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Good Reading -- December 2011

Two Bonus Year-end Features (Original Content!)

  1. Collection of Quotations on Investing -- since I started reading and learning about value investing I've been collecting some of the most trenchant quotations and soundbites on the topic as I came across them. I've since learned that other people have found this useful as well (notably, Santangel's Review has mailed out some great collections) and so I thought I'd share this. I also need to apologize in advance, because this document is huge and it's a mess. It's mostly unorganized, it's not uniformly formatted, and only in the past year or two did I think to footnote things as I added them. Hopefully you can still scroll through it and find some nuggets of wisdom (or "CTRL + F" to find something specific). I tried to group some of the "best of the best" in first 25 pages; later you'll see large collections that were usually sourced by someone else and organized around a theme or a particular person/source. Starting on page 26, the sections include: Ben Graham; Warren Buffett (p.28); Seth Klarman (56); Charlie Munger (65); Misc./Other (121); Michael Burry (132); Jim Chanos (138); Joel Greenblatt (139); Howard Marks (140); Charles Kindleberger (149); Peter Cundill (150); James Montier (153); and David Dreman (155), among others.

  • There are bound to be a lot of mistakes -- when you find errors, duplicates, or missing attributions, please let me know. Even better, if you have additions and recommendations, please pass those along as well.

  1. Peninsula Capital Advisors, LLC 13-F filings -- I think one of the most instructive practices an investor can follow is to study the investments of great investors. So when Berkshire announced the hiring of Ted Weschler a few months ago, I pulled down the 13-F filings from his fund, Peninsula, and started going through them. (My apologies for not sending this out sooner.) I think there are a lot of interesting things to learn here:

  • Consider the overall portfolio:

  • concentrated (9-18 investments at any given time)

  • very low turnover (most investments held for a period of years)

  • generally limited to a few industries he apparently knows very well (communications/media, transportation, healthcare, etc.)

  • By looking at the instances in which he made new purchases, you can go back and pull the company's filings from that time period and try to "reverse engineer" his thought process; obviously you're going to have extreme hindsight bias because you know how the story ends, but try to put yourself in his shoes based on what information was available at the time -- I think this is a great way to learn

  • For examples and great case studies, I'd suggest WR Grace (which is Weschler's former employer and a bit more complicated because it was in bankruptcy); any of the Liberty Media entities; and Fresenius and DaVita (Fresenius used to be owned by WR Grace, and DaVita is Fresenius's main competition).

  • Please note:

  • I just pulled down these filings and made the calculations/additions/adjustments myself, so all mistakes are my own (when you catch them, please let me know)

  • the quarterly filings are available, but I limited it to year-end only for simplicity's sake; by no means am I attempting to reflect the exact timing of the investments or gains/losses on the individual investments; the year-over-year stock prices are shown just to highlight some of the big moves

  • as always, we only know what was in the filings (i.e., we don't know the fund's cash balances, other investments, etc.)

Facts and Figures

  • The year's not over yet, but the U.S. is on pace to be a net exporter of petroleum products for the first time in 62 years

  • In 2005, we imported almost 900 million barrels; ytd 9/30/11, we exported 64 million barrels (source: U.S. Energy Information Administration)

  • Note: the news isn't all "good" given that we (a) still import a lot of crude oil, and (b) have more to export because our own demand is so weak (U.S. consumption of gasoline is down 7-8% from the peak in 2007), but the point is that any level of net exports is a major reversal of a decades-long trend of imports that was considered by many to be permanent


  • "Charlie Rose interviews Seth Klarman" -- a rare appearance from Seth Klarman in a November interview with Charlies Rose in which he discusses his charitable endeavors (first 18 minutes) and then investing...highly recommended

  • "Active Management: Private Equity, Venture Capital, and Hedge Funds" -- more Seth Klarman (along with several other investors). This is more than three years old but still very worthwhile. (The whole thing is pretty good, but Klarman's remarks are from approximately the 12:30-20:30 mark; 26:00-29:30; 35:30-37:30; 43:00-45:40; 50:50-51:30; 54:00-55:40; and 68:00-72:00.)

  • Bruce Greenwald moderates a panel featuring Li Lu -- the discussion is centered on investing in perilous times. Li Lu comments at 5:00-7:30; 31:50-37:00; and 55:30-59:00...highly recommended

  • "Profits Are High, Wages Are Low and Taxes Are Below Average" -- some good food for thought in these charts and data stretching back several decades.

  • "Inside McKinsey" -- an interesting profile of the company in the wake of the recent scandals.

  • "What Really Happened Aboard Air France 447" -- the best account I've seen of the horrible tragedy of AF 447, this is as much a case study on human behavior under stress and uncertainty as anything else. (Note: not recommended for anyone with a fear of flying.)The author of this article also wrote a book, "Extreme Fear: The Science of Your Mind in Danger."

  • "Digging a Pension Hole" -- this would be a great case study in Ponzi finance (abetted by a heaping dose of political corruption and incompetence, misaligned incentives, absurd financial assumptions, and extraordinarily risky investment policies and accounting). The only problem is that the fallout is going to be expensive and painful. Illinois and Chicago are extreme (and extremely corrupt, incompetent) examples, but the same lessons and implications apply broadly to many other states (cough, California, cough) and to any institution that uses similar pension "accounting."

  • Continuing on the Chicago theme, and on the heels of ex-Governor Blagojevich's recent 14-year prison sentence, here's an example of the culture that produces these outcomes. Here's another.

  • I've never done this before, but here's a short recommendation. (I kid. Sort of.)

  • "Farnam Street's Ultimate Book Lover's Resource 2011" -- lots of great recommendations (from a great blog).

  • Enron -- to commemorate the 10 year anniversary of the Enron filing, a few looks back at the scandal and its context are here (general overview; also pasted below), here (accounting-focused; click through for a great blog and more on the topic), and here (academic paper focused on the social and economic context).

  • Year-end Book Survey -- a friend is organized a year-end book survey to compile a "best of" list. A great idea and I'm sure it will be a source of some great book recommendations. The results are here.

Copied Below

  • "Has U.S. Learned the Lesson of Enron 10 Years Later?"

  • "Ex-Freddie Mac, Fannie Mae CEOs Sued for Understating Loans" -- better late than never, I guess. I distinctly remember being duped by their public comments (see below)...then I read their financial statements and got a much, much different picture. And even that was hugely misleading as to the true situation.

Has US learned the lesson of Enron 10 years later?

By BERNARD CONDON, AP Business Writer – Dec 1, 2011

NEW YORK (AP) — From humble origins as a natural gas distributor, Enron became a trading operation with the Midas touch. It made bets on oil, water, Internet traffic, even the weather. Wall Street's brightest worked there. Its stock tripled in two years.

Virtually no one knew how it had made so much money.

Ten years ago Friday came the answer: It hadn't.

Enron's bankruptcy on Dec. 2, 2001, revealed a fraudulent illusion. Investors swore they would not be so profoundly deceived again. But it was only the beginning of a decade when so much in the economy was not as it seemed.

Can't-lose Wall Street guys turned out to be cheats. Home values did not go up forever. Promising signs of recovery after the Great Recession turned out to be nothing, and hard times endure.

The theme was shredded faith — that and debt, the more the better.

"We have faith in the big score," financial historian Charles Geisst says, trying to explain why Americans have, time and again, believed in what was too good to be true.

In the simple story of the past decade, a journey from corporate scandals to a housing bubble, then to a collapse and a frustratingly slow recovery, the villain is Wall Street and the victim Main Street. The reality is more complicated.


One reason people didn't know how Enron made money was that it was an amalgam of 3,000 private deals that came to light in its collapse, partnerships with names like Raptor, Condor and Chewbacca.

Behind those obscure names, Enron shunted billions of dollars of debt off its books. Investors were safe as long as they didn't ask too many questions. The company borrowed from Wall Street banks, mutual funds and insurers, pledging its hot stock as collateral.

The collapse wiped out $11 billion in stock value, nearly 10 percent in the 401(k) retirement accounts of Enron employees.

A month later, an outspoken, Harley-riding CEO with an uncanny ability to pull profits out of a seemingly dull New Hampshire manufacturer appeared on BusinessWeek's list of top corporate managers. His name was Dennis Kozlowski. By the end of 2002, he was indicted for stealing $150 million from shareholders, and his company, Tyco International, was bankrupt.

Several other heroes of capitalism toppled after him. Bernard Ebbers drove WorldCom into bankruptcy after misleading investors in his high-flying company in an $11 billion accounting fraud. John Rigas, who turned a $300 purchase into a cable TV empire, was convicted of fraud after prosecutors said he ran Adelphia Communications like a "personal piggy bank," including using $26 million of company money to buy timberland next to his home to preserve his view.

Martha Stewart, who built her cooking and decorating business on an image of homespun goodness, faced a grilling from regulators that suggested a life more tawdry than tidy: She had dumped shares of a drug company on what appeared to be an illegal tip from her Merrill Lynch broker. She was convicted of lying, though never accused of insider trading. The amount the one-time billionaire saved by selling early was $51,000.

It was a time of plummeting stocks, trashed retirement accounts, lost jobs and lost trust. One headline from 2002: "Scandals Shred Investors' Faith."

Regulators cracked down, offering hope. Congress created a board to police the accounting industry. It also passed the Sarbanes-Oxley Act, requiring executives to sign off on financial statements so they could be criminally liable for posting phony numbers.

Investors were thought more vigilant, too. But they got sloppy again, and almost immediately.

Around the time of Enron's collapse, press reports detailed how Italy, years earlier, had struck complicated "currency swap" deals with banks so it could borrow money without having to recognize the debt on its books. Later, Greece was shown to have camouflaged its debt in a similar way.

In 2002, no one seemed to care. By the end of the year, Italy was paying about 4 percent a year in interest on its national bonds, roughly what the U.S. was offering and a sign that few investors were worried.


In 2003, as jurors heard how Kozlowski got Tyco to pitch in $1 million for his wife's birthday party, featuring an ice sculpture of Michelangelo's David that urinated vodka, the seeds of a new crisis were being planted.

American consumers had run up debt to record levels by the end of 2003, and more of them than ever were filing for bankruptcy. Yet the stocks of companies extending mortgages to the riskiest borrowers, so-called subprimes, were rising fast.

Subprime was a euphemism for people who had too little income, too much debt, a bad record of paying lenders back — or all three. As home prices rose, worry that they would not meet their mortgage payments was replaced with faith that, even if they couldn't, they could always sell the home for more than they borrowed and return the money.

Lenders eventually grew so cocky that they seemed willing to give money to virtually anyone who wanted a home. They also offered mortgages on top of mortgages — so-called home equity loans that allowed people to tap their magically rising values to raise cash for flat-screen TVs or Caribbean vacations. Or to pay their credit card bills.

"If your home keeps appreciating, why not use the equity," Robert Cole, CEO of mortgage lender New Century, said at the time.

If the lenders were duping Americans, they made easy targets.

Long before the housing boom, Americans were borrowing more, saving less and increasingly convinced they would not suffer the consequences. In the 1980s, Americans saved more than 6 percent of what they earned each year in income. Their debts totaled 70 percent of take-home pay. By 2007, they were saving nearly nothing, and debt had exploded to 140 percent of income.

"People were using their homes like automated teller machines," says David Rosenberg, chief economist at Gluskin Sheff & Associates and a big critic of lending during the boom. "At some point, people have to own up to their mistakes."

Stoking all this borrowing was the Federal Reserve, which had slashed benchmark interest rates to 46-year lows after the 2000-2001 tech-stock bust, pushing the cost of loans lower. Fannie Mae and Freddie Mac, the government-sponsored companies that buy mortgages from lenders, played a role by targeting ever-riskier loans.

The biggest, most sophisticated Wall Street firms fooled themselves, too.

Banks bought subprime lenders whole. Elegant mathematical formulas from their "risk management" departments told them their gambles were fine. Standard & Poor's and other credit rating agencies provided reassurance by slapping their highest ratings on bundles of risky mortgages.

Wall Street was gripped by what chronicler Roger Lowenstein called a "mad, Strangelovian" logic. Not content to bundle thousands of subprime mortgages into mortgage securities, banks bundled the bundles into something called collateralized debt obligations, or CDOs. Next, they created bundles of bundles of bundles, called CDO-squared.

They created something known as synthetic CDOs that didn't even contain mortgages but merely referenced them, exchanging cash between two parties taking opposing bets that a mortgage lender unconnected to them would get its money back.

Adding to the confusion, it wasn't clear which financial firms held many of the original mortgages on which everyone was betting. They had been bought and sold so many times among investors that no one could follow the paper trail.

By 2006, the men who had wounded a nation's faith in capitalism were finally getting justice. Enron's former president, Jeffrey Skilling, began serving 24 years in prison. Kenneth Lay, the chairman, died before he could be sentenced. Rigas, the cable titan, got 15 years, Ebbers and Kozlowski 25 each.

But we were about to discover that the lies we tell ourselves can be more damaging.


In 2007, subprime lenders went bust, one after another. Then all the mounting debt, made possible by years of half-truths and self-deceptions, turned the fall of a single industry into a worldwide financial crisis.

In March 2008, investors fearing bad mortgage bets at Bear Stearns pulled money out of the bank, leaving it to collapse into the arms of a rival.

Unable to untangle the web of mortgage risk, they began to wonder who was next. They focused on Lehman Brothers, and as that bank teetered, it became clear that the danger of complexity wasn't the only lesson from Enron that had been ignored.

Lehman had hidden debt just like Enron.

Using a financing technique called Repo 105, the bank had borrowed money in a series of deals structured to make it seem as though it had been "selling" assets to raise money. Lenders demanded money back, triggering a run on the bank and leaving ordinary investors scrambling to understand just how much the company had borrowed.

Lehman's bankruptcy in September 2008 froze credit worldwide and helped turn the U.S. recession into the worst since the Great Depression. Stocks eventually fell to 12-year lows, retirement accounts were devastated, and many Americans' biggest asset, their home, plummeted in value.

By the end of 2008, Bernard Madoff was arrested for lying to investors in a $60 billion Ponzi scheme over two decades. A few months later, President Barack Obama started talking up the strengths of the economy, but that soon proved a bit of a mirage, too.

More than a year later, the White House announced its "Recovery Summer," a series of public projects to goose economic growth. But a year and half later, the unemployment rate is stuck at 9 percent and economic growth uninspiring.

A sad footnote: After an overhaul of Wall Street rules last year, broker MF Global turned to the same Lehman-like Repo 105 deals to fuel its bet on indebted European governments. The heavy borrowing helped send the firm run by ex-New Jersey Gov. Jon Corzine into bankruptcy, throwing 1,000 people out of work and creating chaos in markets as brokerage customers scrambled to get their money back.

A month after the firm's collapse, regulators still can't find $1.2 billion of customer funds.


Now Europe is paying for years of using government debt to fund early retirements and long vacations that its citizens really couldn't afford. Streets are choked with protesters, governments are toppling and interest rates rising, some to crippling highs.

Rosenberg, the prescient housing critic, sees trouble for America, too.

Frightened investors are buying Treasury bonds, which is making it cheaper than ever for Washington to borrow despite its trillion-dollar-plus deficits. The danger is that low rates could lull Americans into believing that, even if they themselves can't borrow recklessly, it's OK for their government to.

"A government debt bubble is already creating misery in Europe," Rosenberg says. "If we don't watch out, we'll face the same problem."

Stocks have barely moved in the decade of lost faith. On the Friday before the Enron bankruptcy, the S&P 500 closed at 1,139. Last Friday it closed 19 points above that. The incomes of many middle-class Americans haven't kept up with inflation. Home prices are still falling.

Pretending we were wealthier has made us poorer.

Ex-Freddie Mac, Fannie Mae CEOs Sued for Understating Loans

2011-12-16 16:07:09.352 GMT

By David Glovin and Joshua Gallu

Dec. 16 (Bloomberg) -- Daniel Mudd, the former chief executive officer of Fannie Mae, and Richard Syron, ex-CEO of Freddie Mac, were sued by the U.S. Securities and Exchange Commission for understating by hundreds of billions of dollars the subprime loans held by the agencies.

The lawsuits filed today in Manhattan federal court were followed by an SEC statement that it had entered into non- prosecution agreements with each lender. Fannie Mae, the government-sponsored enterprise which issues almost half of all mortgage-backed securities, and Freddie Mac, the McLean, Virginia-based mortgage-finance company, had “agreed to accept responsibility” for their conduct, the SEC said.

In the lawsuits, the SEC said Syron, Mudd and others understated the lenders’ exposure to subprime mortgage loans.

From 2007 to 2008, Freddie Mac executives said the company’s exposure was between $2 billion and $6 billion when it was actually as high as $244 billion, according to one SEC complaint. From 2006 to 2008, Washington-based Fannie Mae executives said the firm’s exposure to subprime mortgage and reduced documentation loans was about $4.8 billion when it was nearly 10 times greater, according to the regulator.

“Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” Robert Khuzami, director of the SEC’s enforcement division, said today in a statement. “These material misstatements occurred during a time of acute investor interest in financial institutions’ exposure to subprime loans, and misled the market about the amount of risk on the company’s books.”

The lawsuits, which together name six former executives at the government-sponsored entities, come amid criticism from judges and lawmakers that the SEC hasn’t done enough to hold individuals responsible for misconduct related to the housing crisis and financial-market collapse that followed.

The two non-prosecution agreements require Freddie Mac and Fannie Mae to “accept responsibility” for their conduct and to cooperate with the SEC probe of the former executives.

“Under the agreement, without admitting or denying liability, Fannie Mae has offered to accept responsibility for its conduct and to not dispute, contest or contradict a set of factual statements regarding the disclosures,” Fannie Mae said today in a securities filing.

In the individual lawsuits, the SEC is seeking financial penalties, disgorgement and bars on them serving as officers or directors in other companies.

Also named as defendants are Patricia Cook, Freddie Mac’s former executive vice president; Donald Bisenius, ex-senior vice president at Freddie Mac; Enrico Dallavecchia, who was chief risk officer for Fannie Mae; and Thomas Lund, Fannie’s Mae’s former executive vice president.

Mudd, now CEO of Fortress Investment Group LLC, was ousted when Fannie Mae and Freddie Mac were seized by regulators in September 2008. In a statement, he said the federal government and investors were aware of “every piece of material data about loans held by Fannie Mae.”

“The government reviewed and approved the company’s disclosures during my tenure, and through the present,” Mudd said today in the statement. “Now it appears that the government has negotiated a deal to hold the government, and government-appointed executives who have signed the same disclosures since my departure, blameless -- so that it can sue individuals it fired years ago.”

Mark Hopson, Syron’s attorney at Sidley Austin LLP in Washington, didn’t return a call seeking comment.

Michael Levy, Lund’s attorney at Bingham McCutchen LLP in Washington, said his client “did not mislead anyone. During a period of unprecedented disruption in the housing market, nobody worked more diligently or honestly to serve the best interests of both investors and homeowners.”

Dallavecchia is now chief risk officer at PNC Financial Services Group. A phone call to Laurie Miller, his attorney at Nixon Peabody LLP, wasn’t immediately returned.

During Mudd’s tenure as CEO of Fannie Mae, from 2004 through its government takeover in 2008, the firm ramped up its business with lower-quality mortgages. Mudd said in a 2006 interview that he planned to expand the companies’ holdings to include more higher-risk loans. Anything else would be “counterproductive,” he told investors in March of that year.

In April 2007, Mudd said in testimony before lawmakers that the firm’s exposure to subprime loans “remains minimal, less than 2.5 percent of our book.”

At the same hearing, Syron said his firm hadn’t “been heavily involved in subprime all along.”

Within 18 months, U.S. regulators seized Fannie Mae and Freddie Mac after losses on the soured loans pushed them to the brink of insolvency.

The cases are SEC v. Syron, 11-cv-09201, and SEC v. Mudd, 11-cv-09202, U.S. District Court for the Southern District of New York (Manhattan).

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