Good Reading -- May 2010
Happy reading. Hope everyone is doing well.
Investor Psychology Illustrated
(courtesy of Ben Claremon) The best of the write-ups of the recent Berkshire Hathaway annual meeting, which was held two weeks ago
"Chasing Bernie Madoff" -- a Powerpoint presentation by Harry Markopolos, author of "No One Would Listen." Markopolos was desperately trying to get the SEC to shut down Madoff's fraud as early as 2000. The story of his efforts and the SEC's incredible failure is a very important one; the book, I hate to say, isn't as good (I thought it was poorly written and poorly edited).
Sidenote: I've read most of the bailout/financial crisis books released so far. A couple people have asked for recommendations, and I think the best one, in terms of comprehensive overview with just enough detail and thoughtful commentary, is Roger Lowenstein's The End of Wall Street. Like Michael Lewis's book, Lowenstein's book benefits from his extensive knowledge of the subject combined with his excellent writing -- most of the other books had one or the other attribute, but not both. A couple of Lowenstein's other books (a truly excellent Buffett biography and a narrative of the LTCM crisis) are also highly recommended.
"Meet the Real Villian of the Financial Crisis" -- a superb column by Bethany McLean. I agree with basically every word on the page. McLean is an excellent financial journalist; her book on Enron is very good, and I can't wait for her new book on the financial crisis.
"The Best Financial Reform? Let the Bankers Fail" -- James Grant's op-ed in the Washington Post argues, simply and correctly, that the most basic and effective tool is -- as always -- properly aligned incentives.
A note from Moody's -- this will make your head hurt. "Our ratings really suck, so please buy this other expensive product from us that will tell you just how much our ratings suck!"
"13 Life Lessons from Warren and Charlie" (courtesy of Scott Dinsmore) -- a good summary of some of Buffett and Munger's favorite philosophical sound bites.
"Dimon Tries, Fails to Pacify Syracuse Protester With Phone Call" -- we all remember that principled, moralistic, often incredibly naive urge to "fight the man" that is often so prevalent on college campuses. But these morons at Syracuse like totally need to go back to saving the whales, or whatever.
Regarding the financial meltdown generally and the Goldman Sachs lynching* specifically, Charlie Munger says:
''Our problem is that our commercial banks and our investment banks have been regulated with a combination of permissiveness and stupidity,'' Munger said.
Munger compared the bankers that have caused problems to tigers that escaped from the circus and ran amok.
''It's that idiot tiger keeper that didn't do his job,'' Munger said. ''The government regulatory system has utterly failed us.''
* Don't be mistaken: Wall Street is loaded with scumbags doing scummy things. But unless I'm missing something (e.g., that Goldman lied and clearly said/wrote that Paulson was long, or that Goldman really directed or permitted Paulson instead of ACA to pick the assets, as opposed to just not disclosing Paulson's short position) the SEC has failed spectacularly (yet again!) by bringing these charges. Again, Goldman specifically and Wall Street in general are rife with conflicts of interest and occasional criminality, but it is truly strange that the SEC chose this case rather than the dozens (hundreds? thousands?) of more pressing concerns.
Meet the Real Villain of the Financial Crisis
By BETHANY McLEAN
TODAY, we will have the pleasure of watching outraged members of the Senate Permanent Subcommittee on Investigations fire questions at a half-dozen executives from Goldman Sachs. The firm first attracted anger for its return to making billions, and paying its employees millions, right after the financial crisis. And since the Securities and Exchange Commission this month charged Goldman with fraud over an investment tied to subprime mortgages, politicians have turned the firm into the arch-villain of the economic collapse.
But the transaction at the heart of the S.E.C.’s complaint is a microcosm of the entire credit crisis. That is, there are no good guys here. It’s dishonest and ultimately dangerous to pretend that Goldman is the only bad actor. And the worst actor of all is the one leading the charge against Goldman: our government.
Each of the supposed victims here was, at best, a willing accomplice. Let’s start with those who bet that the investment in question, Abacus 2007-AC1, would be profitable for them: a bond insurer called ACA Capital Holdings and a German bank named IKB Deutsche Industriebank. These companies allegedly didn’t know that Goldman, in exchange for $15 million in fees, had allowed a client, the hedge fund manager John Paulson, to help design the investment in order to improve the odds that it would fail.
But there was nothing hindering ACA’s ability to see that mortgages sold to people who probably couldn’t pay weren’t great investments. Meanwhile, the company’s insurance arm was covering as many subprime mortgages as it could to increase its own short-term profits. In some ways, the ACA story is the A.I.G. story: The company thought it had found free money — and basically bankrupted itself.
Similarly, the German bank advertised itself as a sophisticated investor, but didn’t seem to have bothered to analyze the subprime-backed bonds it was buying. The bank just relied on the AAA rating and, not surprisingly, pretty much bankrupted itself, too.
Which brings us to the rating agencies that stamped over 75 percent of Goldman’s Abacus securities with that AAA rating, meaning the securities were supposed to be as safe as United States Treasury bonds. They did the same to billions of dollars worth of equally appalling securities backed by subprime mortgages at other firms. Without the cravenness of the rating agencies, there would have been no Abacus, and no subprime mortgage crisis.
None of this excuses Goldman. Whether the transaction was legal or not, there’s a difference between what’s legal and what’s right. Goldman, where I worked at a junior level from 1992 to 1995, has always held itself up as a firm that adheres to a higher standard. “Integrity and honesty are at the heart of our business” is one of Goldman’s 14 principles. There is no way to square this principle with the accusation that Goldman did not tell a customer who didn’t want to lose money — the very definition of a buyer of AAA-rated securities — that the investment it was selling had been rigged to amplify the chances that it would, yes, lose money.
Transactions like this one open up a window into modern finance, and the view is downright ugly. This deal didn’t build a house, finance a world-changing invention or create any jobs. It was just a zero-sum game that transferred wealth from what Wall Street calls “dumb money” (often those who manage the public’s funds) to a hedge fund. It certainly belies what Lloyd Blankfein, the firm’s chief executive, told me last fall: “What’s good for Goldman Sachs is good for America.” Could the scary truth be that, at best, the success of one has nothing to do with the success of the other?
Yet, in the end, it comes down to this: Goldman Sachs, ACA Capital, IKB Deutsche Industriebank and even the rating agencies never had any duty to protect us from their greed. There was one entity that did — our government.
But it was the purported regulators, including the Office of the Comptroller of the Currency and the Office of Thrift Supervision, that used their power not to protect, butrather to prevent predatory lending laws. The Federal Reserve, which could have cracked down on lending practices at any time, did next to nothing, thereby putting us at risk as both consumers and taxpayers. All of these regulators, along with the S.E.C., failed to look at the bad loans that were moving through the nation’s banking system, even though there were plentiful warnings about them.
More important, it was Congress that sat by idly as consumer advocates warned that people were getting loans they’d never be able to pay back. It was Congress that refused to regulate derivatives, despite ample evidence dating back to 1994 of the dangers they posed. It was Congress that repealed the Glass-Steagall Act, which separated investment and commercial banking, yet failed to update the fraying regulatory system.
It was Congress that spread the politically convenient gospel of home ownership, despite data and testimony showing that much of what was going on had little to do with putting people in homes. And it’s Congress that has been either unwilling or unable to put in place rules that have a shot at making things better. The financial crisis began almost three years ago and it’s still not clear if we’ll have meaningful new legislation. In fact, Senate Republicans on Monday voted to block floor debate on the latest attempt at a reform bill.
Come to think about it, shouldn’t Congress have its turn on the hot seat as well? Seeing Goldman executives get their comeuppance may make us all feel better in the short term. But today’s spectacle shouldn’t provide our government with a convenient way to deflect the blame it so richly deserves.
Bethany McLean, a contributing editor for Vanity Fair, is writing a book about the financial crisis with Joe Nocera of The Times.
The best financial reform? Let the bankers fail
By James Grant Friday, April 23, 2010; A19
The trouble with Wall Street isn't that too many bankers get rich in the booms. The trouble, rather, is that too few get poor -- really, suitably poor -- in the busts. To the titans of finance go the upside. To we, the people, nowadays, goes the downside. How much better it would be if the bankers took the losses just as they do the profits.
Happily, there's a ready-made and time-tested solution. Let the senior financiers keep their salaries and bonuses, and let them do with their banks what they will. If, however, their bank fails, let the bankers themselves fail. Let the value of their houses, cars, yachts, paintings, etc. be assigned to the firm's creditors.
Of course, there are only so many mansions, Bugattis and Matisses to go around. And many, many such treasures would be needed to make the taxpayers whole for the serial failures of 2007-09. Then again, under my proposed reform not more than a few high-end sheriff's auctions would probably ever take place. The plausible threat of personal bankruptcy would suffice to focus the minds of American financiers on safety and soundness as they have not been focused for years.
"The fear of God," replied George Gilbert Williams, president of the Chemical Bank of New York around the turn of the 20th century, when asked the secret of his success. "Old Bullion," they called Chemical for its ability to pay out gold to its depositors even at the height of a financial panic. Safety was Chemical's stock in trade. Nowadays, safety is nobody's franchise except Washington's. Gradually and by degree, starting in the 1930s -- and then, in a great rush, in 2008 -- the government has nationalized it.
No surprise, then, the perversity of Wall Street's incentives. For rolling the dice, the payoff is potentially immense. For failure, the personal cost -- while regrettable -- is manageable. Senior executives at Lehman Brothers, Citi, AIG and Merrill Lynch, among other stricken institutions, did indeed lose their savings. What they did not necessarily lose is the rest of their net worth. In Brazil -- which learned a thing or two about frenzied finance during its many bouts with hyperinflation -- bank directors, senior bank officers and controlling bank stockholders know that they are personally responsible for the solvency of the institution with which they are associated. Let it fail, and their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.
The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver's demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.
Nevertheless, conclude a pair of academics who gave the "double liability system" serious study (Jonathan R. Macey, now of Yale Law School and its School of Management, and Geoffrey P. Miller, now of the New York University School of Law), the system worked reasonably well. "The sums recovered from shareholders under the double-liability system," they wrote in a 1992 Wake Forest Law Review essay, "significantly benefited depositors and other bank creditors, and undoubtedly did much to enhance public confidence in the banking system despite the fact that almost all bank deposits were uninsured."
Like one of those notorious exploding collateralized debt obligations, the American financial system is built as if to break down. The combination of socialized risk and privatized profit all but guarantees it. And when the inevitable happens? Congress and the regulators dream up yet more ways to try to outsmart the people who have made it their business in life not to be outsmarted. And so it is again in today's debate over financial reform. From the administration and from both sides of the congressional aisle come proposals to micromanage the business of lending, borrowing and market-making: new accounting rules (foolproof this time, they say), higher capital standards, more onerous taxes. If piling on new federal rules was the answer, we'd long ago have been in the promised land.
Until 1999, Goldman Sachs was a partnership, with the general partners bearing general and unlimited liability for the firm's debts. Today, Goldman -- like the vast majority of American financial institutions -- is a corporation. Its stockholders are liable only for what they invested, no more. And while there are plenty of sleepless nights, the constructive fear of financial oblivion is, for the senior executives, an all-too-distant nightmare.
The job before Congress is to bring the fear of God back to Wall Street. Not to stifle enterprise but quite the opposite: to restore real capitalism. By all means, let the bankers savor the sweets of their success. But let them, and their stockholders, pay dearly for their failures. Fair's fair.
James Grant is editor of Grant's Interest Rate Observer.
From: Clark, Neal [mailto:Neal.Clark@MKMV.com] Sent: Wednesday, May 05, 2010 1:17 PM To: [redacted] Subject: Moody's Meeting in May
I oversee the relationship between [firm's name redacted] and Moody’s Analytics around credit risk solutions. Recently, many clients have incorporated Moody’s Analytics market-based signals as a powerful complement to their existing ratings and research subscriptions. I would like to meet with you the week of May 17th to discuss how some of their approaches may benefit your team.
A particularly compelling example that comes to mind involves one of our hedge fund clients wishing to identify risky broker-dealers. At the time, most broker-dealers were highly rated by the credit rating agencies, making such identification difficult. By adding Moody’s Analytics market-based risk measures to its credit process, our client created a shortlist of broker-dealers at risk of default. Using this list as a basis for action, the hedge fund severed its relationship with one firm that later would experience a major default.
The following link is to a recent default case study: http://v3.moodys.com/viewresearchdoc.aspx?docid=PBC_124080
Are you available to meet the afternoon of Monday, May 17th? If not, please let me know what works for you and if I should reach out to others in your group. A Moody’s Analytics senior researcher can be on hand for our meeting.
Neal Clark Credit Products Specialist
Moody's Analytics 100 N. Riverside Plaza, Suite 2220 Chicago, IL 60606 312-706-9961
13 Life Lessons from Warren and Charlie: Reporting back from 2010 Berkshire Hathaway Shareholder’s Meeting
Written by: Scott Dinsmore
Average Reading Time: 5 minutes
For one day each year, any and all of us get the chance to listen to 6.5 hours of live questions and answers with Warren Buffett and Charlie Munger (and even ask one of your own if you’re lucky). This year almost 40,000 people took advantage of the opportunity. I was one of them. As I was last year and the two years prior to that. The weekend has become an annual highlight that words cannot describe. Despite the fact that it’s important for our business in the investment partnership my partner and I run, this is one of the best weekends of the year for learning about life and personal improvement. I love it.
The topic of the day: Life Lessons.
To most people’s surprise, this is not simply another dry talk on investing and business. It’s far from it. The great majority of the meeting revolves around lessons in life, relationships, education and career decisions. These guys have experienced over 160 combined years of amazing life experiences and seen success (and even some failure) on numerous fronts. They are brilliant and happen to be two of the best teachers I have come across in all my reading and learning. And the price of admission…free! Ideally you should be a shareholder but there are plenty of other ways to get into the meeting if you’d like. I have to shares some of the most recent pearls with you all. I’ll stick to broader life lessons, but feel free to send a note if you’d like more from the business and investing side.
13 Life Lessons from Warren and Charlie:
1. Lose money and I will forgive you, but lose even a shred of reputation and I will be ruthless [Warren]. This has been echoed across the business world for years and it applies to us all. Life is too short to cut corners to make an extra buck. Wealth can always be recreated but reputation takes a lifetime to build and often only a moment to destroy. As Warren says, “we will not trade reputation for money.”
2. The best defense in a tough economy is to add the most you can to society. Your money can be inflated away but your knowledge and talent cannot [Warren]. No matter the external circumstances, you are always in control of your talent, learning and passion for life. “There will always be opportunities for talent” as Warren says.
3. We get worried when people start to agree with us [Warren]. The best fruit is found out on the limbs. The road less traveled makes all the difference. Make a rule to always stay on the side of the minority in your life’s path and you will likely be greatly rewarded and you’ll certainly experience a lot more excitement.
4. We celebrate wealth only when it’s been fairly won and wisely used [Charlie]. The goal is not to make money at all costs. It’s easy to forget that in a lot of industries and sub-cultures around the U.S. where everyone is in constant competition to keep up with the Jonses. Wealth is worthless if you’ve destroyed all your relationships to attain it. As Charlie says “take the high road. It’s far less crowded.” Sad but often true. Makes it pretty easy to stand out.
5. When you are exceptional you jump off the page. There really isn’t that much competition there [Warren]. Be your own best competitive advantage. Then it doesn’t make a difference what others are doing. You are in control.
6. Do what you’re passionate about. If you do this, there will be few people competing or running faster than you [Warren]. The best way to be exceptional is with passion! As Tony Robbins says every day of his life, “Live with Passion!”And trust me, life is a lot more fun this way.
7. I think I developed courage when I learned I could deal with hardship. You need to get your feet wet and get some failure under your belt [Charlie]. Courage does not grow on it’s own. Just like a muscle, it must be constantly worked out and developed. Life begins outside your comfort zone and that is where your courage is developed. Most people don’t succeed because they’re afraid to fail. Failure isn’t that bad anyway. It will make you tougher and more likely to win the next time around. No one has succeeded without going through their own failures at some point. To try and fail is much better than to never try. Why not get started early and get some of them out of the way! What’s the worst that could happen anyway? As big wave surfer Laird Hamilton says “If you’re not falling then you’re not learning.”
8. There’s no better way to be happier than getting your expectations down [Charlie]. Most unhappiness comes from misaligned and unrealistic expectations of life. Expect the world of yourself, but expect nothing of the world. Then you can not help but live your life pleasantly surprised.
9. If I can be optimistic while I’m nearly dead, you can deal with a little inflation [Charlie]. This had the crowd laughing out loud. Life is what you make it. Don’t let things get you down. It could always be worse.
10. If the only reason you find for doing something is because others are doing it then that’s not good enough [Warren]. Enough said.
11. Bad behavior is contagious. That’s how human nature works [Warren]. Watch out for this. It can catch you off guard.
12. We’ve done a lot of stupid things but we’ve avoided a small subset of stupidity and that subset is important. It’s about avoiding the dumb things [Charlie]. They hammer this every year. Their success does not come from doing so many things right. It comes from avoiding the things that are terribly wrong. Some say this is two sides of the same coin. But it’s not. It requires a fundamental shift in psychology. The stories are endless of people who did a few things right and were massively successful, but then did something stupid that took them back to zero. Before Charlie and Warren do anything, they “invert, always invert” as Charlie says. They list every way imaginable in which they could fail at a particular task and then take massive effort to avoid those failures. Do that and the success will come automatically.
13. Go to bed a little wiser than when you woke up [Charlie]. This covers the whole meeting in a word. Life is about learning. If you are always learning you can never lose. Keep this as your only rule for the day and the world be yours for the taking.
Go to bed a little wiser than when you woke up.
The lessons from Warren and Charlie are endless. We can all stand to learn and be better people from what they are willing to share. They don’t charge any money or ask for anything in return. Except of course that we live a life with a burning desire to learn and do all we can to be valuable additions to society. Take these lessons to heart. There will likely not be another Warren and Charlie for a very long time. Take advantage of the education while you can. Do so and I have a feeling success and fulfillment will come naturally.
Thank you Warren and Charlie. We owe you a great deal.
Dimon Tries, Fails to Pacify Syracuse Protester With Phone Call
2010-05-14 04:01:01.3 GMT
By Dawn Kopecki
May 14 (Bloomberg) -- Twenty-one-year-olds never listen.
Just ask Jamie Dimon.
"Individual to individual, all interaction has been pretty amicable," said Mariel Fiedler, the Syracuse University senior who fielded a call from Dimon after helping lead protests against his selection as commencement speaker. "Otherwise, it’s just difference in opinion."
More than 1,200 Syracuse students, alumni and supporters have signed an online petition urging the university to rescind the invitation to Dimon, JPMorgan Chase & Co.’s chief executive officer. The group said it opposed allowing JPMorgan to use the occasion to "restore the public image of the banking industry and validate the anti-environmental and anti-humanitarian interests of JPMorgan Chase."
Dimon, 54, told reporters on April 14 that he planned to deliver the address as planned and that the students should "stand up for what they believe in." He called Fiedler that month after seeing her comments about the speech, which is set for May 16, said Joe Evangelisti, a spokesman for the New York- based bank.
"We had, like, a really in-depth conversation," Fiedler, a broadcast journalism and English major from Long Island, said in an interview yesterday. "He basically just asked me, like, what it was that we were so opposed to with having him speak here. I laid out the different reasoning that people had."
Dimon wasn’t available to comment about the phone call, Evangelisti said. The call was reported by the university’s Daily Orange newspaper on May 12.
"He said if he had known there would have been this much of a commotion about it, he questioned whether he would have agreed to do it," Fiedler said.
Fiedler’s group, Take Back 2010 Syracuse University Commencement, plans to protest Dimon’s address by removing their graduation robes during his speech, she said. They will be wearing clothes underneath. Another student has produced a rap video about the protest.
JPMorgan opened a technology center last year at Syracuse, which costs about $52,000 a year to attend.