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The financial sector remains the main focus next week, as the credit markets hang by a thread.

Speculation of brokerage firm accounting irregularities, more writedowns and a downgrade of


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, based on its questionable capital base, dominated investor sentiment last week, despite the

Federal Reserve's

25 basis point rate cut and a much-better-than-expected new jobs report for October.

All eyes will remain on

Goldman Sachs

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Merrill Lynch


, Citi,

Morgan Stanley

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JPMorgan Chase

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as they attempt to restore confidence in the quality of their earnings and their ability to pull through the current credit crisis.

The fight is tooth and nail for these firms, as rumors and innuendo can send shares tumbling. Goldman Sachs shares slid over 4% Friday, on speculation that the firm has off-balance sheet exposure to the mortgage market. Merrill Lynch tumbled about 8% Friday after a

Wall Street Journal

article reported the firm may be investigated by the

Securities and Exchange Commission

. Things didn't get better for Merrill when Deutsche Bank banking analyst Michael Mayo wrote that he estimates the firm may have to write down another $10 billion tied to subprime mortgages.

Standard & Poor's chief investment strategist Sam Stovall asks in a note Friday about the sector, "Is it too late to underweight? We think not." He predicts the financial group's earnings will decline 25.7% in the third quarter from one year ago, due to unpredictable writedowns. That compares with his prediction at the start of the year of a 4.2% increase for the quarter.

The S&P Financial sector index fell 4.6% alone on Thursday, when the

Dow Jones Industrial Average

fell 2.6% and the Federal Reserve and investors fled to safe-haven Treasury bonds. The sector is down just over 15% year to date, while the investment banking and brokerage subgroup is also down about 15% as well.

The continuing executive suite shuffle on Wall Street could, however, bring some relief to shareholders. Last week, Merrill Lynch's Stan O'Neal relinquished his CEO title. It didn't do much for the stock, but a successor has yet to be named. And, according to a

Wall Street Journal

report, Citigroup is planning an emergency board meeting to convene over the weekend. The firm has been under pressure to reconsider its CEO Chuck Prince, after the bank's $5.5 billion writedown.

These firms continue to be tested by the mortgage and housing markets, for which there is no data expected next week. But there's still the leveraged loan pipeline to work through, and there are signs emerging that the banks are attempting to unload their LBO commitments more quickly than they have been, say credit market participants.

Investors had expected the financing for


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buyout to come at the end of the year. Instead, lead underwriter Citigroup announced plans late Thursday to sell $7.7 billion in high-yield bonds, including a portion of controversial pay-in-kind notes to help finance its buyout by Goldman Sachs Group and TPG Inc. The Alltel buyout is also expected to include over $16 billion in leveraged loans.

"There's a sense that the banks want to get as much off their books as quickly as possible," says one junk bond manager, who spoke on the condition of anonymity. Previously the plan was to trickle out the deals slowly, so as not to overwhelm the market and depress prices.

With recent angst in the credit markets, mega-LBO financing deals for First Data and TXU are trading around their issue prices. If things get worse and these bonds fall in the open market, the Alltel debt will be a hard sell, says the junk bond fund manager.

High-yield managers, like himself, are readjusting their portfolios to focus on higher-rated securities as concerns mount about the U.S. economy. He believes the current climate suggests defaults could start to perk up as tough borrowing conditions prevail -- a scenario that would raise risk premiums in junk bonds and loans regardless of the new issues pipeline. With that in mind, the banks need to act quickly or risk a weaker market later that's damaged by economics, not supply and demand woes.

Next week's economic data includes the Institute for Supply Management's report on conditions in the service sector, the third-quarter report on productivity, September's read on the state of consumer credit, the September trade balance and the first read on November's University of Michigan consumer confidence report.

The markets may also finally get more insight into last week's Fed decision to cut interest rates and its accompanying statement that the risks to growth and inflation are balanced. Several Fed speakers pepper the week, and Federal Reserve Chairman Ben Bernanke testifies before Congress next Thursday.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.