So what are all those idle bankers betting on this holiday season?  Well, depends which bank fired them!

Citigroup - Abercrombie and Fitch (NYSE:ANF)

We all know the kind of guy that goes to work at Citigroup - he wore the polo shirt with the collar up and pretended he knew what he was talking about while tagging along with whoever he thought was the coolest guy in the room.  Well, we’ve got a stock for this sycophant who still hasn’t gotten the recession memo - it’s been twelve months, dude! - Abercrombie and Fitch.

The company is known for its preppy (lame) clothing and aggressive (naked) marketing campaigns…and it’s recession proof!  At least according to its CEO.  ”We hear your concerns,” Michael Jeffries said last month, but “promotions are a short-term solution with dreadful long-term effects.”  So Abercrombie won’t be offering any special deals this holiday season…and while competitors like American Eagle (NYSE:AEO) are fighting the slowdown by offering deals like “Buy one shirt, get the second 50% off!” Abercrombie’s going to keep charging $60 for a polo shirt.  So just show Mom what you want…and she’ll walk down the mall and get you two shirts, instead of one, for 50% less at American Eagle ($30 for two polos after the mark down).  I wonder who’s going to get more business this Christmas?

To be fair, AEO’s approach puts a hurt on its gross margins, which slid over 6 points in the thrid quarter to 41% of sales, while Abercrombie’s stayed relatively flat at 66% of sales.   But can the higher gross really make up for all of the lost business?  It’s hard to believe that Abercrombie’s brand is strong enough to beat economic realities…unless, of course, you’re concerned with style, not substance (a model that’s served Citigroup quite well over the years).

Merrill Lynch - McDonald’s (NYSE:MCD)

Just pure genius, the way Michael Lewis described Merrill’s place in Wall Street’s pecking order in his recent expose on the financial fiasco.  Picture the playground pickup game, with the big kids (Goldman Sachs, Morgan Stanley) running the show…”Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things.”

Well, what better stock for the fat kid than McDonald’s?   It’s easier to eat cheap as the economy sours, and more people are turning down sit-down dinner for a Big Mac as the recession goes on.  McDonald’s earnings have been strong all year, and Monday MCD announced overall same store sales increased almost 8% in the last month and 4.5% in the super-slow U.S. market. Of the 30 companies in the Dow Jones Industrial Average, only McDonald’s and Wal-Mart have higher stock prices than they did a year ago.

Analysts are worried about the negative effect of currency exchange on McDonald’s overall earnings, since so much of its business is in international markets.  And if the economy turns around, MCD’s advantages might evaporate quickly.  But when you’re the last pick on the playground and slow to the ball, you’ve got to take whatever you can get…and McDonald’s could be a nice, low-risk play for the old Bulls of Wall Street.

Goldman Sachs - Goldman Sachs (NYSE:GS)

What could be a better play for the arrogant king of the castle?  Buying yourself is kind of a dirty trick…but it might actually make some sense for those forced into early retirement by one of the last bastions of Wall Street.  Goldman’s not a pure-play investment bank anymore, and as a result risk (and reward) will be reduced, resulting in lower profits.  But “lower profits” is a bit of a misnomer when it comes to Goldman, which was making money hand over fist on derivatives and other investments before the recent subprime write-offs and punishment of the market.

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Goldman’s stock price is down almost 60% since June, and the WSJ reported last week that Goldman would post losses up to $5 a share when it reports earnings this month.  But the Columbia Journalism Review picked up on something funky here - nowhere in the report was a Goldman source cited, and an accompanying graphic showed a loss of just under a dollar a share.  So maybe the bleeding isn’t really that bad…or maybe Goldman is planting a seed to get bad news into its stock price early.

It’s this kind of savviness that Warren Buffet loves - and he believes in Goldman enough to invest $5 billion in the company in September.  News that it was thinking of joining the internet banking business sent ripples through a skeptical market last week - but this shouldn’t impact Goldman’s core business, and in fact may strengthen it.  It could be enough for an ‘09 rebound for GS stock, and the company’s former employees might get one last handout from their old cash cow.

“What great time to buy shipping stocks - before you know it demand will be back because pent-up demand will force products to ship. Stocks like Genco (GNK) and others will expode again.”

Not sure about the “explosion” you’re anticipating, Gary, but I’ve got to agree with you on this point - demand for the dry bulk shippers will be back. Dry bulk goods, like metals and grains, are the foundation of economic growth - and even as the world’s economy shrinks in the short term, its population (and corresponding demand for food, energy, and consumer products) continue to grow in the long term.

If only I had paid attention to Gary’s advice on Friday afternoon and pulled the trigger on a dry bulk shipper. I’ve been tracking DryShips (NYSE:DRYS) for a while now, and it’s ugly - down 96% in the last six months. That’s a huge number, but in line with what’s happened to the Baltic Dry Index (down 92% in the same period). Since the BDI measures the price of shipping dry bulk goods, as this price bottoms out, so do the prospective earnings of companies like DryShips.

But the BDI may finally have hit bottom. It’s been pretty much flat since November 3rd…and it really can’t go much lower, so its just a matter of time before the climb.   So if you do believe in shipping stocks, which one to pick? Here’s some of the companies to watch:

Key Companies in the Dry Bulk Shipping Industry

Zeroing in on one of these companies - Genco Shipping (GNK) - you see the potential for explosive growth that has captivated investors like Gary. Revenues grew 235%, and net income almost 400%, between 2005 and 2008 as shipping rates reached incredible heights. The driver of the company’s growth has been Chinese demand, which spiked at 3 billion tons of dry bulk goods in 2007 - and that’s been part of the recent decline, too, as Chinese demand has dried up along with the global economic slowdown.

Let’s assume that Chinese demand will pick back up, and look at a few of the fundamentals of Genco’s stock and business. GNK earnings per share were $8.54, and P/E ratio was at 0.86 at market close on Friday. That’s eye-popping - but not so much as the $4.00 per share dividend, for a yield percentage of 54.6% according to Friday’s share value! You can be assured, though, that the dividend will decline this quarter since the stock price has rocketed south.

Genco’s current ratio (current assets to current liabilities) is over 7 - rock solid as a measurement of the company’s ability to meet short-term debt obligations. But total debt-to-equity is less rosy, well over 1, but that’s standard in an industry where the major fixed cost is ship-building, and companies often take on big debt obligations to grow in the short term. Also worrisome is Genco’s PEG ratio (a measure of potential for earnings growth) at just 0.11. This likely reflects the pain that the BDI and the industry as a whole have been feeling lately, and forecasts can change quickly if demand picks up again.

It’s just a snapshot - but I’ve got to think that the optimism surrounding these companies is pretty well grounded. At any rate, its a good time to take shots at undervalued stocks, while prices scrape bottom - and with strong fundamentals, dry bulk shipping is a gamble you’re unlikely to regret.

But smart investors know that when the market looks bleak, opportunity abounds. Plummeting stock prices means that your existing holdings are dragging, but it also means those stocks you’ve been watching for months are ripe for the picking. But which ones to hone in on, when it seems like every stock on the market is attractively priced?

One thought is to go big for value. This means large, stable companies that earn consistent revenues in good times and in bad. If you like that strategy, check out the Price-to-earnings ratio of stocks in the Fortune 500. Most of these big name brands aren’t at risk of bankruptcy, even in a recession, and their P/E becomes more attractive as stock prices plummet but earnings stay relatively stable. Here’s some examples:

• Exxon Mobil (XOM) - 7.41 P/E
  
• Walt Disney (DIS) - 8.25 P/E
• Microsoft (MSFT) - 9.18 P/E

At such low prices relative to their earnings these stocks seem like big bargains, especially if you believe we’re in a bear market and that stock prices are approaching a bottom. If you get in now, while stock prices are low, you’ll reap the benefits of the market’s growth as investors slowly come back to stocks and resume paying a premium for company earnings.

But some investors might think we’re not seeing a bear market, and instead a market correction. In other words, what we saw before the fall was an inflated, over-priced market, and now we’re paying the price. But for these conservative, glass-is-half-empty folks, there’s another metric to watch - dividend yield.

A lot of big name companies have a history of rewarding their shareholders with a percentage of their profit, in the form of a quarterly dividend. Dividend yield measures how much a company pays out in dividends relative to its share price. While the dividend percentage is at the company’s discretion, stocks with a history of paying big yields are likely to do so again in a recession, to keep shareholders happy and maintain a floor on the stock’s price. Here’s three companies who payed big yields last year:

• Pfizer (PFE) - 5.10% dividend yield
  
• Wells Fargo (WFC) - 3.91% dividend yield
• General Electric (GE) - 3.10% dividend yield

A nice dividend yield is especially attractive to investors who think stocks are going to keep falling, or stay flat over the next six months. And that might very well be the case, as the financial services industry sorts out its mess, auto makers struggle, and home prices continue to hold their breath at the bottom of the pool. Pick up a few stocks with nice dividends and stable earnings, and you’ll still get paid even if the value of your shares stays flat. It’s an important point to consider when many signs point to a prolonged recession.

The Baltic Dry Index (BDI) tracks rates in the 22 main shipping routes for these key inputs. The BDI has plummeted in the past several months, as the U.S. financial crisis has snowballed into a global economic downturn and the consumption of raw materials has ground to a halt. For example, China is the world’s biggest consumer of steel, but it has cut its consumption as infrastructure projects have slowed in response to slumping economic growth. The same situation has played out with a host of other raw goods - and as demand for materials slows, so too does the earnings growth of a dry bulk shipper.

And there’s more to the story than a simple supply-demand curve. Companies that ship goods overseas often use “letters of credit,” or contracts in which a bank will guarantee a company’s ability to pay back loans. This way, a company can take delivery of orders immediately, but pay for them weeks or even months later. When they pay, they’ve already turned the raw goods in the order into revenues by manufacturing products and selling to consumers. These letters of credit are an essential part of the shipping system - but they create risk for banks, which are on the hook for the balance owed by the company that shipped the goods in the event of a default. In today’s lame economic climate, when banks are wary of all risk, it is increasingly harder for struggling companies to pay back loans - and it has also become quite difficult for companies to get letters of credit. This means that companies can’t pay to have their goods shipped overseas - and their shipments simply sit at port, waiting for the voyage to be financed. As the cargo languishes, so too do the companies that depend on shipping orders for revenue growth.

But the credit crunch is just one reason why DryShips and its peers have seen their stock prices get hammered in recent weeks. There’s another force at play as well - shipping companies are being squeezed from both sides because while revenues dry up, the value of their assets (shipping vessels) are also declining. Forbes reports that net asset values for dry bulk ships have fallen roughly 50% in the last four months, but outstanding loans for ships and contracts have remained static - creating a situation that has quite a few parallels to what happened to homeowners and property values during the subprime lending crisis.

Shipping companies now owe more on the loans taken to build or buy a ship than the ship is currently worth. Furthermore, a company’s existing fleet is often used as the collateral to secure loans for new building projects - and as the value of these underlying assets declines, the company must post more collateral to secure a loan. This could possibly lead to foreclosures by major shipping lenders like the Royal Bank of Scotland and HSBC and will certainly lead to a slow-down in the construction of new ships, as owners become wary of taking on these costs while struggling to make good on existing loans.

So what does this mean for the dry bulk shipping business? Two things - ships sitting at anchor, with no cargo to transport (but no fuel or crew costs for a company to pay either); or, more ships hitting the scrap heap as companies downsize to stay efficient. It’s unlikely that the turnaround for shippers will be quick, as revenue growth will depend on a revitalized global economy creating demand for raw materials. It seems unlikely that stock prices (down 75% in this industry in the past six months) can fall any lower - but if 2008 has taught investors anything, its that you never know just how low we might go.

But if you’ve got a long term financial plan, and you’re looking for the right moment to jump back into the market, then one economic indicator you should pay close attention to is the TED spread. The TED spread is calculated by subtracting the interest rate on treasury bills from the three-month Eurodollar LIBOR (T for T-bill, ED for “eurodollar”). T-bill interest rates demonstrate the yield on a short-term loan to the U.S. government, perceived as nearly risk-free, while the LIBOR rate reflects the risk of a short-term loan from one bank to another. If the TED spread is relatively low, this means that inter-bank loans are perceived to be almost as stable as lending directly to the government - and the TED spread historically has hovered around 50 basis points, or a half a percent difference between the two rates.

But lately, as the volatility of the market and long-term solvency of banks has come into question, the TED spread has become dramatically wider - as high as 460 basis points, a new record, on October 10th. What this means is that banks are finding borrowing prohibitively expensive, tightening the credit markets, discouraging cash flow, and crippling economic growth. More importantly, the massive TED spread indicates a lack of confidence in the market, as banks hoard capital rather than lend to each other, sacrificing profit because the risk of default on the loan is simply too high. Also factored in are lower yields on T-bills, as investors become willing to pay higher prices at auction and accept lower interest rates in return for the relative safety of guaranteed Treasury money.

So, if you’d like to evaluate whether the government’s Emergency Economic Stabilization Act (a.k.a Bailout Bill) is working, don’t watch the Dow Jones average, which reacts to the expectations, and fear, of retail investors. Instead, keep tabs on the TED spread (you can find it here, on Bloomberg) and wait for it to come back to earth. Look for treasury yields to rise again as investors put their money back into stocks, corporate bonds, money markets, and other assets, and the inter-bank loan rate will come back down. When this happens, banks and businesses can once again begin to borrow, and the economy will have the cash flow it needs to resume business as usual.

That’s when earnings and stock prices might start growing once again - and your portfolio will stop the rollercoaster ride that you surely have not enjoyed watching in recent weeks.

And there’s reason to believe that the markets will keep falling in the great financial crisis of 2008. Some major macroeconomic indicators point to tough times in coming quarters.

Here’s a top 5:

1. The U.S. unemployment rate has increased to 6.1%, with 84,000 jobs lost in August 2008 alone. Year-over-year employment is now negative, meaning there were more Americans with jobs in August 2007 than in August ‘08.

U.S. Unemployment Percentage, monthly, since 1998 (Source:Bureau of Labor Stastics)

A peek at the monthly unemplyment percentages for each month since 1998 show that we’re just a tick below a 10-year high (6.3% in 2003) - and given the economic climate, that number’s not going to shrink. 8.0% unemployment is likely…and the 10% high not seen since 1982 is even a possibility.

2. U.S. corporate tax levels are among the highest in the world, at up to 39% of a company’s income. In a credit crunch that’s making it harder for American corporations to raise money to finance growth, this tax burden is going to make it a lot harder for companies to grow, or to give their employees raises. And this means a higher unemployment rate, and lower consumer spending levels - in a vicious economic cycle that will exacerbate a recession.

Ratio of U.S. National Debt to GDP (Source:zFacts.com)

3. The U.S. national debt is at an unprecedented $10 trillion level. It’s useful to compare the national debt to the gross domestic product (essentially what we owe to how rich we are). The debt-to-GDP ratio was at its lowest point since 1931 when Ronald Reagan took office. It climbed for 12 years under Reagan and the first George Bush, but Clinton reversed the trend. Under George W Bush, however, the debt has gone back up, hitting 69% of GDP on Sept 30. That’s the highest the ratio’s been since 1955 - and of course, the $10 trillion that we owe is a historical high.

4. Over 70% of U.S. GDP comes from consumer spending. And for the first time, spending habits are reversing in America. For years, the savings rate in the U.S. hovered on 0 - but in 2008, its climbing to a net gain for the first time in 10 years. In May 2008, for example, when government stimulus checks hit mailboxes, the U.S. savings rate jumped to 4.9%. And given the dour news coming from all economic fronts, and the sorry state of the retail industry as one company after another reports lower earnings, it looks like savings accounts will continue to get pumped with cash as Americans put their dollars away for the future. That’s bad news for an economy that’s in desperate need of liquidity.

Oil Prices since 1996 (Source:Wikipedia)

5. Inflation and the continued weakness of the U.S. dollar. As worldwide demand for commodities continues to climb, prices for oil, corn, coal, wheat, and the other staple inputs won’t hit the floor. While oil and gas prices have fallen quite a bit since huge historical highs in summer 2008, they are still hovering around $90 - quite a difference from 2007, when prices were below $60 a barrel.

And while prices at the gas station and grocery store have never been higher, weakness in the U.S. currency means that each dollar earned buys less. On July 15, the U.S. dollar hit an all-time low against the Euro. And as it gains one day against other benchmark currencies like the yen and Euro, but loses ground the next, there isn’t much confidence among investors that the dollar will quickly reverse its recent losses. There’s some upside to this that actually may help the economy - U.S. companies that do a large percentage of business overseas will profit when foreign earnings are converted back into U.S. dollars, for example - but ultimately a weak currency is a poor long-term indicator for the economy’s growth.

September 29, 2008 Vote, U.S. House of Representatives

What happened today was historic, and the market knew it. $1.2 trillion was erased from the market value of American stocks as frightened investors fled for the safety of gold and government Treasury bonds. The Dow Jones Industrial Average fell 777 points, the largest one day decline since the index was first published in 1896. The S&P 500 fell almost 9%, a drop not seen in two decades. Meanwhile, Wachovia Bank was bought by Citigroup for $1 a share, making it just the latest financial institution to surrender in a fear-driven downward spiral that has crushed venerable institutions like Lehman Brothers, Merrill Lynch, and Washington Mutual in recent weeks.

So where does it end? Our country’s economic leaders, Paulson, Bernanke, Dodd and Bush, were hoping that today would bring a tourniquet to stop the bleeding. Bush worked the phones on Monday morning, calling undecided Republican congressmen to plead his case. But it didn’t work - 133 House Republicans voted against the bill, compared to just 65 in favor. They were joined by 95 Democrats who were afraid to pass a bill sure to be met with anger among their constituents. In Congress, just as in the markets, fear was the main factor impeding progress. With elections coming up in 36 days, it seems many members of the House interpret “public service” as “Save myself, F**K the public good!”

Do the people really understand what has happened here? The perception is that the the bailout plan will save just a few rich bankers, who should instead suffer for their mistakes. But that’s a pipe dream - the wealthy bankers who are running failed firms like Lehman Brothers surely don’t have all their eggs in their own company’s basket (unless they are very, very stupid). These guys will continue to enjoy comfort and an easy retirement - its regular Americans, many of whom cry out in opposition to a government bailout, who will suffer as their 401k plans bleed value, their family members lose their jobs, and economic growth stagnates.

The mistakes made in the mortgage market are certainly inexcusable, but the government’s bailout was never going to correct or condone that. It was going to buy failing assets for pennies on the dollar, and hold them until the market corrected itself. More specifically, until home prices that are in the toilet and sinking lower every day finally rebound. This might take months, or even years - but the government, with billions in tax revenues to stabilize its balance sheet, would never become insolvent no matter how bad the debt got. Not so for a private company. Even the biggest, baddest private companies like Goldman Sachs were shaken to their very core by this credit crisis. And more companies are sure to fall if the government fails to step in - and after today’s inaction, it seems very likely that it won’t.

So this may only be the beginning of a long, deep, economic slump. Banks won’t lend to each other, as demonstrated by the skyrocketing Libor rate that measures the cost of one bank borrowing from another. If banks won’t lend, businesses large and small can’t grow - and that means unemployment will continue to fall at a much steeper rate than the 105,000 jobs the economy shed in September ‘08. If businesses don’t grow, earnings won’t either - and that means stocks will keep slumping, investors won’t be happy, and the fundamentals of our economy will keep on hurting.

So if you like apples, and you’d be excited by a selling a few dollars of fruit to passersby on a sunny day, then by all means, write to your representative to commend him for his valiant stance against government tyranny. But if you value your job, and your retirement, then start thinking about the implications of another “no” vote later this week. It won’t be pretty.

Smart Phone Market Share as of May 2008

But smart phone users are savvy folks, and they’re looking for devices that will make life more efficient, and more enjoyable.  That’s where the cache of Google’s brand name comes in.  But will Android work as promised?  And, importantly, what effect will this new product have on the earnings (and stock prices) of Google, Deutsche Telekom, and the other companies involved in the cell phone industry?

Android is a software suite, including an operating system and key applications, that works on mobile phones.  It’s an open source platform, meaning its code is available to be copied or modified by any developer as a model for future versions of software.  The code is based on the famous Linux operating system, developed in 1991 by Linus Torvalds,  and the product’s origins can be traced to a Silicon Valley startup called Android, Inc. that Google acquired in 2005.

Google claims that Android allows it to improve on its existing mobile apps - for example, a new view in its mapping service that rotates the image based on the direction the phone is pointing, like a compass.  And the company has emphasized the importance of the “Android Marketplace,” where users can download software applications for their Android phones.  In contrast to Apple, many of these programs will be free - and even those that cost money will challenge the iPhone’s dominance.  The music download service, for example, will work through a partnership with Amazon rather than Apple’s iTunes store.

The G1 will sell for $179, $20 less than the 3G iPhone, and data plans will cost between $25 and $35 a month.   It’s likely that most of the target market will be existing smart phone users who convert from RIMM or Apple’s products.  As such it will be an uphill battle for Android to win market share - according to the WSJ, research firm Strategy Analytics estimates that the new platform will earn a 3.8% market share in the fourth quarter of this year, meaning 400,000 units sold.

For a company with massive revenues like Google, this isn’t going to move the needle much in the short term.  Ditto for T-Mobile - the company will need to keep selling basic phone service to close the gap on industry leaders AT&T and Verizon. But intangible benefits are worth some thought, especially if you’re thinking about DT or GOOG stock.

For T-Mobile, the collaboration with Google is at least as cool AT&T’s relationship with Apple - but with the added benefit that T-Mobile and Google are the good cops, making their platform accessible to all in an attempt to revolutionize the mobile software business.  And Google can boast of another ground-breaking technology as it expands its reach even further beyond the core internet search business.  While Google’s revenues will continue to be driven by advertising, this may not be true forever - and value investors might want to place a long bet that Android will help Google morph from the king of search to a diversified tech titan.

The key difference between an investment bank and a commercial bank is the source of their cash flow.  A commercial bank like Bank of America or Wachovia takes consumer deposits, which are insured by the federal government to prevent depositors from pulling out all at once (a major catalyst of the Great Depression in the 1930s that is now prevented by tighter regulation and insurance).  Investment banks take no such deposits, and as a result benefit from lighter government oversight that allows them to take big risks to earn huge profits.  To finance their short term operations, rather than taking consumer’s deposited cash the i-banks borrow in the commercial-paper market and the repo market, putting up securities as collateral for short-term loans.

This works well - as long as the securities being used as collateral retain their value.  But with the onset of the subprime lending crisis, and subsequent crash of home prices, suddenly billions of dollars in mortgage-backed securities were worth much less.  As the value of the assets they used as collateral declinded, i-banks began to struggle to raise money.  Bear Stearns and Lehman simply couldn’t borrow enough cash to cover their losses - and Merrill, afraid of the same fate, sold out before it could meet the same indecent fate.

And out of the wreckage emerges a new, more powerful type of investing institution - a hybrid commercial/i-bank.  These titans weren’t even legal in the United States until 1999, when a law dating to the Great Depression called the Glass-Steagall Act was repealed.  This law had prohibited commercial banks from engaging in the investment banking business; on its repeal, companies like Citigroup and UBS were able to combine the two business models.  This strategy has proven risky with the onset of the 2007 credit crunch; but those two companies, despite widespread speculation about their imminent failure, have thus far weathered the storm, while the prominent stand alone i-banks (without the benefit of consumer deposits to prop up their crumbling balance sheets) have capsized and sunk.

And now, Bank of America seems poised to hit the pinnacle of finance, acquiring the “thundering herd” of Merrill Lynch’s 17,000 broker-dealers to complement its ever expanding branches of retail banks.  But BAC is not the first commercial bank to have this idea - in fact, all over the world many of the industry’s titans have already hopped on the train.  JP Morgan Chase & Co is integrating Bear Stearns; Deutsche Bank has agreed to pay $4.3 billion to acquire 850 branches of the German retail bank Postbank AG; and Spain’s Banco Santander paid $2.26 billion in July for struggling British mortgage lender Alliance & Leicester.

It makes sense that in a credit crunch, consumer deposits are one area of the financial services industry that’s been pretty stable, since a savings account seems like a pretty safe bet while real estate bleeds its value and the stock market takes investors on a rollercoaster ride.   At the end of August, according to the Federal Reserve, U.S. consumer savings and deposits were up 7.6% from a year earlier, to $6.9 trillion.  Meanwhile, the comparable asset-backed commercial paper market that i-banks rely on for funding has shrunk to $780 billion as of Sept. 10, down by more than a third since the onset of the subprime crisis.

There are challenges to the super-bank model, to be sure - both Citigroup and UBS have struggled to retain investor’s confidence in 2008 as their under-performing securitized assets cannot be separated from the more stable retail banking business.  And Goldman Sachs and Morgan Stanley, the two remaining stand-alone investment banks, have strong balance sheets and analysts don’t seem to doubt their future viability.  But the world will be changing rapidly for these firms, and it seems that savings and deposits, the staple of the banking business since its conception, will once again provide the backbone of the industry.

REITs are corporations that pool investor capital to purchase either income property or mortgage loans.  An example of the former is Simon Property Group (NYSE:SPG), which owns strip malls and shopping centers throughout the United States.  The latter group includes companies like Annaly Capital Management (NYSE:NLY), which invests in the mortgage-backed securities - collections of individual mortgages that are packaged and sold to investors by banks and mortgage lenders.  Any REIT depends on loans in order to buy new mortgages, or to build new properties (depending on its business model), and Fannie Mae and Freddie Mac are key lenders in this industry.

When the government bailout plan was announced Friday, many REITs saw their stock prices jump - Annaly, for example, jumped nearly 15% over the weekend.  Annaly specializes in buying the mortgage-backed securities guaranteed by the government - a market that had been viewed as low-risk but became more volatile in 2008 as the long-term future of Fannie and Freddie was clouded with doubt.  It’s pretty clear that government intervention will allow Annaly and its closest competitors (including America First Mortgage Investments and Capstead Mortgage) to survive and continue to invest in mortgages backed by the government.  A cause for optimism is the Treasury Department’s stated intention to start buying up mortgage-backed securities on the open market, boosting the plummeting prices of these bonds; one analyst estimates that this new action will boost Annaly’s book value by nearly 10%.

What’s less clear, however, is whether Fannie and Freddie will continue to lend to residential REITs, including those that invest in apartments and multifamily housing.  Companies like Equity Residential (NYSE:EQR) and Camden Property Trust (NYSE:CPT) depend heavily on Fannie and Freddie to finance their growth by purchasing groups of apartment loans.  As the feds decide which of Fannie and Freddie’s businesses to retain, and which to dissolve, these companies could be impacted in several ways.  The government may decide to scale back this line of business, lending less capital to these companies; or, it might make it easier for families to finance loans for single-family houses, making renting a less attractive option and indirectly hurting the apartment business.  Apartment REITs can take solace in numbers, however - Fannie and Freddie’s market share in multifamily financing has grown to over 90% from less than 50% in 2007 as other lenders shy away from real estate.  Furthermore, apartment lending has become the only profitable line of business for both companies lately - Fannie’s delinquency rate for multifamily loans has been 0.11% in the past year, compared to a 1.36% rate on loans for single-family housing.

Whatever decisions the government makes, in the short term investor uncertainty has led to a pullback in REIT stocks.  On Tuesday the Dow Jones Equity REIT index fell 4.1%, giving back almost all of the 4.7% it gained over the weekend.  The 116 REITs in the Dow index own a variety of real estate properties and related assets, and they won’t all be affected the same way by the government’s actions with Fannie and Freddie.  But in a market as volatile as real estate in 2008, there are no sure things, and REIT investors should watch their stocks (and the news) carefully as the historic takeover takes shape, and the government’s true intentions become clear.