Evening folks,
Welcome to another addition of US Government Lotto Giveaway, with your host, Treasury Secretary, Hank Paulson. And tonight’s lucky couple are Fannie and Freddie.

Hank’s just promised Fannie and Freddie $200 billion of taxpayers’ money in exchange for their independence. And, just like our shows earlier in the year, you all love a good giveaway. Equity markets rallied between 2-3% (Ireland’s bank-dominated ISEQ put on a cracking 6%) and the good old Dollar nicked between 4-500 pips off the European currencies.

But is this really a turning point for the markets, or yet another nasty squeeze in a bear market? First I’ll talk about what’s going on and then I’ll talk about how it’s feeding into my trading plan.

Let’s start with a 30-second summary of Treasury Secretary Hank Paulson’s rescue package:

The US Treasury placed Fannie Mae and Freddie Mac in ‘government-operated conservatorship’ (they nationalized them). The firms’ chief execs were sent home to enjoy some quality ‘family time’ and shareholders’ dividends were scrapped. A total of $200 billion of taxpayers’ money will be injected into the firms ($100 billion each), as and when it’s required, and there’s loads of other financial tinkering designed to keep the firms solvent and get the mortgage market up and running again.

If you’re keen on seeing the finer details click here.

Why Was This Such Good News?
1) The US government managed to avoid the mother of all financial disasters. Fannie and Freddie were too big to be allowed to fail (but were dangerously close to doing so); their rescue will restore a measure of confidence to the credit market, and to the US in general.

2) Holders of Fannie’s and Freddie’s bonds are listed in the Who’s Who of big swinging dicks in the investment world. They range from the Chinese central bank to UK investment banks like Barclays. But recently these bonds had the same appeal as Joey Barton on a free transfer. Now, the prospect of a government guarantee will have central banks pushing and shoving to be first in the queue for new Fannie and Freddie bonds. This will make it easier, and consequently cheaper, to raise funds and eventually trickle down to the guy on the street in terms of better mortgage rates, putting more cash into the consumers’ pockets and helping to restart the housing market. The hope is that this ‘feel good’ factor will gradually extend to other borrowers.

3) Banks around the world have been hampered by humongous write-downs on bonds exposed to the US mortgage market. If (and it’s a big, big ‘IF’) the US housing market does start to slowly improve then the value of these loans might just get revalued upwards.

4) Banks should no longer be worried about Fannie and Freddie debt becoming worthless and driving the whole industry to pot. So they might start lending to each other again.

What Does This Mean For Irish and UK Banks?
On Monday, bank shares in Ireland and the UK rose by between 10-12%. But how much do they stand to benefit from a bail-out on the other side of the Atlantic? Now, I’ll come clean here, I’m not a banking analyst, so this is just my humble interpretation of how I see things.

First off, the banks holding shed-loads of Fannie and Freddie bonds will benefit from the higher prices, brought on by the government guarantee. The known suspects here are Barclays and RBS. On the flip-side are banks, like poor old AIB, that have exposure to the preferred stock (via its holding in M&T). However the AIB share price reacted well to the news, as did all Irish banks, so I guess the idea that the Fannie and Freddie shares were worthless was already priced in. The new structure means that the existing preferred and ordinary shares will be virtually worthless.

Banks will also gain from their holdings of other US mortgage-related bonds. These should benefit from a gradual improvement in the housing market. And if confidence does return to the credit markets then it should be easier to raise money at lower interest rates.

Right, so that’s about as much good news as I can see. Hank Paulson hasn’t yet offered any of his taxpayers’ money to repay the record levels of existing debt in the UK. Or to meet the cost of rising fuel and food bills.

The availability and cost of mortgages is only one part of the housing problem. The fact that Shazza on the fish counter in Sainsburys needs to borrow 50 times her salary to buy a one-bedroom shed is another part. House prices need to fall further; this, and the fact that unemployment is rising, doesn’t paint a great background for the banks.

In short, a few benefits flew across the Atlantic on Sunday, but the banks over here have got plenty of their own battles to fight with a deteriorating economic background and a need to boost balance sheets before they can take on more business.

Forex
There were three lines of thought on how to trade the Dollar after the news broke:
1) The new liabilities taken onto the US balance sheet are 2.5% of US GDP, and it’s going to take more than a premium phone-line scam to get that sort of money back. The US will need to issue a whole skip-load of Treasury bonds to finance the rescue plan. As a large chunk of these will be put in a parcel marked ‘Johnny Foreigner’, or more precisely, ‘Wang Ling Foreigner’, the currency will need to be low enough to make it attractive.

2) Alternatively, the bailout should help to put a floor under the collapsing US housing market. This will leave the US as the country looking to have the best chance of recovery. It also makes it look the most likely of the major economies to raise interest rates.

3) Don’t argue with the trend. If Kylie Minogue and Nelson Mandela were to have a love-child, blessed by the Pope and named Diana, it still wouldn’t be as popular as the Dollar currently is.

How Am I Going To Trade It?
Previous episodes of US Lotto Giveaway have seen favourable ratings in the days following the shows. Check out the chart below; episodes in January, March and July all saw market rallies. But once traders with short bets had been squeezed back into the market, there was little demand left and shares turned south again.

I’m definitely in the ‘sell the rally’ camp on equity markets. I opened several short bets on FTSE yesterday, but sloppy stop-loss management limited my gains. I’m currently short of £6 on FTSE at 5501.

The banks are a bit trickier; I’m a seller of the UK banks, but not keen on opening positions ahead of Alistair Darling’s imminent plan to save the Labour Party. I’m sure that whatever his proposals, they’ll be hyped to cause an initial rally in bank stocks. I’ll bide my time and sell into strength. I’ll focus on HBOS (I’ve a scrappy £2 short at the moment) as it’s so exposed to the UK mortgage market, where I don’t believe there’ll be a quick fix. Also, I think it’ll still struggle to raise new capital in the near term.

Currencies are a different kettle of fish; I can see both sides of the argument-and a very strong Dollar trend. I’m happy to trade the Dollar in either direction, whilst keeping an eye and an ear to the ground for any sign of budget deficit worries.

Watch out for further episodes with lucky winners Lehmans and Washington Mutual.