Q: What is the upside for their shares? A: Fannie and Freddie are selling for 25% or 35% of what they are worth. The upside is three- or four-fold once the mortgage crisis unfolds. These stocks in the $20s don't make any sense, even in a bear case where they have to raise lots of capital. Even if Freddie has to issue $5 billion in equity at $20 a share, massively diluting the existing shareholder base, you still come up with earnings power of almost $4 a share. In a best-case situation, assuming nobody else gets back into this market and they are the only game in town, you can get $9-$10 of earnings power for a stock that is in the $20s. You don't ever see that kind of risk/reward trade-off. Hence, big positions for us in both Fannie and Freddie.

Q: What is the upside for their shares? A: Fannie and Freddie are selling for 25% or 35% of what they are worth. The upside is three- or four-fold once the mortgage crisis unfolds. These stocks in the $20s don't make any sense, even in a bear case where they have to raise lots of capital. Even if Freddie has to issue $5 billion in equity at $20 a share, massively diluting the existing shareholder base, you still come up with earnings power of almost $4 a share. In a best-case situation, assuming nobody else gets back into this market and they are the only game in town, you can get $9-$10 of earnings power for a stock that is in the $20s. You don't ever see that kind of risk/reward trade-off. Hence, big positions for us in both Fannie and Freddie.

Q: Is that one you are buying now? A: Yes. We use normal earnings power as the indicator, which is not what they are going to make next year. But it is what they would make if conditions were neither boom nor bust. To buy financials at four to six times their normal earnings power is as good as it gets, and that's what I see. We're looking for earnings before special items of $7.05 a share for this year, and $4.75 after the items, and against a recessionary backdrop, we're looking for $4.85 a share in 2008.

Q: What is your downside risk? A: There is some short-term downside risk. Looking out three years-plus, you have a really spectacular risk/reward trade. The odds that Citigroup sells for less than 30 in three years are very low, and the odds of it selling for substantially above that are very high.

Q: Do you feel the same about other banks? A: Bank of America [BAC] is the same story. They are going through a downturn, so they're going to have losses and provisions. We're estimating earnings of $3.70 a share for 2007 and $4.10 for '08. Right now, people aren't buying banks because the next quarter might be bad. Whenever investors become hypersensitive to the next piece of information, value opportunities arise.

Q: Which other financials have been unfairly tarred? A: It is pretty much across the board. Lehman Brothers [LEH] and Morgan Stanley [MS] are interesting.

Q: Which other financials have been unfairly tarred? A: It is pretty much across the board. Lehman Brothers [LEH] and Morgan Stanley [MS] are interesting.

Q: Beyond finance, you're a fan of Alcatel-Lucent. A: In the end the price war will abate and Alcatel-Lucent will be successful in reducing costs as per the merger plan. There is a lot of earnings power here -- between $1.25 and $1.50 a share of earnings on a stock that is now $7 a share. It is pretty outstanding, given the quality of the franchise. In '08 we'll see improvement. We won't hit $1.25 to $1.50 of earnings power next year, but we'll be moving in the right direction. When it happens, the stock won't stay at $7.