Buying Countrywide Ahead of Today's Fed Action

Today, the Federal Reserve Open Market Committee (the FOMC, or simply, the Fed) will emerge from deliberation and direct monetary policy in this country.

Futures have priced in a 50 basis point (.50%) cut.

The Fed will cut at least 50 basis points. Many market analysts have pointed out that the tail (Futures markets) may be wagging the dog (the Fed), which is probably partially true. However, at this point, both fiscal policy (taxes, etc. - determined by Congress) and monetary policy (interest rates, etc. - determined by the Fed) seem aimed to prevent recession (or a slowdown) at all costs.

Fiscal "hawks" had been concerned about inflation in the past, but it now seems that cuts in favor of economic stimulation have taken priority. Little resistance has been seen when the Fed has cut in the past; as more write-downs and bad news continue to trickle out, I don't know why opposition would materialize now.

So 50 basis points is a virtual guarantee for the announcement, while 75 is a realistic possibility. Here's how I see the market reacting:

• A cut of 50 basis points will be immediately disliked. Financial stocks and homebuilders may sell off. (This will be bad for me, since I currently hold Countrywide shares and Hovnanian LEAP calls.) However, I think the market will eventually right its overreaction (whether it be by the end of the day, week, or in a few weeks).
• A cut of 75 points will please the cheerleader analysts. The market will probably finish up a few percent. The downside? Much of the gains due to the announcement of interest rate cuts may be superficial and short-lived, considering monetary policy doesn't even affect the economy for six months.
• A cut of 25 points will be disastrous for the markets tomorrow. Even if the Fed rationalizes it with improving economic data, the same cheerleaders will boo the decision as irresponsible and unreasonable.

Since I have already mentioned them, I'll reiterate an investment idea I've made before:

Buy Countrywide (CFC)

Countrywide is set to be bought by Bank of America sometime this year. When the deal closes, investors holding CFC shares will get .1822 BAC shares for each one of CFC. As of the market close today, a share of Countrywide costs $6.31 and BAC sells for $41.94.If the deal closed tomorrow, Countrywide would essentially be bought for $7.64 per share. Or, to look at it another way, you can buy a Bank of America share for $34.63 by buying the corresponding amount of CFC.

Of course, there is some possibility the deal won't close. However, BAC's deal terms cited only unknown, unexpected, and misleading information as a reason for breaking the deal. Countrywide reported earnings today, losing a ton of money, but nothing was surprising or misleading, and BAC said nothing about any problem going forward from this point.

Yes, there is inherent risk of owning a financial stock right now. But the arbitrage spread is still over 20%, so there's lots of money to be made in a very questionable market. If you're looking to own Bank of America over the next 5, 10, or 20 years, this may be your best opportunity.

If the Fed doesn't please today, both BAC and CFC may get hammered. It's certainly going to be a volatile few months for financials, but the reward may be worth the risk.

For my sake, and for the portfolios of millions of investors like me, I hope that the tail keeps wagging the dog.

Disclosure: none

Comments

[william L. ...:]

I don't believe you are telling people to buy Countrywide!! Do you think they are excluded from all these investigations, including the one going on by the FBI..thats the Federal Bureau of Investigation, in case you don't know . Countrywide, Mozilo, their brookers and agents that deceived and swidled for years are going DOWN..Sure as Shit ...Are you just as nuts as that bunch of hoods..or is it that you believe that the political machine that let them get away with all this deception will let them skate !! for the sake of the U.S.A. I surely hope not...You and I know the only way to restore stability is for these hoods to return, to the honest people they swindled,their hard and honestly earned dollars !!!!! GREED>>>>N... HEALTHY FOR THE SURVIVAL OF THIS COUNTRY <<<< I AM SURE YOU AGREE !! GOOD DAY TO YOU ...

2008 Jan 30 08:20 AM

[The Sluce:]

William, you sound like you may be in a bad loan yourself. Although there were some deceptive practices by some lenders and probably more individual brokers the ultimate responsibility should be on the backs of people taking these loans. The amount of fraud out there by many of these borrowers is astounding and I am just upset that so many of them will now be getting assistance through loan modification and perhaps even some form of government help. For the responsible out there this is just sickening. Nonetheless, with housing bringing the economy and financial system down with it I understand the need for stimulus and help. It will help save us all. With so many people holding bad loans they seem to now have the power in the lender/borrower relationship. Much like Trump did in the early 90s.

Buying CFC here as an arbitrage play isn't a bad idea at all. Most likely the deal will go through as planned. The financial system will start to recover quickly with all the stimulus being pumped into it and BAC will have gotten a great deal. The risk is that BAC trades lower in the mean time or that the deal is halted or modified. Stephen, another benefit to the trade is the roughly 10% yield on CFC. This is an arbitrage deal worth a good 25% total return and you end up with owning shares of BAC. Not a bad deal!

2008 Jan 30 10:30 AM

[Richard Shi...:]

A cut of 50 basis points will be immediately disliked. Financial stocks and homebuilders may sell off. (This will be bad for me, since I currently hold Countrywide shares and Hovnanian LEAP calls.) However, I think the market will eventually right its overreaction (whether it be by the end of the day, week, or in a few weeks).

So far it kind of went the other way, we will have to see the long run. Also, BTW in a contract, an "out" clause that is that broad is really pretty significant, although, there may be a duty of good faith that poses some restrictions.

2008 Jan 30 06:05 PM