Category: Accounting

Still More Odds & Ends (Twelve this Time)

Still More Odds & Ends (Twelve this Time)

Posted on by David Merkel

1) I might not be able to post much for the next two days. I have business trips to go on. One is to New York City tomorrow. If everything goes right, I will be on Happy Hour with my friend Cody Willard on Tuesday.

2) As I wrote at RealMoney this morning:


 David Merkel
Buy Other Insurers off of the Bad AIG News
2/12/2008 2:54 AM EST

Sometimes I think there are too many investors trading baskets of stocks, and too few doing real investing work. I have rarely been bullish on AIG? I think the last time I owned it was slightly before they added it to the DJIA, and I sold it on the day it was added.Why bearish on AIG? Isn?t it cheap? It might be; who can tell? There?s a lot buried on AIG?s balance sheet. Who can truly tell whether AIG Financial Products has its values set right? International Lease Finance? American General Finance? The long-tail casualty reserves? The value of its mortgage insurer? I?m not saying anything is wrong here, but it is a complex company, and complexity always deserves a discount.

You can read my articles from 2-3 years ago where I went through this exercise when the accounting went bad the last time, and Greenberg was shown the door. (And, judging from the scuttlebutt I hear, it has been a good thing for him. But not for AIG.)

AIG deserves to be broken up into simpler component parts that can be more easily understood and valued. Perhaps Greenberg could manage the behemoth (though I have my doubts), no one man can. There are too many disparate moving parts.

So, what would I do off of the news? Buy other insurers that have gotten hit due to senseless collateral damage (no pun intended). As I recently wrote at my blog:

If Prudential drops much further, I am buying some. With an estimated 2009 PE below 8, it would be hard to go wrong on such a high quality company. I am also hoping that Assurant drops below $53, where I will buy more. The industry fundamentals are generally favorable. Honestly, I could get juiced about Stancorp below $50, Principal, Protective, Lincoln National, Delphi Financial, Metlife? There are quality companies going on sale, and my only limit is how much I am willing to overweight the industry. Going into the energy wave in 2002, I was quadruple-weight energy. Insurance stocks are 16% of my portfolio now, which is quadruple-weight or so. This is a defensive group, with reasonable upside. I?ll keep you apprised as I make moves here.

What can I say? I like the industry?s fundamentals. These companies do not have the balance sheet issues that AIG does. I will be a buyer of some of these names on weakness.

Position: long LNC HIG AIZ

3) More on AIG. As Cramer said yesterday: One last thought on the AIG issue: if President and CEO Martin Sullivan were to step down, the company might be more of a buy than a sale!

Maybe. Sullivan is a competent insurance executive with the biggest insurance job in the world. Breaking up the company, and letting the parts regain focus makes more sense. As an aside, M. R. Greenberg was known to be adamant about his ROE goal (15% after-tax on average equity), but he also liked the company to have bulk (high assets ? he liked asset-sensitive lines), which is why the ROA slid in the latter part of his tenure.

4) Some praise for Cramer on the same topic. As he said yesterday: AIG let me have it after I said last year that I couldn?t value the stock. They told me that there was a 92-page disclosure document and they wanted to know if I even looked at it. I shot back that not only did I look at it, but I had people comb it, including the forensic accountant I have on staff. The issue was always that despite the disclosure that they had CDO exposure, we couldn?t figure out what the real exposure was and we questioned whether THEY could.

Nothing gets a management more angry than being told that they don?t know what they are doing, but I was marveling at the certainty that they expressed. I told them they had tons of disclosure, but their estimation of possible losses seemed chimerical. I couldn?t figure out how THEY could value the stuff when no one else could with any certainty until it was off their books or written down. OF course, insurance companies aren?t held to the same standards of mark-to-market that banks are. They used mark-to-model, and the model, we learned today ? the Binomial Expansion Technique ? was totally wrong and dramatically understated the losses. All of this cuts to the incredible level of arrogance and stupidity on the Street, making judgments that were anti-empirical on data that could not be modeled but had to be experienced and examined nationally. In short, they were scientific and certain about something that couldn?t be quantified by science and certainly couldn?t be certain about.

Aside from the quibble that insurers for GAAP purposes are subject to the same rules as banks, Cramer got it right here. It is a major reason why I have been skeptical about AIG. Complexity in financial companies, especially financial companies that grow fast, is warranted. It is an unforgiving business where moderate conservatism works best.

5) Brief NAHC note: the CEO purchased more shares in the last few days. At least, it looks like it. Could he be acquiring shares to combat Hovde Capital? Honestly, I?m not sure, but this is looking more interesting by the day.

6) A new favorite blog of mine is Going Private. This post on insurance issues in Florida was unusual for that blog, but I thought it was perceptive. I wrote similar things at RealMoney:


 David Merkel
Move to Florida, Become a Reinsurer
3/27/2007 3:30 PM EDT

Interesting note in the National Underwriter on a Towers Perrin Study (also try here) describing how much Floridians will have to pay if a 1-in-250 hurricane hits Florida. Cost per household: $14,000, or $467 per year for 30 years. On a 1-in-50 storm, the figures would be $5,640, or $188 per year. There would also be a higher initial assessment as well. Note that the odds are actually higher than stated odds would admit. The stated odds of the large losses from the 2004 and 2005 storms happening in consecutive years would have been considered astronomical, but it happened anyway.

The Florida legislature can determine how the pain is shared, but they can?t legislate that the pain go away. No free lunch.

P.S. As an aside, the state of Florida is subsidizing reinsurance rates through its catastrophe fund. Ostensibly, Florida homeowners get a cut in rates, but the insurers give that cut only because their reinsurance costs are lower. Who?s the loser? The citizens of Florida will have to reach into their pockets to recapitalize the Hurricane Catastrophe Fund if big losses hit, and at the very time that they won?t want to do it. (Note to S&P: why do you give this state a AAA GO bond rating?)

Position: none mentioned


 David Merkel
The Worst Insurance State In The USA
2/2/2007 3:52 PM EST

I don?t want to go on a rant here, but I do feel strongly about this. It ill-befits a state government to behave like a bunch of thugs, even if it pleases the electorate. For over two decades, the worst state to do business in as an insurer was Massachusetts. New Jersey was competitive for a while, and California was pretty bad on Worker?s Comp, but now we have a new state on the top of the heap: Florida.

The failure of the Florida property insurance market was due to the lack of willingness to allow rates to rise sufficiently to attract capital into the market. The partial socialization of risk drove away that capital. So what does the governor and legislature of Florida do to meet the crisis? Increase the level of socialization of risk, and constrain companies to a binary decision: accept profits that don?t fairly reflect the risks underwritten, or leave the state. (And, they might try to forbid insurers from leaving.)

In my opinion, if they bar the door to insurers leaving, or not being allowed to non-renew policies, it is an unconstitutional ?taking? by the state of Florida. No one should be forced to do business that they don?t want to do. Fine to set up the regulatory rules (maybe), but it?s another thing to compel parties to transact.

Okay, here?s a possible future for Florida:

1) By the end of 2007, many insurers leave Florida; the state chartered insurer now has 33% of all of the primary property risk.
2) Large windstorm damages in 2008-2009, $100 billion in total, after a surprisingly light 2006-2007.
3) Florida finds that the capital markets don?t want to absorb more bonds in late 2009, after the ratings agencies downgrade them from their present AAA to something south of single-A.
4) The lack of ability to raise money to pay storm damages leads to higher taxes, plus the high surcharges on all insurance classes to pay off the new debt, makes Florida a bad place to live and do business. The state goes into a recession rivaling that of oil patch in the mid-1980s. Smart people and businesses leave, making the crisis worse.

Farfetched? No, it?s possible, even if I give a scenario of that severity only 10% odds. What is more likely is a watered-down version of this scenario. And, yes, it?s possible that storm damages will remain light, and Florida prospers as a result of the foolishness of their politicians. But I wouldn?t bet that way.

Position: long one microcap insurer that will remain nameless


 Marc Lichtenfeld
Florida Insurance
2/2/2007 4:17 PM EST

David,

While I don?t pretend to be the insurance maven that you are, I don?t believe it?s quite as black and white as you portray.

First, let me preface my comments by saying that I believe in free markets and don?t agree with the Governor?s plan, although I stand to benefit. Secondly, my insurance rates, while higher than I?d like are not too bad compared to others in the state.

That being said, I think something had to be done. In one scenario that you lay out, you describe smart people leaving due to higher taxes. That was already happening due to high insurance rates. Some people with affordable mortgages suddenly found their insurance rates skyrocketing from $2,000 to over $6,000. Lots of seniors on fixed incomes also saw their rates jump.

One factor in the housing slump is that buyers are having a hard time finding insurance on a house they are ready to close on. I know that three years ago, we were scrambling at the last minute to find an insurer who would write a policy ? and that was before all of the storms.

I?m not sure what the answer is. I fear that in an entirely free market, there will be very few insurers willing to do business here if there?s another bad storm.

Maybe that?s an argument that we shouldn?t be building major population centers right on the coast, but that?s another story.

Position: None



 David Merkel
My Sympathies to the People of Florida
2/2/2007 4:45 PM EST

Marc,

I understand the pain that many people in Florida are in. I know how much rates have risen. What I am saying is that the new law won?t work and will leave the people of Florida on the whole worse off. Florida is a risky place to write property coverage, and the increase in rates reflects a lack of interest of insurers and reinsurers to underwrite the risk at present rates and terms.

We don?t have a right to demand that others subsidize our lifestyle. But Florida is slowly setting up its own political crisis as they subsidize those in windstorm-prone areas, at the expense of those not so exposed. Commercial risks must subsidize coastal homeowners. Further, there is the idea lurking that the Feds would bail out Florida after a real emergency. That?s why many Florida legislators are calling for a national catastrophe fund.

They might get that fund too, given the present Congress and President, but Florida would have to pay in proportionately to their risks, not their population. Other proposed bills would subsidize Florida and other high risk areas. Why people in New York, Pennsylvania, Ohio should pay to subsidize Florida and California is beyond me.

The new law also affects commercial coverages; the new bill basically precludes an insurer from writing any business in Florida, if they write homeowners elsewhere, but not in Florida. If you want to chase out as many private insurers as possible, I?m not sure a better bill could have been designed. The law will get challenged in the courts; much of it will get thrown out as unconstitutional. But it will still drive away private insurance capacity.

I?m not writing this out of any possible gain for myself. I just think the state of Florida would be better served, and at lower rates, with a free market solution. Speaking as an insurance investor, I know of half a dozen or so new companies that were contemplating entering Florida prior to the new law. All of those ideas are now dead.

I hope that no hurricanes hit Florida, and that this bet works out. If there is political furor now in Florida, imagine what it would be like if my worst-case scenario plays out.

Position: long a small amount of one microcap insurer with significant business in Florida

Florida had now dodged the bullet for two straight years. Hey, what might happen if we have a bad hurricane year during an election year? Hot and cold running promises; I can see it now!

7) One of the best common-sense writers out there is Jonathan Clements of the WSJ. He had a good piece recently on why houses are not primarily investments. Would that more understood this. There are eras where speculation works, but those eras end badly. You can be a landlord, with all of the challenges, if you like that business. You can own a large home, but you are speculating that demand for the land it is on will keep growing. That is not a given.

8 ) My favorite data-miner Eddy, at Crossing Wall Street comes up with an interesting way to demonstrate momentum effects. Large moves up and down tend to continue on the next day, and the entire increase in the market can be attributed to the days after the market moves up 64 basis points.

9) This is not an anti-Cramer day. I like the guy a lot. I just want to take issue with this article: ?Trading in CDOs Slows to a Trickle.?? The basic premise is that CDOs are going away because trading in CDOs is declining.? Well, the same is true of houses, or any debt-financed instrument.? Volumes always slow as prices begin to fall, because momentum buyers stop buying.

Short of outlawing CDOs, which I don’t think can be done, though the regulators should consider what financial institutions should be allowed to own them.? That would shrink the market, but not destroy it.? Securitization when used in a moderate way is a good thing, and will not completely disappear.? Buyers will also become smarter (read risk-averse) at least for a little while.? This isn’t our first CDO blowup.? The cash CDO vintages 1997-1999 had horrible performance.? Now we have horrible performance.? Can we schedule the next crisis for the mid-teens?

10) On Chavez, he is a dictator and not an oil executive.? Maybe someone could send him to school for a little while so that he could learn a little bit about the industry that he is de facto running?? As MarketBeat points out, take him with with a grain of salt.? Venezuelan crude oil needs special processing, much of which is done in the US.? If he diverts the crude elsewhere, who will refine it for sale?

11) I am really ambivalent about Bill Gross.? He’s a bright guy, and has built a great firm.? Some of the things he writes for the media make my head spin.? Take this comment in the FT:

That the monolines could shoulder this modern-day burden like a classical Greek Atlas was dubious from the start. How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world?s sixth-largest economy? How could an investor in California?s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation?s largest state with its obvious ongoing taxing authority? Apply the same logic to the gargantuan size of the asset-backed market it has insured in recent years ? subprimes and CDOs in the trillions of dollars ? and you must come to the same logical conclusion: this is absurd. It is as if Barney Fife, television?s Sheriff of Mayberry in The Andy Griffith Show, promised to bring law and order to the entire country.

Most municipal defaults are short term in nature, even those of states, of which there have been precious few.? Ambac, or any other guarantor, typically only has to make interest payments for a short while on any default.? It is a logical business for them to be in… they provide short term liquidity in a crisis, while the situation gets cleaned up.? In exchange for guarantee fees the municipalities get lower yields to pay.

The muni business isn’t the issue here… the guarantors should not have gotten into the CDO business.? That’s the issue.

12) I try to be open-minded, though I often fail.? (The problem of a permanently open mind is that it doesn’t draw conclusions when needed.? Good judgment triumphs over openness.)? I have an article coming soon on the concept of the PEG ratio.? This is one where my analytical work overturned my presuppositions, and then came to a greater conclusion than I would have anticipated.? The math is done, but the article remains to be written.? I am really jazzed by the results, because it answers the question of whether the PEG ratio is a valid concept or not.? (At least, it will be a good first stab.)

Full disclosure: long AIZ HIG LNC NAHC

Ten More Odds & Ends

Ten More Odds & Ends

Posted on by David Merkel

I’m just trying to clean up old topics, so bear with me:

1) This blog is not ending because of my new job. Finacorp wants me to keep it going, and they may use the posts in PDF form for clients. Also, unlike my prior employer, Finacorp wants me to have a high degree of exposure, because it aids them. You may see me in more venues, which could include TV and radio.

2) In one sense, I had an unusually productive Saturday. I built two models — one for a critique of the PEG ratio, and one for a model of the Treasury yield curve. You will see articles on both of these, and I am really jazzed on both of them. It is not often that I get one impressive result in a day. Today I got two. I’ll give you one practical upshot for now, if you are an institutional bond investor: go long 10-year Treasuries and short 7-year. We are very near the historical wides. If you are like me, and can live with negative carry, dollar duration-weight the trade, so that you are immune to parallel yield curve shifts.

3) I didn’t read Barron’s, Forbes, or The Economist today, but I did read the Financial Analysts Journal. In it there were three articles that are worth a comment. There was an interesting article on fundamental indexation that comes close to my view on the topic. Fundamental indexation, when properly done, is nothing more than enhanced indexing with a value tilt. Will it make you more money than an ordinary index fund? Yes, it will, over a long enough period of time. Will it work every year? No. Is there one optimal way to fundamentally index? No. There is no one cofactor, or set of cofactors that optimally define value, if for no other reason than the accounting rules keep changing.

4) The second article went over the value of immediate annuities as risk reducers to retirees, something I commented on recently. The tweak here is buying annuities that start paying later in retirement, for example at 80 or 85, with the risk that if you die before then, you get nothing. Longevity insurance; a very good concept, but the execution is tough.

5) The third article was on Risk Management for Event-Driven Funds. Here’s my take: risk arb is like being a high yield bond manager. Anytime a deal is announced, you have to do a credit risk analysis:

  • How likely is it that this deal will go through?
  • How badly could I be hurt if it does not go through?
  • Am I getting paid more than a junk bond with equivalent risk?

But the portfolio manager must ask some more questions:

  • Are there any common factors in my risk arb book that could bite me? Sectors? Need for debt finance?
  • What if deal financing terms go awry all at the same time? How will that affect the worst risks in my book?
  • Am I getting paid more than a junk bond with equivalent risk? (Okay, it’s a repeat, but it deserves it.)

Risk arbs have been burned lately, with all of the deals that have been busted because financing is not available on easy terms. It’s tough but this happens. Most easy arbs tend to get overplayed before blowups happen. The lure of easy money brings out the worst in people, even institutional investors.

6) Naked Capitalism had an interesting post on GM. I made the following comment:

I took some criticism at RealMoney.com for writing things like this about GM, though the author here was a much better writer.

The thing is, there are enough levers here that GM can keep the debt ball in the air for some time, as can many of the financial guarantors, so long as they can make their interest payments.

The “Big 3” lose vitality vs. Toyota and Honda each year — in the long run GM and Ford don’t make it. Perhaps after they go through bankruptcy, and shed liabilities to the PBGC, and issue new equity to the current unsecured bondholders, they can exist as smaller companies that have focus. Maybe Ford could be a division of Magna, and GM a division of Johnson Controls. At least then there would be competent management.

7) Barry Ritholtz had a good post called, 5 Historical Economic Crises and the U.S. The paper he cited went into five recent crises in the developed world, and how the current US situation stacks up against that.? Here was my comment on one of the areas where the US situation did not seem so dire, that of the run-up in government debt:

On the last point about the increase in the debt, what is missed is that a lot of the government debt increase is hidden by the non-marketable Treasury bonds held by the entitlement programs. Add that in, and consider the unfunded promises made at the Federal, State, and municipal levels, and the debt increase on an accrual basis is staggering.

We do face real risks here.? The rest of the world will not finance us in our own currency forever.? Oh, one critical difference between the US and the 5 crises — we are the worlds reserve currency, for now.

8 )? I like Egan-Jones on corporate debt.? They have quantitative models that follow contingent claims theory, and use market based factors to estimate likelihood and severity of default.? They are now trying to do models for asset backed securities.? Very different from what they are currently doing, and their corporate models will be no help.? They will also find difficulties in getting the data, and few market-based signals that inform their corporate models.? I wish them well, but they are entering a new line of business for which they have no existing tools to help them.

9) This article from Naked Capitalism pokes at the rating agencies, and the proposed reforms from the SEC.? My view is this: the financial regulators need a model on credit risk.? They need a common platform for all credit risks.? They need one set of ratings that allow them to set capital levels for the institutions that they regulate, or they need to bar investments that cannot be rated adequately.? The problem is not the rating agencies but the regulators.? How do they properly set capital levels.? They either have to use the rating agencies, or build internal ratings themselves.? Given my experiences with the NAIC SVO, it is much better to use the rating agencies.? They are more competent.

10)? Finally, on Friday, a UBS report stirred the pot regarding non-borrowed reserves.? You can see the H.3 report here. Both Caroline Baum of Bloomberg and Real Time Economics debunked the UBS piece.? But it was simpler than that.? The Fed published its own explanation at the time they put out the H.3 report.? UBS did not include the effect of the new TAF.? Whoops.? Oh well, I make mistakes also.? It’s just better to make mistakes when one doesn’t sound so certain.
Full disclosure: long MGA, HMC

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A Bonus from MoneySense Magazine

Posted on by David Merkel

For my readers, particularly my Canadian readers, you can read an article that I wrote on risk control in portfolio management for MoneySense magazine.? In the process of writing the piece for MoneySense, I got to read a number of back issues, and found it to be a good quality publication, of most use to Canadians.? Having passed the Life Actuarial exams, I know enough about Canadian tax law and financial services to be a danger to myself, and those who listen to me.? Fortunately, the piece I wrote was generic, and can benefit investors anywhere.

Notes on Stocks and the Fed

On a side note, why didn’t the stock market fall more today? For me, it boils down to two things: the FOMC surprise move, which ratcheted up total rate cut expectations for January, and seller exhaustion.? It’s hard for the market to fall hard when you have already had a high level of down volume net of up volume, and huge amounts of 52-week lows net of 52-week highs.? This wasn’t just true of the US, but of most global equity markets.

So, if we are going down further, the market will have to rest a while.? That said, valuations are more compelling than they were, especially compared to Treasuries.? Compared to BBB corporate yields, they are still attractive.? I think I would need to see 10-year BBB corporates at yields of 7% or so before I would begin edging in there.

One other note, the forward TIPS curve is showing some life again; perhaps that will be another fake-out, as in August, but there is certainly more oomph in the inflationary effort now than when the stimulus effort was grudging and fitful as it was back then.

The Fed, Financial Guarantors, and Housing

The Fed, Financial Guarantors, and Housing

Posted on by David Merkel

This post will be a little more disjointed than others. One housekeeping note before I start: I’m behind on my e-mail. I will catch up on it next week, DV.

Fed and Federal Government Policy

I don’t know; it seems like there are rumblings that the Fed will imminently take action, and that does not resonate with me. You can also read the stuff from Doug Kass at RealMoney, or consider the rebirth of the Plunge Protection Team. We are not so far from the next Fed meeting that waiting would make that much of a difference, particularly since the Fed tipped its hand when Bernanke spoke recently. There is a decent-sized cut coming, and the Treasury yield curve reflects it.

Now, I have my doubts as to the long-term efficacy of unusual measures from the Fed or the Treasury. You can’t get something by government fiat. Even a Fed Governor thinks we expect too much from the Fed, a sentiment with which I heartily agree, even though the Fed is partially responsible for creating that illusion. If the Fed took more of a “we do our best, but our powers are not that large in the long run” approach, market players might not give them so much credence.

Now, I’m not going so far as Anna Schwartz, who thinks the current Fed isn’t up to the task. That may or may not be true; what is hard to dispute is that Alan Greenspan dealt the existing FOMC a bad hand from a prior monetary policy that too easily responded to minor crises, rather than letting the economy take some pain. Moderate recessions are good for the economy; save the heroics for depression-like conditions.

Financial Guarantors

I may fail at it, but I try to be honest and self-critical here at my blog. For example, I did not suggest that Warren Buffett would buy Ambac, but I was misinterpreted as saying so. Now that Ajit Jain says that Berky might buy into one of the financial guarantors, I am not going to say that I predicted that, because I didn’t. It would be amusing if Buffett announced his new entry into the financial guaranty space to drive their prices down so he could buy a stake cheaper, but that is not his style. He values his reputation. That said, the NY regulator may not have thought enough steps ahead in pushing for Berky to set up a new guarantor. Good for new issues; perhaps not as good for old ones at legacy carriers.

Now, I admire Marty Whitman and Aldo Zucaro, but so far, their forays into the mortgage guaranty space have not worked out. I’m not counting them out, but it still may be early for that trade. Maybe we should wait for one of the companies to fail. The remaining companies should do well, once capacity drops out.

As for MBIA, they cut their dividend, which to me indicates a lower future level of profitability. Then they raise $1 Billion through surplus notes at their operating subsidiary, and pay 14% to do that. That has to be a record spread for a new-issue nominally AA-rated bond. Personally, I think I would pass on the notes, except for a flip. I would rather hold the common. Scenarios that would kill the common would most likely also kill the surplus notes. The common has more upside potential.

Residential Real Estate

I am fascinated by the willingness of some of the courts to insist on strict standards before they allow lenders to foreclose. Examples:

In general, I think there are legitimate flaws in the documentation that got ignored before the number of attempted foreclosures became so large. This is pointing out some stresses in the system. When this is done, securitization will not vanish; it will just be better managed.

Now as a final note, it is somewhat shameful that banks can’t follow FAS 114. The calculations aren’t hard; they just don’t want to recognize losses that they should recognize. That’s the real issue, so FASB and Congress should not give in here.

Pandora and the Fair Value Accounting Rules

Pandora and the Fair Value Accounting Rules

Posted on by David Merkel

I’ve been involved in financial reporting for a large amount of my career, so even though I’ve never had an accounting course in my life, I’ve had to work with some of the most arcane accounting rules out there as an actuary, and later as an investor.? Over the years, the direction that the FASB and IASB have gone is in the direction of presenting the statement of financial position (balance sheet) on more and more of a fair market value basis.? (Please ignore the treatment of goodwill, advertising,? R&D, you get the idea though…)? To soften the blow on the income statement, changes in the value of many balance sheet items don’t get run through net income, but through accumulated other comprehensive income, so that income can reflect sustainable earnings power, in theory.? Now, I agree with Marty Whitman’s critique on these accounting issues.? We may be getting more accurate on individual companies (if the accounting is done by angels, for humans we are granting too much freedom), but we are losing comparability across companies.? What an item means on the balance sheet of one company may be considerably different than the value at another company.
The hot topic today is SFAS 157 and 159.? I would point you to Dr. Jeff’s article this evening on the topic.? I would like to give my perspective on this, becaue I have had to work with these accounting rules, and ones like them.

At one company that I managed money for, I originated a bunch of long duration high quality assets that did not trade.? At year end, our incentive payment was based on the total return that we generated.? Interest rates had fallen through the year, and so my high quality illiquid assets had yields well in excess of where new money could be deployed.? What were those assets worth?? Historic cost?? The cash flow streams were fixed.? As a conservative measure, though spreads over Treasury yields had fallen for those instruments, we kept the spreads from the issue, and accounted for the price change due to the move in Treasury yields.? (If spreads had risen, I would have argued that we move the spreads up as a conservative gesture.)? Now this was prior to SFAS 157, but it illustrates the point.? How do you calculate the value of illiquid instruments?? Worse, under SFAS 157, you can’t be conservative; you have to try to be realistic.

Now, that was a simple example.? Almost every moderate-to-large life insurance company has a variety of illiquid privately placed bonds for which there is no market.? What is the fair value?? Who can tell you?? Well, the broker(s) that brought the deal are supposed to provide continuing “color” on the bonds, and what few trades might transpire.? Typically, they don’t move the prices much as the interest rate and spread environments change, and third party pricing services are loath to opine on anything too illiquid.? Though the rating agencies night give a rating at issue, they might not update it for some time.? What’s the fair value?? The life insurer has a hard time determining that for that small minority of assets.

Now let’s take it to a yet more difficult level.? If we are talking about many asset-backed securities, they are generic enough that pricing models can determine a spread to Treasury or Swap yields for tranches with a given vintage, maturity, originator, and rating.? Yes, there will be many assets that “trade special,” but those are deviations from the model that the traders feel out.

With CDOs, things get more difficult, because aside from indexed CDOs, there is no generic structure.? The various tranches are bought and held.? They rarely trade.? Projecting the cash flows is a difficult talk, because there are many different bonds in the trust, with many different scenarios for how many will default, and what recoveries will be obtained.? The best a good simulation model can do is to illustrate what a wide variety of possibilities could be, and look at the average of those possibilities.? Even then, the modeler has an expected cash flow stream.? What’s the right discount rate to use?

There is no good answer here.? One can try to infer a rate from what few trades have happened in the market with similar instruments, but that can be unreliable as well.? During a bear market, the sellers will be more incented than the buyers, particularly if they are trying to realize tax losses.? One can try to look at the scenarios across the tranches, and see which tranches have cash flows that behave like bonds, equities, and warrants, and apply appropriate discount rates like 6%, 20%, and 40% respectively.? Some explanation:

  • Bonds: pays interest regularly, and principal within a narrow window.? Few deferrals of interest.
  • Equities: high variability of payoffs.? Pays something in almost all scenarios, but the amounts vary a lot.? Timing and existence of principal repayment varies considerably.? Interest deferrals are common, but rarely last long.
  • Warrants: many scenarios have very low or zero payoffs.? Some scenarios have significant payoffs.? Interest deferrals last a long time, many never end.? Principal payments are rare.

Estimating fair value in a case like this is tough, if not impossible.? But a fair value must be estimated anyway.? Management teams may try to make the third party estimator come to a certain value that fits their accounting goals.? Given the squishiness of what the discount rate ought to be, management teams could say that once the market normalizes a low discount rate will prevail, and our models should reflect normalized, not panic conditions.

Well, good, maybe.? The thing is, once we open Pandora’s box, and allow for flexibility in valuation methods, subject to auditor sign-off (now, who is paying them?), our ability as third party investors to evaluate the value of illiquid assets and liabilities declines considerably.? There’s a great argument here for avoiding companies that own/buy complex assets in an era where fair value accounting reigns.? There is too much room for error, and human nature tells us that the errors are not likely to yield positive earnings surprises for investors.

What Did Buffett Know about the Gen Re Finite Reinsurance Deal with AIG?

What Did Buffett Know about the Gen Re Finite Reinsurance Deal with AIG?

Posted on by David Merkel

Start with my disclaimer: I don’t know for sure. Buffett says that he didn’t know about the details, and certainly didn’t approve of the deal. From the Dow Jones Newswires:

Buffett said in a 2005 statement that he “was not briefed on how the transactions were to be structured or on any improper use or purpose of the transactions.”

Buffett’s attorney, Ronald Olson, said in a recent statement that Buffett “denies that he passed judgment in any way on the challenged AIG/Gen Re transaction in November 2000 or at any other time.”

Personally, I find this amazing for a few reasons. 1) In any dealings with AIG, a smart insurance executive would want to know what was going on. AIG has had a history of getting the better end of the deal in working with reinsurers. Buffett is not dumb, and there had been a decent amount of rivalry between the two companies over the years. 2) Buffett was not “hands off” on the insurance side of the house when it came to large insurance contracts. From his 2001 Shareholder Letter (page 8 ):

I have known the details of almost every policy that Ajit has written since he came with us in 1986, and
never on even a single occasion have I seen him break any of our three underwriting rules. His extraordinary
discipline, of course, does not eliminate losses; it does, however, prevent foolish losses. And that?s the key: Just as
is the case in investing, insurers produce outstanding long-term results primarily by avoiding dumb decisions, rather
than by making brilliant ones.

Now, maybe Buffett was overstating the case of how much he knew about what Ajit did. It is clear that he spent more time with Ajit than the managers at Gen Re, but I find it difficult to believe he didn’t review a major contract of a client who was also a major competitor known to be tough reinsurance negotiator.

3) He understands finite insurance very well. From this article of mine at RealMoney about the 2004 Shareholder letter, my last point:

12) Finally, what was not there: a discussion of Berkshire’s activities in the retroactive (or retrocessional or finite or financial) reinsurance business. This is notable for two reasons: first, in 2003, he split out the retroactive reinsurance in order to give a clearer presentation of the insurance groups operating results. This year the data is only presented in summary form. Second, Buffett made a big positive out of the retroactive reinsurance results, going so far as to explain the business in both the 2000 (page 8 ) and 2002 (page 9) shareholder letters.

Now, to varying degrees, Buffett made effort over the prior four years to explain the profitability of Berky’s retroactive reinsurance business, because it skewed the loss ratios of Berky upward. In the 2004 Shareholder letter, it was too much of a hot potato to give similar coverage to, even eliminating the entries that would have allowed one to see the accounting effect. In 2000 and 2002, he gave mini-tutorials on the business. In 2000 (page 8 ):

There are two factors affecting our cost of float that are very rare at other insurers but that now loom large at Berkshire. First, a few insurers that are currently experiencing large losses have offloaded a significant portion of these on us in a manner that penalizes our current earnings but gives us float we can use for many years to come. After the loss that we incur in the first year of the policy, there are no further costs attached to this business.

When these policies are properly priced, we welcome the pain-today, gain-tomorrow effects they have. In 1999, $400 million of our underwriting loss (about 27.8% of the total) came from business of this kind and in 2000 the figure was $482 million (34.4% of our loss). We have no way of predicting how much similar business we will write in the future, but what we do get will typically be in large chunks. Because these transactions can materially distort our figures, we will tell you about them as they occur.


Other reinsurers have little taste for this insurance. They simply can?t stomach what huge underwriting losses do to their reported results, even though these losses are produced by policies whose overall economics are certain to be favorable. You should be careful, therefore, in comparing our underwriting results with those of other insurers.


An even more significant item in our numbers ? which, again, you won?t find much of elsewhere ? arises from transactions in which we assume past losses of a company that wants to put its troubles behind it. To illustrate, the XYZ insurance company might have last year bought a policy obligating us to pay the first $1 billion of losses and loss adjustment expenses from events that happened in, say, 1995 and earlier years. These contracts can be very large, though we always require a cap on our exposure. We entered into a number of such transactions in 2000 and expect to close several more in 2001.


Under GAAP accounting, this ?retroactive? insurance neither benefits nor penalizes our current earnings. Instead, we set up an asset called ?deferred charges applicable to assumed reinsurance,? in an amount reflecting the difference between the premium we receive and the (higher) losses we expect to pay (for which reserves are immediately established). We then amortize this asset by making annual charges to earnings that create equivalent underwriting losses. You will find the amount of the loss that we incur from these transactions in both our quarterly and annual management discussion. By their nature, these losses will continue for many years, often stretching into decades. As an offset, though, we have the use of float — lots of it.


Clearly, float carrying an annual cost of this kind is not as desirable as float we generate from policies that are expected to produce an underwriting profit (of which we have plenty). Nevertheless, this retroactive insurance should be decent business for us.


The net of all this is that a) I expect our cost of float to be very attractive in the future but b) rarely to return to a ?no-cost? mode because of the annual charge that retroactive reinsurance will lay on us. Also ? obviously — the ultimate benefits that we derive from float will depend not only on its cost but, fully as important, how effectively we deploy it.


Our retroactive business is almost single-handedly the work of Ajit Jain, whose praises I sing annually. It is impossible to overstate how valuable Ajit is to Berkshire. Don?t worry about my health; worry about his. Last year, Ajit brought home a $2.4 billion reinsurance premium, perhaps the largest in history, from a policy that retroactively covers a major U.K. company. Subsequently, he wrote a large policy protecting the Texas Rangers from the possibility that Alex Rodriguez will become permanently disabled. As sports fans know, ?A-Rod? was signed for $252 million, a record, and we think that our policy probably also set a record for disability insurance. We cover many other sports figures as well.

And 2002:

Ajit Jain?s reinsurance division was the major reason our float cost us so little last year. If we ever put a photo in a Berkshire annual report, it will be of Ajit. In color!


Ajit?s operation has amassed $13.4 billion of float, more than all but a handful of insurers have ever built up. He accomplished this from a standing start in 1986, and even now has a workforce numbering only 20. And, most important, he has produced underwriting profits.


His profits are particularly remarkable if you factor in some accounting arcana that I am about to lay on you. So prepare to eat your spinach (or, alternatively, if debits and credits aren?t your thing, skip the next two paragraphs).


Ajit?s 2002 underwriting profit of $534 million came after his operation recognized a charge of $428 million attributable to ?retroactive? insurance he has written over the years. In this line of business, we assume from another insurer the obligation to pay up to a specified amount for losses they have already incurred ? often for events that took place decades earlier ? but that are yet to be paid (for example, because a worker hurt in 1980 will receive monthly payments for life). In these arrangements, an insurer pays us a large upfront premium, but one that is less than the losses we expect to pay. We willingly accept this differential because a) our payments are capped, and b) we get to use the money until loss payments are actually made, with these often stretching out over a decade or more. About 80% of the $6.6 billion in asbestos and environmental loss reserves that we carry arises from capped contracts, whose costs consequently can?t skyrocket.


When we write a retroactive policy, we immediately record both the premium and a reserve for the expected losses. The difference between the two is entered as an asset entitled ?deferred charges ? reinsurance assumed.? This is no small item: at yearend, for all retroactive policies, it was $3.4 billion. We then amortize this asset downward by charges to income over the expected life of each policy. These charges ? $440 million in 2002, including charges at Gen Re ? create an underwriting loss, but one that is intentional and desirable. And even after this drag on reported results, Ajit achieved a large underwriting gain last year.

What I am trying to point out here is that Buffett had significant knowledge of the retroactive (finite) deals at Berkshire Hathaway. He was even somewhat proud of them, though perhaps that is a matter of interpretation. He liked the almost riskless profits that they provided.

Before I move onto my last point, I’d like to digress, and simply say that not all finite reinsurance is a matter of accounting chicanery. The key is risk transfer. Without risk transfer, regardless of what the technical accounting regulations might say, there should be no reserve relief granted, regardless of the amount of money given to the cedant by the reinsurer; that money should be treated as a loan, because it will have to be paid back with interest. With full risk transfer, the company ceding the risk should not have to hold any reserves for the business. In between, the amount of reserve credit is proportional to the amount of risk shed; excess money given to the cedant by the reinsurer should be treated as a loan. Economically, that’s what it should be, even though that is not what always happens in the accounting. (Side note: yes, I know that it is difficult to determine the amount of risk shed, and different actuaries might come to different conclusions, but can’t we at least agree on the underlying theory?)

What has happened is that in many cases, little risk is shed, and a full credit for risk reduction is taken. Sometimes FAS 113 would be followed, with its 10% chance of a 10% loss as a miserably low tripwire for risk transfer. Sometimes FAS 113 would get bent, and other times, badly bent. That brings me to point 4.

4) Berky had a lot of experience with many different types of finite insurance. I remember a notable asbestos contract they took on for White Mountains where they would bear a large amount of risk. (On that one, I think White Mountains got the better end of the deal.) There were others, like the finite contract with Australian insurer FAI, which made them look solvent while experience was deteriorating. HIH bought FAI, and later went bankrupt, partly due to the acquisition. There were other finite reinsurance deals, like Reciprocal of America, where it made a company that was insolvent look solvent.

I can argue that in many cases, Berky’s underwriters did not know the accounting treatment that the cedant would use, and could not be responsible for the troubles that followed. In many cases, Berky bore significant, if limited, risk. That’s fine too. The greater question is if they were a large writer of finite coverages, which they were, they would have to have some knowledge of the cedant’s goals if they were to underwrite properly. Also remember that Buffett watches the “float” that his insurance businesses generate like a hawk. If there was a large amount of float that would come from a new contract, he likely would have known about it.

The AIG contract was big. AIG is a tough reinsurance negotiator. AIG and Berky have been rivals (Greenberg insulted Buffett on at least one occasion). Buffett watches underwriting carefully, even that of his trusted lieutenant Ajit Jain (a nice guy, really). That makes it really hard for me to believe that Buffett did not have any significant knowledge of the AIG finite reinsurance contract. In the end, I really don’t know; I’m only guessing. My guess is this: Buffett had general, but not detailed knowledge of the deal with AIG. In my estimation, he probably checked to see that there were adequate risk controls to make sure that AIG was not getting too good of a deal.

I admire Buffett. I have learned a lot from him. In general, compared to most businessmen, he is an honest and open guy who speaks his mind. If he said that he never had any significant knowledge of the contract with AIG, we should give him the benefit of the doubt, maybe. But from my angle, it is inconsistent with the way he has done business generally.

Tickers mentioned: AIG, BRK/A, BRK/B, WTM

PS — If you ask me how I feel about writing this, I will tell you that I am not crazy about what I have written. I’m not after publicity for criticizing a man that I admire greatly. I think that Buffett should be more forthcoming on the topic, and be willing to be a witness in the trial. Five people are facing ruined lives, and if Buffett really knew about it, and is saying nothing now because he is powerful enough to get away with it, well, shame on him. If he didn’t know anything about it, well, his testimony would clear the air, because it is a distraction at the trial.

Book Review: Financial Shenanigans

Book Review: Financial Shenanigans

Posted on by David Merkel

A few readers asked me if I would review some books dealing with accounting issues. I’m happy to do that. I am not an accounting expert, and certainly not a forensic accountant, but my investing has benefited from being willing to look at the weaknesses in financial statements, and avoid companies where the economic results are likely worse than the accounting statements.

Howard Schilit, in his book, Financial Shenanigans, highlights seven areas where accounting can be fuddled:

  1. Recording revenue too soon.
  2. Recording bogus revenues.
  3. Boosting income with one-time gains.
  4. Shifting current expenses to a later period.
  5. Failing to record or disclose all liabilities.
  6. Shifting current income to a later period.
  7. Shifting future expenses to the current period.

There are several common factors at play here.

  • Beware of companies where earnings exceed operating cash flows by a wide margin. (1-4)
  • Watch revenue recognition policies closely. It is the largest area of financial misstatement.? (1-2)
  • Look for assets and liabilities that aren’t on the balance sheet, and avoid companies with hidden liabilities. (5)
  • When companies do well, they often hide some of the profitability, and build up a reserve for bad times. This will show up in an excess of cash flows over earnings, so look for companies with strong cash flow.? (6,7)

The book liberally furnishes historical examples of each of the seven main categories for accounting machinations, showing how the troubles could have been seen from documents filed with the SEC in advance of? the accounting troubles that occurred.? Now, aside from point 5, the other six points boil down to a simple rule: watch operating cash flow versus earnings.? I wouldn’t say that the cash flow statement never lies, but investors pay more attention to the income statement and balance sheet.? Aside from outright fraud, ordinary deceivers can manipulate one statement, and clever deceivers can manipulate two.? To do three, it takes fraud.

Now, suppose you have found a company where the operating cash flows are weak relative to reported earnings.? That is where this book can help, because it will give you ways to analyze whether the difference is accounting distortion or not.? For those of us who use quantitative methods to aid our investing, this is particularly important, because many companies are seemingly cheap on GAAP book and earnings, but a review of the cash flow statement will often highlight the troubles.

The book is an easy read, and does not require detailed knowledge of accounting in order to get value out of it.? For fundamental investors, I recommend this book, with the proviso that it only works with non-financial companies.? Financial companies are more complex (they are all accruals — the cash flow statement is not very useful), and can’t easily be analyzed for earnings quality from looking at the financial statements alone.

Full disclosure: I get a pittance from each book sold through the link listed above.

If Hedge Funds, Then Investment Banks, Redux

If Hedge Funds, Then Investment Banks, Redux

Posted on by David Merkel

Every now and then, you get a reader response that deserves to be published.? Such was this response to my piece, “If Hedge Funds, Then Investment Banks.”? I have redacted it to hide his identity.

=-=-=-=-=-=-=-=-=-=-=-

I read your latest blog entry with interest because I have worked in the derivatives business and as a part of that helped to set up General Re’s financial subsidiary in 19XX – General Re Financial Products (GRFP). I was one of XX people that started that business from the ground up. I left shortly XXX Buffett arrived on the scene but I still knew a large number of people that remained and I have very good information about what happened there. I may be a bit biased so you should consider where I am coming from as you continue to read.

To be short about it, what happened at GRFP after Buffett took over was a complete mess. I can give you more information on that if you like but I will simply say that what Buffett writes about GRFP, has spin on it. Let me give you a somewhat quick example. Of that $104 million loss he refers to, how much of that could be attributed to salaries and operating expenses? How much of it was due to the forced unwinding of trades on the wrong side of the market? We know that there are high operational costs (these people are paid very well with nice offices, technology, etc.) and that one would expect to pay to get out of these transactions even if they are being marked perfectly correctly. It SHOULD cost money to unwind these trades. So why doesn’t Buffett, who normally gives us so much information, tell us how much of the loss was due to mismarking and how much was due to expected costs? I’ll let you guess at that answer. There’s a lot more to this story but let’s move on…

I am sure you felt safe quoting someone like Buffett – meaning he is likely to get things right almost every time, but even Buffett is not perfect and he has his blind spots. I believe that derivatives may be such a blind spot. I could go into detail about where I see holes in Buffett’s arguments however the bottom line is that I believe the vast majority of transactions done in the derivatives market are plain vanilla transactions that are extremely easy to mark. Did you know that the US Treasury market is now quoted as a spread off of swaps? That is how liquid the plain vanilla instrument is these days. These transactions will certainly not have two traders both booking a profit even though they are on opposite sides of a transaction. Bid/ask spreads in the plain vanilla market are less than 1 basis point per year in yield. I am certain there are exotic transactions that are mismarked for all the reasons that Buffett mentions but how many of these are really out there? My suspicion is that the total number is small enough to not be of any huge concern from a systematic standpoint.

Here is something interesting to consider. Why would the leader of a AAA-rated institution (a financial Fort Knox) that competes in many ways with other large financial institutions wish to lead people to believe that those other institutions may be engaged in a business that is particularly risky?

Just thought I would add my two cents (looks more like 25 cents now).
-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

For the record, both he and I are admirers of Buffett, but not uncritical admirers.? The initiator of a trade usually has to offer a concession to the party facilitating the trade.? Forced sellers or impatient buyers typically don’t get the best execution.? What my correspondent suggests here is at least part of the total picture in the liquidation of GRFP.? All that said, I still think there are deadweight losses hiding inside that swap books of the major investment banks.

Book Review: The Aggressive Conservative Investor

Book Review: The Aggressive Conservative Investor

Posted on by David Merkel

I am a fan of value investing in all of its different variations, and so when I run across a book on the topic, particularly from a skilled practitioner, I buy it. I’ll do more book reviews on value investing, but one of the first that I wanted to do was Value Investing, by Marty Whitman.

So, I start looking around for my copy, and I can’t find it. Arrrgh, I can guess what happened. I lent it out, I can’t remember who I lent it to, but the borrower never gave it back to me. Annoyed at myself, I do notice a book that was just as good, The Aggressive Conservative Investor, by Marty Whitman and Martin Shubik. Even better, it is back in print, after being out of print for 20+ years.

So, what’s so great about the book? (Most of this applies to both books.) Marty Whitman has a strong “What can go wrong” approach. He realizes that he, and most other investors, will be outside passive minority investors. We only ride on the bus. The inside active control investors drive the bus, and if we are going to make money with reasonable safety, we have to understand the motives of those that control the companies. They benefit somewhat disproportionately from control. They receive wages and benefits that other shareholders do not receive, can gain cheap outside financing, and limit tax exposures, in addition to other benefits.

Like me, Whitman doesn’t care much for modern portfolio theory. More notable for a value investor, he has a few criticisms for the traditional “Graham-and-Dodd” type of value investing.

  • Typically, it works best for “going concern” situations, and not situations where activism could be necessary to unlock value. (Though, Graham did do things like that in his career; he just didn’t try to teach amateurs about it.)
  • He doesn’t always stick to high quality companies, if enough information can be obtained about the target. Information allows for more risk to be taken.

There are four things that he insists on in equity investments:

  1. Strong financial position
  2. Honest management that is creditor-aware and shareholder-oriented
  3. Adequate disclosure of information relevant to the success of the company
  4. The stock can be bought for less than the net asset value (adjusted book value) of the firm.

If you have these items in place, you won’t lose much, and if the management team makes value enhancing decisions, one can make a lot of money on the stock.

Whitman places a lot of stress on reading through the documents filed with the SEC. They may not be perfect, but managements know that they need to provide adequate disclosure of material information, or they could be sued. A lot gets revealed in SEC filings, and not every investor sees that.

He also places great stress on understanding the limitations of the accounting, whether under GAAP, Tax, or any other basis. Comparing the various accounting bases can sometimes illuminate the true financial well-being of a company. (Note: this is what killed me on Scottish Re. I should have questioned the GAAP profitability, when they never paid taxes.) He lists the underlying assumptions behind GAAP accounting, and explains how they can distort the estimation of economic value. Honestly, it is worse today in some ways than when he wrote the First Edition in 1979. GAAP accounting is more flexible, and less comparable across companies today.

Marty Whitman looks for situations where resources in a company can be used in a better manner, creating value in the process.

  • Is the company too conservatively financed? Perhaps borrowing money to buy back stock, or issuing a special dividend could unlock value.
  • Are there divisions that are undermanaged, or would fit better in another company?
  • Are management incentives properly aligned with shareholders?
  • Would the company be better off going private?
  • Is government regulation a help or a hindrance? (Barriers to entry)
  • Analyzing corporate structures for where the value is.

Beyond that, he explains how to calculate net asset values, as distinct from book values. He describes the problems with earnings as a value metric. He explains the value of dividends and other distributions. He also explains when it can make sense to own companies that are losing money. (Underlying values are growing in a way that the tax accounting basis does not catch.)

It’s a good book. Together with Value Investing, it gives you a full picture of how Marty Whitman thinks about value investing. He is one of the leading value investors of our time, but he has spent more time than most on the underlying theory. For those who want to think more deeply about value investing, Marty Whitman is a highly recommended read. For those wanting still more, read his shareholder letters here.

Full disclosure: if you use the links on this page to buyread books, I receive a small amount of money.

PS — Twelve years ago, I wrote Marty Whitman, begging to be one of his analysts. Though I didn’t get a response, I still admire him and his staff greatly.

Ten Chosen Items from the Current Market Troubles

Ten Chosen Items from the Current Market Troubles

Posted on by David Merkel
  1. Superstition is alive and well.? Google at $666?? Personally, I think it is all hooey.? There has always been a morbid fascination about the Antichrist in Western Culture.? Would that they had more concern about Christ.
  2. Longtime readers know I am no fan of FAS 157 or FAS 159.? From the Accounting Onion, here is a good demonstration of what could go wrong as FAS 157 is implemented.? In my opinion, the concept of fair market value allows managements too much flexibility.? For assets that have a liquid market bigger than the holdings of the company in question, fair market value is not a problem.? It is a misleading concept otherwise, because the ability to realize that asset value in a sale is questionable.
  3. This is an “uh-oh” moment on two levels.? Level one is defined benefit pension plans exiting US equities.? They are big holders, and a reallocation could hurt US stock prices.? Level two is that foreign markets have outperformed the US by a great deal over the last few years.? Perhaps the DB pension plans are late to the party?
  4. There are no “almosts” in investing.? I have owned Genlyte twice in my life.? Great company.? I had it on my candidate list in my last reshaping.? I didn’t buy it then.? Now it is being bought out by Philips Electronics.? Good move for Philips; the only way they could make it better would be to take the management team of Genlyte, and have it run Philips.? That won’t happen; it is more likely that Philips will ruin Genlyte.
  5. Activist hedge funds don’t always know best.? Smart managements and boards don’t get scared.? They calculate.? What’s the best thing for shareholders in the long run?? Do the hedge funds really have the willingness to fight?? Personally, I think it is usually best for managements to “call their bluff” and make the hedge funds work for control, rather than wave the white flag early.
  6. Higher US dollar oil prices are only partly a dollar phenomenon.? Oil prices are rising in almost every currency; there is a relative shortage of crude oil globally.
  7. Want an antidote to pessimism?? Read this post from VOX.? Personally, I think the lending issues are bigger than they think, but it is true that corporate balance sheets are in good shape.? Would that we could say the same for the consumer or the government.
  8. Appreciation of the Chinese Yuan versus the Dollar may be accelerating.? Alongside that, many of the Gulf States are re-evaluating their peg to the US Dollar.? Given the inflation, who can blame them?
  9. $300 Billion in losses from US residential mortgages?? That’s a believable figure to me.? Underwriting got progressively worse from 2003 to the first quarter of 2007.? Needless to say, that would kill a lot of non-bank mortgage lenders, and a few banks as well.
  10. Could Japan be the great countercyclical asset in this market phase?? There is more speculative fervor in Japan at present, and many Japanese investors are buying stocks and selling bonds, partly due to relative yield measures.

That’s all for now.? More to come.

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