Thursday, August 23, 2007

Countrywide Deal Eases Concerns

From Bloomberg:

U.S. Treasuries fell, led by two- year notes, as a cash infusion for Countrywide Financial Corp. fueled speculation the crisis in credit markets is waning.

Notes tumbled and traders reduced bets the Federal Reserve will cut interest rates after Countrywide, the biggest U.S. provider of home loans, said it sold $2 billion of preferred stock to Bank of America Corp. Countrywide was among lenders that drove investors to the safety of government debt in the past month because of losses tied to a U.S. housing slowdown.

``The market has taken heart from the Countrywide deal,'' said Jonathan Gibbs, an investment director in Edinburgh at Standard Life Investments Ltd., which manages about $70 billion in fixed-income assets. ``I'm not betting on a rate cut.''

This is the result of Bank of American's injection of $2 billion into Countrywide:

Bank of America Corp. bought $2 billion of preferred stock from Countrywide Financial Corp., erasing concern the nation's largest mortgage lender will go bankrupt and boosting investor confidence in stocks worldwide.

``Countrywide is no longer on the endangered company list,'' Punk Ziegel & Co. analyst Dick Bove wrote in a note to clients yesterday. ``This investment makes sense for both companies. Bank of America will now presumably be the preferred lender to Countrywide.''

The cash infusion gives Countrywide the funds it needs to keep making loans after the highest defaults on U.S. subprime home loans in 10 years drove up the cost of credit. That forced central banks to pump more than $400 billion in emergency funds into the money markets. Stocks in Europe and Asia advanced and U.S. stock futures climbed, while government bonds fell today.

So far this financial crisis has played out in an interesting way. At first (and still) there is clamor for a rate cut from a variety of circles. However, the Fed has done everything it can to not cut rates. First they added liquidity -- but not that much compared to other regions. I have speculated this was a coordinated effort with other central banks, which would make sense as the problems hit worldwide. Unfortunately, this liquidity injection went straight into the T-Bill market. However, that appears to be changing, as T-Bill yields are backing off recent lows. This indicates recent purchases are probably being sold and moving into other short-term assets.

Lowering the discount rate was a way for the Fed to buy some time. It was about 75% psychological and 25% practical. I'm guessing the announcement yesterday that the four largest US banks borrowed from the discount window was a coordinated publicity effort. But, it may have helped to buy some time.

And Fed President Lacker's recent comments may indicate the Fed isn't going to cut rates just because of the problems. Yesterday, the WSJ's Marbetbeat Blog ran a story titled Five Reasons the Fed Won't Cut Rates. Absent from this list was the dollar's value, which has been dropping for the last year or so and is currently trading near multi-year lows. I think this adds another very important reason why the Fed doesn't want to cut rates.

I am beginning to think the Fed is "jawboning" the private sector and working quietly behind the scenes encouraging parties into action without any action from the Federal Reserve. Think of this as a Physician, heal thyself scenario. And it looks like Bank of America has listened and is taking action based on the Fed's recent words. If we have more announcement like this over the coming weeks I would take it as a sign the Fed won't be cutting rates.