Jeremy Grantham - Classic Stuff

The legendary investor Jeremy Grantham has some classic thoughts in his latest quarterly report:

2. The Other Teflon Men

Larry Summers, with a Financial Times bully pulpit, had done little bullying and blown no warning whistles of impending doom back in 2006 and 2007. And, famously, in earlier years as Treasury Secretary he had encouraged (I hope inadvertently) wild and reckless financial behavior by helping to beat back attempts to regulate some of the new and most dangerous instruments. Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks. And there are several others (discussed in the 4Q 2008 Letter). You know who you are. All promoted!

3. Misguided, Sometimes Idiotic Mortgage Borrowers

The more misguided or reckless the borrowers, the more determined the efforts to help them out, it appears, although it must be admitted these efforts had limited effect. In comparison, those who showed restraint and either underhoused themselves or rented received not even a hint of help. Quite the reverse: the money the more prudent potential buyers held back from housing received an artificially low rate. In effect, the prudent are subsidizing the very same banks that insisted on dancing off the cliff into Uncle Sam's arms or, rather, the arms of the taxpayers - many of whom rent.

5. Over-spenders and Under-savers

To celebrate the overwhelming consensus among economists that U.S. individuals have been dangerously overconsuming for the last 15 years, we have decided to encourage consumption and penalize savers by maintaining the aforementioned artificially low rates, which beg everyone and sundry to borrow even more. The total debt to GDP ratio, which under our heroes Greenspan and Bernanke rose from 1.25x GDP to 3.25x (without even counting our Social Security and Medicare commitments), has continued to climb as growing government debt more than offsets falling consumer debt. Where, one wonders, does this end, and with how much grief?

6. Banks Too Big to Fail

Here we have adopted a particularly simple and comprehensible policy: make them bigger! Indeed, force them to be bigger. And whatever you do, don't have any serious Congressional conversation about breaking them up. (Leave that to a few journalists and commentators. Only pinkos read pink newspapers anyway!) This is not the first time that a cliché has triumphed. This one is: "You can't roll back the clock." (See this quarter's Special Topic: Lesson Not Learned: On Redesigning Our Current Financial System.)

Monty Hall Paradox

I have spent the better part of the day trying to figure out and explain the Monty Hall Paradox:

Suppose you're on a game show and you're given the choice of three doors. Behind one door is a car; behind the others, goats. The car and the goats were placed randomly behind the doors before the show. The rules of the game show are as follows: After you have chosen a door, the door remains closed for the time being. The game show host, Monty Hall, who knows what is behind the doors, now has to open one of the two remaining doors, and the door he opens must have a goat behind it. If both remaining doors have goats behind them, he chooses one randomly. After Monty Hall opens a door with a goat, he will ask you to decide whether you want to stay with your first choice or to switch to the last remaining door. Imagine that you chose Door 1 and the host opens Door 3, which has a goat. He then asks you "Do you want to switch to Door Number 2?" Is it to your advantage to change your choice?

The answer is "yes", it is to your advantage to change your choice. And here is why (best I can do to try to make sense out of this):

The goal is to win the car.

My door has a 1 in 3 chance (33%) of having a car.

The "other two doors" (think of them like one door) have a 2 in 3 chance (67%) of having a car.

Monty tells me that one of the "other two doors" (the 67% f having a car) doesn't have a car.

The 2 in 3 chance (67%) of the "other two doors" now only applies to one of the "other two doors". Monty has essentially transferred the 67% split between "other two doors" into one door.

So, here is what we have as it relates to the math:

My door (not been opened yet): 33%

"Other two doors" #1: 67% (not been opened yet)

"Other two doors" #1: 0% (already been opened so I know it doesn't have the car)

So, probability wise, it is much better to have a 67% chance of winning a car than have a 33% chance of winning a car.

The Harsh Reality of Failure and Misjudgment

Mitch Daniels - Health Care Letter

Mitch Daniels, Governor of Indiana, sent a fantastic letter to the Indiana members of the U.S. House of Representatives regarding the health care bill.

Please read the entire letter here:

My favorite part is when Daniels just hammers home the absolute ridiculousness of the House bill:

A partial list of the negative impact on our state would include:

Billions in costs for Hoosier taxpayers through the mandated expansions of Medicaid to some 1/4 of the population. The official estimate for the first few years is $1.4 billion, which would be bad enough, but never in Medicaid history have these original projections not been exceeded, so we know the real number will be much higher.

Hundreds of thousands of Indiana citizens would be forced out of their current coverage, and a similar number would experience a doubling or tripling of their premiums if their coverage continued at all. The notion that enormous new taxes can have any effect other than to raise costs flunks the common sense test in any Hoosier coffee shop.

Hoosiers, particularly younger ones, will share for their lifetimes in the unbearable costs this scheme will add to the dangerous levels of national debt which other recent legislation is already making much, much worse.

In many ways, I want to thank President Obama for pushing so hard on his health care scheme. We as a nation are now faced with the very real choice of going down the French, German, and British path of socialism-lite or remembering the words of Ronald Wilson Reagan who said, "Concentrated power has always been the enemy of liberty."

College Football Coaches - Overpaid?

This morning on ESPN Radio, Colin Cowherd made a great point about the salaries of college football coaches.

In many respects, it seems absurd that a coach like Texas' Mack Brown could earn nearly $3,000,000 per year for coaching football. How can Mack Brown make $3,000,000 per year coaching a kid's game when the tenured Sociology professor, who has spent his entire life in studying, earning degrees, and educating the leaders of tomorrow, makes around $100,000.

The answer lies in the finances of college football.

Let's take a look at the average attendance figures for Mack Brown's first year as head coach at Texas.

For the 1998 season, Texas had an average attendance of 77,440. Based on what Cowherd said on the radio this morning, the average ticket price in 1998 was about $30.00. So, for the six home games in 1998, Texas pulled in about $13,939,200 from ticket sales.

For the 2008 season, Texas had an average attendance of 98,046 and the average ticket price was about $90.00. To keep an apples-to-apples comparison, we will keep with the six game home schedule (Texas played 7 home games in 2008. In 2008, Texas pulled in about $52,944,840 from ticket sales. They also played in a BCS Bowl Game which earned the school an additional $2,000,000 or so.

For you non-math majors out there, Texas pulled in over $39,000,000 more in ticket sales in 2008 compared to 1998 (74% increase).

When you start to consider the increased concession sales, souvenir sales, and donations from alumni, you realize that the difference between a mediocre football program, which Texas was before Mack Brown arrived on campus, and a great program is, on a very conservative basis, about $50,000,000.

So, considering the figures above, does it still seem absurd that Mack Brown makes $3,000,000 per year while Professor Whatshisname in the Math Department makes $100,000?

Can you feel the "Hope" and "Change" yet?

Thomas Sowell sure seems to:

Just one year ago, would you have believed that an unelected government official, not even a Cabinet member confirmed by the Senate but simply one of the many "czars" appointed by the President, could arbitrarily cut the pay of executives in private businesses by 50 percent or 90 percent?

....Did you imagine that anyone would even be talking about having a panel of so-called "experts" deciding who could and could not get life-saving medical treatments?

...How about a federal agency giving school children material to enlist them on the side of the president? Merely being assigned to sing his praises in class is apparently not enough.

....Among the people appointed as czars by President Obama have been people who have praised enemy dictators like Mao, who have seen the public schools as places to promote sexual practices contrary to the values of most Americans, to a captive audience of children.

....Nothing so epitomizes President Obama's own contempt for American values and traditions like trying to ram two bills through Congress in his first year-- each bill more than a thousand pages long-- too fast for either of them to be read, much less discussed. That he succeeded only the first time says that some people are starting to wake up. Whether enough people will wake up in time to keep America from being dismantled, piece by piece, is another question-- and the biggest question for this generation.

Marketing and Management Wisdom from Drayton Bird

Some great stuff here on marketing in tough times from the master Drayton Bird:

"There is absolutely NOTHING new in management or marketing to be learned from the current crisis. But there are many OLD things that people have NEVER learnt.

In Marketing a) Always measure, not gamble on what you or your boss or your wife likes. b) never spend without testing on small numbers before wasting money on large numbers.

In Management a) look outside at customers, not inside at your own organisation - "There is only one profit centre in business. It is your customer" - Peter Drucker. b) Ask constantly about every person in your business: "What is this person doing to make or save money for the business?"

And, in marketing and management: Never have a meeting unless it has a purpose that you are SURE is aimed at improving profits and that any decision will be acted on.

I am rather depressed that I decided these things made sense about 40 years ago. I have learned nothing much since, which is no surprise. But nor has anybody else, which is.

Or am I wrong?

Housing Industry Update

My wife asked me today if we had seen the bottom of the housing market.

Since I am in commercial real estate, my immediate response was "I have no idea."

As I was reading a few things tonight, I ran across some notes taken from the recent Value Investing Congress. One of the speakers at this year's Congress, Steve Dobson, CEO Amherst Securities, pointed to a few facts regarding the state of the housing industry:

• There are 8 million homes currently not paying their mortgage
• Once a borrower has missed 2 mortgage payments, foreclosure is all but inevitable
• The rate of recoveries is still declining
• The resolution process is grinding to a halt
• The amount of bank-owned real estate is falling, but that’s primarily because of a slowdown in the foreclosure process
• 29% to 50% of modified mortgages re-defaulted within six months
• 79% of all defaulted loans have a current loan to value (LTV) ratio above 120%

So, have we hit bottom in the housing market? I will once again state "I have no idea."

The Value of Simplicity

James Montier, one of my favorite thinkers, recently had a few thoughts on the value of simple and clear thinking:

"the great belief is that more information is always better. The problem is that it ignores the fact that the human brain is a limited processing device. We're not a crazed supercomputer that can handle bytes and bytes of information simultaneously. If you give people more information they actually make worse decisions. So it's far better to be focused on what matters rather than trying to collect all this information which doesn't really improve your performance at all."

Here are the three things Montier recommends an investor think about when making an investment decision:

1) Is the stock cheap? "If it is, it's a potential investment. If its not, forget about it there and then".

2) What does the balance sheet look like? A stock needs to be cheap for a reason. "You can't really analyse earnings without understanding the balance sheet behind those earnings. Yet I feel that a lot of professional analysts have very little grasp of it."

3) What is the management doing with the capital given to them? "Are they going to spend it on their pet projects or something useful."

I will blog this week about how these same rules can be applied to decisions regarding commercial real estate investments.

A Crying Shame

It really is a crying shame that Governor Mark Sanford had to go and ruin his political career because the man really does possess an outstanding mind.

In an article in Newsweek, Governor Mark Sanford reviews Anne Heller's newest book, Ayn Rand and the World She Made.

From the review:

All told, Atlas has sold more than 6 million copies since it was published just over 50 years ago.

Why? I think at a fundamental level many people recognize Rand's essential truth—government doesn't know best. Those in power in Washington—or indeed in Columbia, S.C.—often lead themselves to believe that our prosperity depends on their wisdom. It doesn't. The prosperity and opportunity we enjoy comes ultimately from the creative energies of the country's businessmen, entrepreneurs, investors, marketers, and inventors. The longer it takes this country to reawaken to this reality, the worse we—and in turn, our children's standard of living—will be.

When the economy took a nosedive a year ago—a series of events that arguably began when the government-sponsored corporations Fannie Mae and Freddie Mac went broke—many Americans, myself included, watched in disbelief as members of Congress placed blame on everyone and everything but government. This wasn't new in 2008. It's an act we've seen over and over since the beginning of the New Deal in 1933. For that reason, I think, those passages in Atlas Shrugged foreshadow what might happen to our country if there is no change in direction. As Rand shows in her book, when the government is deprived of the free market's best minds, it staggers toward collapse.

.....There is one more major flaw in Rand's thinking. She believed that man is perfectible—a view she shared with the Soviet collectivists she hated. The geniuses and industrial titans who retire to Galt's hidden valley create a perfect society based on reason and pure individualism; and Galt himself, in the 57-page speech near the book's end, explicitly denies the existence of original sin. The idea that man is perfectible has been disproved by 10,000 years of history. Men and women are imperfect, or "fallen," which is why I believe there is a role forlimited government in making sure that my rights end where yours begin. There is a role for a limitedgovernment in thwarting man's more selfish instincts that might limit the freedoms or opportunities of others. But we need to remember the primacy of the individual, of his or her ability to make the world a better place. Over the past year, we've seen Washington try to solve all our problems—chiefly by borrowing billions from future generations—to little effect. In that sense, this is a very good time for a Rand resurgence. She's more relevant than ever.