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Dear Tar Heel Nation – That was fun, can we do it again next year?

Dear Tar Heel Nation –

That was fun, can we do it again next year?

Hugs and Kisses,

College of Charleston

JP Conklin

980-475-0268 phone

480-247-5675

fax

www.pensfordfinancial.com

January 18, 2010

PS – Clemson and GT are here with us right now and they are wondering the same thing.

And the Eagles got embarrassed in back to back weeks by their most hated rival. Unlike with Nate Kaeding, however, I feel confident David Akers didn’t have any wagers on the game…

Obama upset a lot of “Atlas Shrugged” fans when he announced that he would tax the banks that paid “obscene” bonuses based on record profits generated by the bail out and ensuing accommodative Fed policy. We are a little split on this topic. On the one hand, the government should not be dictating pay. If the banks paid back the TARP plus interest as required by the government, then theoretically they should pay as they see fit.

But many of these banks would have ceased to exist and are around today only because of the tax payer’s bailout. Just because a bank pays back the TARP and interest, it shouldn’t signal the final checkmark before the government gets out of its hair. These banks not only survived, but thrived because of the bailout. If a bank borrowed $25B to survive, shouldn’t it have to pay back the $25B, plus interest, PLUS some portion of the profits it generated through the government’s year long assistance? For example, part of the reasons banks wouldn’t lend this year was because they had a risk free carry trade as an alternative to lending. Let’s assume you are a bank and can borrow at essentially 0%. Would you rather lend to a real estate project right now OR buy Treasurys at a historically steep yield curve and earn say 2.50% - 3.50% risk free? But a bank’s behavior in that sort of rate environment is fairly predictable and we don’t fault them one bit. That is just smart investing.

What is bothersome is the banks and bankers acting as if record profits are solely a result of their acumen. Even a state-schooler like me could make money all day long by

borrowing at 0% and investing at 3%. Well, to be fair I would probably find a way to screw that up, but you get the picture.

So what should the banks have done with this money instead? What if they set the bonus money aside as reserves against future losses? Commercial real estate still hasn’t bottomed. Banks are still carrying structured notes on the balance sheet at ridiculously inflated levels via FAS 157 MTM. Save the money for a rainy day so that next time (and there is always a next time), they don’t need government assistance…

So while we probably agree that the banks are acting improperly by paying out this cash when they should be holding onto cash just like every consumer is currently doing (as evidenced by the dropping credit balance, decreased consumer spending, and increasing savings rate), we don’t like the Administration’s handling of the situation.

Banks are clearly “for profit” entities, so if we take money away from them, they will react. And the easiest way to compensate for this sudden shock to the bottom line is by passing it along to their customers. Higher interest rates on loans. Lower interest rates on deposits. Higher fees. The end result is banks still generate profit and justify “obscene” bonuses while the average taxpayer gets penalized twice.

Atlas Shrugged was a good book, we just don’t like using it to support every act of excess “incentive”. When one of these investment bankers removes themselves from the workforce, moves to a third world country, and does nothing, we promise to interview them for this Letter and let them explain their position.

Changing gears: conspiracy theory of the week – the government is secretly buying equities to prop up the DJIA and S&P. We thought it sounded ridiculous at first. And then when we thought about the wealth effect, the Administration’s need for some positive economic news, etc, it sounded a little less weird…

Last week various governmental entities released an advisory regarding interest rate risk management. While not earth shattering, it is an interesting read as it highlights a few interesting points, notably the importance of financial institutions to maintain an appropriate risk management strategy.

Lots of talk last week about possible failures in the massive Treasury auctions, but in the end the standard metrics came in stronger than average over the last 6 auctions.

On Thursday, Fed President Plosser said that “the rate rise cannot wait for acceptable levels of unemployment.” And Fed President Evans said that “the extended period

language means no change in Fed policy for 3 or 4 meetings or more.”

imply a summer hike at the earliest, but just as importantly a willingness by the Fed to

signal a hike several months ahead of time.

This would

This week Light economic data, no Treasury auctions, but very heavy corporate earnings.

LIBOR outlook Markets have LIBOR at 2.75% by the end of 2011, but much of that increase is loaded into next year.

Fixed rates outlook We’ve have a few people respond to our emails asking why we are the only people in the world not expecting rates to rise dramatically next year. Let’s take a brief second to clarify our position.

Firstly, there are two types of rates. Short term rates, like LIBOR, which we do not expect to move materially in 2010, if at all. The market is pricing in a hike beginning in the summer, but we just don’t see it.

The other type of rate is long term fixed rates like Treasurys and swaps. We do believe these will increase in 2010 and beyond. We just don’t think they will increase by as much as many observers are forecasting. We remember 2003 when fixed rates moved before the Fed did and then waited for LIBOR to catch up. The T10 has already jumped by more than 1.50% and may again wait for LIBOR to catch up.

But we also know that typically the best time to lock is right before the Fed begins to hike rates because you have benefitted from low LIBOR and the rate that you lock is not much higher than it was back when fixed rates initially jumped. On December 30, 2008, the T10 bottomed out at 2.11%. Just a little over 3 months later, on 4/27/09, it registered a sub 3% yield for the last time. In other words, it jumped 1% in just three months and has been bouncing around between 3% - 4% for nearly a year.

So if you’ve been holding off on locking, keep in mind that you’ve already benefitted

from floating for the last year.

after the markets have figured it out, and by that time it will be too late to lock in current levels.

The headline on the WSJ will read “rate hike likely” long

We only say this to make sure that we advocate a risk management position, not a speculative position.

Anyway, no Pensford Letter next week as we take a completely undeserved vacation and close the office for Friday and Monday.

QUICK MARKET SUMMARY

Benchmark

Today

One Week Ago

Change

One Month Ago

Change

One Year Ago

Change

Fed Funds Target

0.25%

0.25%

0.00%

0.25%

0.00%

0.25%

0.00%

1

Month LIBOR

0.23%

0.23%

0.00%

0.23%

0.00%

0.35%

-0.12%

3

Month LIBOR

0.25%

0.25%

0.00%

0.25%

0.00%

1.12%

-0.87%

6

Month LIBOR

0.39%

0.42%

-0.03%

0.43%

-0.04%

1.55%

-1.16%

12

Month LIBOR

0.89%

0.96%

-0.07%

0.97%

-0.08%

1.83%

-0.94%

2

Year Treasury

0.86%

0.98%

-0.12%

0.79%

0.07%

0.73%

0.13%

5

Year Treasury

1.43%

1.54%

-0.11%

2.27%

-0.84%

1.48%

-0.05%

10

Year Treasury

3.67%

3.83%

-0.16%

3.03%

0.64%

2.40%

1.27%

30

Year Treasury

4.58%

4.72%

-0.14%

3.54%

1.04%

2.97%

1.61%

2

Year Swap

Spread

0.28%

0.28%

0.00%

0.34%

-0.06%

0.60%

-0.32%

5

Year Swap

Spread

1.29%

1.35%

-0.06%

0.37%

0.92%

0.57%

0.72%

10

Year Swap

Spread

0.12%

0.11%

0.01%

0.64%

-0.52%

0.13%

-0.01%

30

Year Swap

Spread

-0.10%

-0.15%

0.05%

0.76%

-0.86%

-0.16%

0.06%

1

Year Swap

0.49%

0.53%

-0.04%

0.52%

-0.03%

1.04%

-0.55%

2

Year Swap

1.14%

1.26%

-0.12%

1.13%

0.01%

1.33%

-0.19%

3

Year Swap

1.76%

1.91%

-0.15%

1.74%

0.02%

1.64%

0.12%

4

Year Swap

2.29%

2.46%

-0.17%

2.24%

0.05%

1.88%

0.41%

5

Year Swap

2.72%

2.89%

-0.17%

2.64%

0.08%

2.05%

0.67%

7

Year Swap

3.31%

3.47%

-0.16%

3.19%

0.12%

2.29%

1.02%

10

Year Swap

3.79%

3.94%

-0.15%

3.67%

0.12%

2.53%

1.26%

30

Year Swap

4.48%

4.57%

-0.09%

4.30%

0.18%

2.81%

1.67%

* Note - Swap Rates from above are based on certain assumptions and likely do not represent where an actual swap could be executed. These are meant to help demonstrate relative levels and trends, not as a basis upon which to execute a hedge. If you lock in a swap using these rates, you may pay an above market rate. Since these quotes are based off of 3 month LIBOR, be particularly careful if your hedge is on 1 month LIBOR.

Generally, this material is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. Your receipt of this material does not create a client relationship with us and we are not acting as fiduciary or advisory capacity to you by providing the information herein. All market prices, data and other informa- tion are not warranted as to completeness or accuracy and are subject to change without notice. This ma- terial may contain information that is privileged, confidential, legally privileged, and/or exempt from dis- closure under applicable law. Though the information herein may discuss certain legal and tax aspects of financial instruments, Pensford Financial Group, LLC does not provide legal or tax advice. The contents herein are the copyright material of Pensford Financial Group, LLC and shall not be copied, reproduced, or redistributed without the express written permission of Pensford Financial Group, LLC.

Economic Data

ECONOMIC CALENDAR

Day

Time

Report

Forecast

Previous

Monday

Markets Closed

 

Tuesday

1:00PM

NAHB Housing Market Index

17

16

Wednesday

8:30AM

PPI m/m

0.0%

1.8%

8:30AM

PPI y/y

4.4%

2.4%

8:30AM

PPI Core

m/m

1.0%

0.5%

8:30AM

PPI Core

y/y

1.0%

1.2%

8:30AM

Housing Starts

 

575k

574k

Thursday

8:30AM

Initial Claims Philly Fed Survey Leading Indicators

445k

444k

8:30AM

18.0

20.4

8:30AM

0.7%

0.9%

Events and Speeches

 

Day

Time

Report

Place

Issuance and Buyback

 

Day

Closing

Issues

Size