Thursday, August 23, 2007

Acting like pirates

Ahoy, maties! It's time investors shed the wool that's been pulled over their collective eyes and now covers most of their bodies, put on an eye-patch and begin swinging swords at stocks.

Today's rescue of Countrywide Financial by Bank of America failed to ignite the rally hounds on Wall Street. While the stock of Countrywide - which faced a serious bank run last week (see story) - gained in after-hours and pre-market trading, the $2 billion injected by BofA is actually nothing more than a thinly-veiled takeover move.

The "loan", which is, in reality, convertible preferred securities priced at 7.5% which can be converted into common stock at $18 a share. If exercised, that would give BofA a 17% stake in the company, but the nation's largest bank would be unable to sell those shares for a period of 18 months.

So, is BofA really thinking "takeover" as opposed to "bailout"? And why was Countrywide so eager to accept money at 7.5% when the Fed just lowered the discount rate to 5.25% and extended the loan period for member banks to from 24 hours to 30 days.

Countrywide obviously cannot access that Fed money, but the 2.25% spread between what BofA is loaning them and the discount rate is the cost of doing business these days.

With a borrowing cost of 7.5%, Countrywide will have to either charge customers somewhere upwards of 9% to customers in order to remain even marginally profitable or sell off a chunk of the company to a "rival" at a discount. It's not a pretty world Countrywide is looking at these days.

In a few words, they're doomed. The larger banks will take the better loans, offering lower rates than Countrywide, who will be forced into a position of sick sister, having to deal with jumbos, home equities, and lenders of less-than-impeccable quality.

This comes at a time when the screws have been tightened considerably already and Moody's is still considering whether or not to lower Countrywide's bond rating to junk status.

By mid-day the markets had turned to mush. Countrywide, up as much as 2.50 early on, was ahead less than 1 point. By 2:00, the earlier gains had all but disappeared, with Countrywide trading as low as 21.98, only 16 cents better than its previous close. The stock closed up a mere 20 cents, at 22.02.

Dow 13,235.88 -0.25; NASDAQ 2,541.70 -11.10; S&P 500 1,462.50 -1.57; NYSE Composite 9,478.62 +1.49

Surely, savvy investors weren't buying the we're out of the woods story being circulated by the banks, the Fed and various shills in the financial press.

All of which brings me to the pirate analogy. Investors, or at least people with an eye on not getting killed in this market, should be looking at short-selling or buying puts on vulnerable companies. Obviously, those in the financial sector are ripe for plunder, though some have already been slashed to pieces.

Like good pirates, traders should look for shifts in opportunities as conditions on the financial seas change. Companies with high debt levels and shaky balance sheets will be prone to suffer some of the more dire circumstances.

As events warrant, I'll be posting some of the better-looking short stories and puts plays right here. For the time being, I'm keeping a close eye on Wells Fargo (WFC), which suffered a two-day computer "glitch" over the weekend which pretty much shut down online operations.

In the aftermath of the 1929 stock market crash, various states and eventually the United States government ordered banks closed due to a liquidity crisis. At the time, they used the innocuous terminology of bank "holidays" to lessen the impact on the American psyche. Might Wells Fargo's "glitch" auger more such technology-related failures as a cover for systemic financial failure? Time will tell, but it's almost certain that soon, cash will again be king.

On the day, declining issues held a 5-4 edge over advancers with the bulk of the losers on the NASDAQ. There were 128 new lows and 79 new highs on lower-than-average volume. So much for volatility. People are afraid to trade in this environment and the risk that hordes of investors might cash out far outweigh the potential for a meaningful recovery in stock values.

Oil crept up 57 cents to $69.83, while gold lost 30 cents and silver added 7 cents. If a credit and cash crunch is upon us, an implosion in commodity prices may be just a warning shot of what lies ahead.

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