treasury put together the set of best practices in the hope of further encouraging the market's development.

Federal Reserve Governor Kevin Warsh told the news conference the U.S. central bank was willing to consider highly rated, high-quality covered bonds as collateral for banks seeking emergency funds from the Fed. "A covered bond framework may attract investor interest and facilitate greater access to mortgage credit," he said.

Some analysts, however, were skeptical covered bonds would be the answer to the housing market's woes unless the capital requirement on the bonds is lowered, thereby placing them on the same footing as agency mortgage-backed securities

The Securities Industry and Financial Markets Association, a bond market industry group, said a dedicated U.S. covered bond trader would be appointed within each of its member firms and those institutions would provide price information to electronic platforms for covered bonds -- steps that could help the market develop. Bank of New York Mellon said banks can use covered bonds as collateral for its repurchase program.

Lower Earnings at Amgen

Amgen reported a lower second-quarter earnings on Monday due to declining sales of its anemia drugs, which have been hurt by safety concerns and reimbursement restrictions. However, positive news regarding its experimental medicine, the osteoporosis drug denosumab, has done a lot to bail out the share price.

Net earnings fell to $941 million, or 87 cents per share, from $1.02 billion, or 90 cents per share, a year ago. Excluding one time items, Amgen earned $1.14 per share.

Under assault for most of 2007, the company’s share price has been recovering, rising some 30 percent this year, due to positive data coming out about denosumab, thereby counteracting the bad news involving its once top-selling anemia drugs.