What "Efficient" Markets

Yesterday afternoon I experienced the irrationality of the markets first hand both as an onlooker and an emotional participant.

As most of you have probably seen, Bank of America injected $2b of capital into Countrywide, ending a week of speculation about a possible takeover of the company only a week following Countrywide's tapping of its $12b credit facility as rumors swarmed that it was going under.

As the headline hit my blackberry via Pownce - Bank of America Invests $2 Billion In Countrywide - I initially panicked. Although I have almost completely closed my short position in CFC I still had a bit of exposure, and more than the pittance of capital at risk, I was worried that I had been wrong: for me a shot to the ego can be more painful more than a shot to the pocket book and it is even worse when they correlate.

After digesting that reaction and seeing that the stock was up over 20% in after hours trading, I decided to delve in a little further.

As it turns out, BofA basically bought a junky piece of preferred equity with a conversion price at a significant discount to the after-hours trading price of $26/share at $18/share. The math isn't complicated, and as this article explains, the deal was smart for BofA as, they were able to mark-to-market a huge gain and also make a strategic expansion while a major player has their backs to the wall:

Countrywide Gives Bank of America $447 Million Gain

Even with this headline on Bloomberg screens across Wall Street, Countrywide's stock opened up the day up almost 10% (down from its peak of an almost 20% increase overnight)...

But by the end of the day, the luster had worn off and CFC ended flat with the previous day's close.

Even this result seems somewhat irrational mathematically, as the company just gave away 20% of its equity value for a discount to the current stock price - but perhaps different return requirements or something could begin to explain some divergence in the two securities.

In any event, the reactions - both my initial gulp and the market's initial pop - were driven by emotion, rather than reason. And even now the volatility surrounding it makes reluctant to go near this situation...

So the next time someone tells you that markets are "efficient" invite them to play poker and feel confident that at least for that day, you won't have to worry about that saying about the sucker at the table being you...