Markets will be very, very quiet until next week as everyone finishes up his vacation. Inside the quiet backdrop, there was a lot of weekend chatter about the money markets, which continue to be essentially non-functional after more than a year. It’s impossible to imagine anything that will unfreeze interbank lending, especially in London. This is going to be a boot planted on the neck of the global economy, perhaps for another year or two.

Watch for signs of a major crackup involving Fannie Mae and Freddie Mac. The markets are going to wipe out the equity of both companies and force Treasury Secretary Paulson to show his hand. He has a handful of interesting choices, but one thing no one should expect is that there will be any impairment in the position of people who hold senior debt issued by Fannie or Freddie. The Chinese and the Russians (who between them are believed to own at least $1.1 trillion in agency paper) won’t like that, not one little bit.

So the only real question (apart from the fate of subordinated agency paper holders) is what Paulson will do about the equity of Fannie and Freddie. Or more precisely, how much of it will he expose US taxpayers to.

The problems in the US residential real estate market are finally showing outward signs of spilling over into commercial real estate. (I say “outward signs” because it’s now showing up in news reports, whereas warning lights have been flashing quietly for those with eyes to see for nearly a year and a half.)

The problem with commercial real estate isn’t that valuations are wrong, as in housing. Nor are cash flows impaired too far beyond what you’d expect in a recession. The problem is that the people who have been using leverage to buy securities backed by commercial real-estate cash flows have lost their access to leverage. And there’s no one willing to buy securities that a knowledgeable and risk-tolerant real-money buyer could probably get for far below their stable long-term value.

These are the times that try the souls of some men. And make other men billionaires.

Side note: I’m sometimes asked what the effect of the political convention will be on the markets this week. Many market participants would probably say “what convention?” And that’s your answer.

-Francis Cianfrocca