Parsad

The amazingly astute insight that Prem, Brian et al had was much more than downside protection. Their earlier hedging strategy had been merely to buy S&P 500 puts. If that was all they had done before the recent crash, they would merely have bought protection against a decline in the value of their equity portfolio. However, they realized that CDS could be bought for an annualized cost not much different than S&P 500 puts, and that these would pay off with a much larger gain once the credit bubble popped, than the usual hedge. They may have noticed that opportunity as credit spreads continued to narrow and added to their stake, but their original investments were made purely on the premise to protect their portfolio and reinsurance recoverables. Virtually all of the swaps they purchased in the first couple of years were done solely for that purpose as Prem indicated in the 2006 Letter to Shareholders excerpt below: Just a brief overview for you on our credit default swaps, which are 5-year to 10-year fixed income derivatives, which fluctuate with credit spreads, that we have purchased from major banks. Here is an example. To purchase a 5-year $100 million credit default swap on a company that sells at a 30 basis point spread over treasuries, one has to invest 150 basis points (30 basis points/year 5 years), so $1.5 million purchases protection on an underlying $100 million of credit exposure of the chosen company over the next five years. The maximum loss to the purchaser in 5 years is $1.5 million if the credit spread stays at 30 basis points or tightens even further. On the other hand, if the credit spread on this company doubles to 60 basis points, the credit default swap can be worth as much as $3 million, and if the company goes bankrupt, that swap can be worth up to $100 million. We have a diversified list of companies, mainly financial institutions, with respect to which we have paid approximately $250 million to purchase protection on underlying credit exposures. Prem does not like to speculate, but he's happy to accept a wager if it is already included in the cost of a hedge. Thus any large profits they would make on the swaps when they initially invested, were just icing on the cake from buying protection at such extraordinarily low prices. Investors don't realize that speculating on things like bubbles often lead to frictional costs that will eat away at returns, since timing is a large part of getting a speculative bet correct. The mortgage bubble could have gone on for several more years. And Fairfax's $500M investment could have easily become a $1.5B investment as the five-year swaps expired and they had to double down on the protection. It's just fortunate (for Fairfax anyway) that the bubble collapsed when it did. Cheers!

HSBC leads the way with regards to UAE loan exposure. Cheers! http://www.cnbc.com/id/34171816

I don't agree with Tilson's assessment. He's expecting significant further downside in pricing. I don't think that will happen. I think you will continue to see pressure in pricing as more homes come onto the market and the second round of ARMS reset, but purchases of distressed properties should ease that pressure over time and banks will continue working with mortgagees. I think the recovery itself will take some time...maybe several years...but most areas have seen the worst of it, other than commercial real estate and retail services. Alot of retailers who got bailed out of the 4th Q of 2008 and 1st Q of 2009 in their debt repayments have only delayed the inevitable. Some of these guys are going to fail over the next couple of years. Cheers!

I still don't understand how Peter Eavis, Fabrice Taylor and Herb Greenberg squirmed their ways out of the Fairfax lawsuit. I'm guessing it would have been very hard to bring them into the suit without them utilizing the first amendment to protect themselves...especially Eavis. http://www.deepcapture.com/tag/peter-eavis/ Eavis remains an employee of the WSJ and is a professional photographer. You can see his works and interviews all over the net. I'm not sure what happened to his pastoring sabbatical, but perhaps it was enough to establish a tax-shelter for his retirement fund. I'm also not sure how the hell John Hempton, one of the main culprits in this whole debacle, managed to be excluded from the lawsuit. Perhaps Hempton has become a rat like Sam Antar and is spilling the beans, or perhaps Fairfax is just going after the big guns. Cheers!

More on the biggest potential soverign default since Argentina! If it goes, I'm sure it will take a few others with it. Some European banks and Arabian banks are going to lose ALOT of money. Cheers! http://www.bloomberg.com/apps/news?pid=20601087&sid=aO.S.lkGgmb0&pos=2

Hope all our American compadres have a terrific Thanksgiving! I'll be in Seattle doing some Black Friday shopping. Cheers!

Gwynn knew exactly who he was releasing the reports to early. The only other people who probably knew were the ones receiving them, and Morgan Keegan since they found enough information to dismiss Gwynn. Cheers!

Probably because the key witness is dead! The article discusses how SAC and Kynikos have not been served Wells notices by the SEC. They note that SAC in seventeen years has never been served a Wells notice. I believe Madoff was never given one either in 30 years! Cheers! http://dealbreaker.com/2009/11/sac-not-sweating-sec-investiga.php

State-controlled Dubai World, the builders of the palm-shaped island development and a myriad of other projects, is on the verge of bankruptcy! Cheers! http://www.bloomberg.com/apps/news?pid=20601087&sid=a.LazCgxcywM&pos=1

Yes, I agree. I think Overstock has been sloppy on certain issues...some past accounting, legal and public relations. They do need to tighten the reins quite a bit. Cheers!

i am surprised people on this site are so devoted to byrne. his own father quit his board. From what I understand from various people I've spoken to, Byrne and his father are pretty much the same, and both are extremely pig-headed. I believe Byrne senior stepped down simply because his relationship with his son was worth more than any directorship at Overstock.com. who knows what the truth is but time will tell and i think the facts indicate that it is more likely than not that ostk has committed accounting fraud. this is not short seller manipulation, this is accounting manipulation. They were saying the same thing about Prem a few years ago. Suddenly all those that were accusing him, participating against him and manipulating the stock are in trouble themselves, or being investigated for related matters to other cases...Chanos, SAC, Exis, Morgan Keegan, Gwynn, etc. Byrne can be accused of a lot of things...ALOT! But unethical behavior is not one of them. Cheers!

I agree with you Eric. There are a lot of reasons to own your own home. Although, the problem for the average in-debted homeowner in the U.S.: Current Mortgage: $2800/month + $5000 a year in property taxes, maintenance, etc. Same Property Rent: $1800/month Do they want to continue paying $2800/month for the next ten-fifteen years, only to recoup the 40% drop in their nestegg? Or they can put about $1400 a month ($1000 rent & $400 in other costs) away towards savings? Alot will choose the latter. Especially if they are under the stress of delinquency, foreclosure or collection. Cheers!

Global empire expands! Cheers! http://www.fairfax.ca/Assets/Downloads/Press/fpr2009-11-24.pdf

A perfect example of those that are now underwater, with good credit histories and are now considering walking away. Cheers! http://finance.yahoo.com/loans/article/108229/distressed-homeowners-ponder-whether-to-stay-or-go;_ylt=AvwHgVFbeb8gTmluEa01Xw.7YWsA;_ylu=X3oDMTE1NzJhNzNmBHBvcwM3BHNlYwN0b3BTdG9yaWVzBHNsawNkaXN0cmVzc2VkaG8-?sec=topStories&pos=5&asset=&ccode= Seven years of bad credit or twenty years of payments for something worth half as much? I'm guessing alot of these people will be walking...especially if their work situation changes or finances become a little more distressed. Cheers!

Our annual Fairfax Financial Shareholder's Dinner is coming up again. Last year, Francis Chou of the Chou Funds came...Francis has been at all of our dinners! Fairfax Financial sent Sam Mitchell, Brian Bradstreet & Wayne Cadwallader. It was an amazing opportunity to ask questions and listen to answers from some of the best investors in North America! Fairfax Financial Shareholder's Dinner Wednesday, April 21, 2010 Joe Badali's 156 Front Street West Toronto, Ontario Drinks: 6:30pm Dinner: 7:00pm Q & A: 8:00pm-9:30pm RSVP: sanjeevparsad@shaw.ca Admission: $5/head with all proceeds going to the "Crohn's Colitis Foundation of Canada" in memory of Joann Butler Corner Market Capital Corporation will match all admissions We'll also be holding our fund's annual general meeting again immediately after the Fairfax meeting. Details are below: MPIC Funds Annual General Meeting Thursday, April 22, 2010 Roy Thomson Hall Green Room/Pickering Room 60 Simcoe Street Toronto, Ontario Meet & Greet: 1:30-2:30pm Presentation: 2:30pm-3:00pm Q & A: 3:00pm-4:30pm Light Snacks & Refreshments Will Be Served RSVP: sanjeevparsad@shaw.ca See you in Toronto! Cheers!

Our annual Fairfax Financial Shareholder's Dinner is coming up again. Last year, Fairfax sent Sam Mitchell, Brian Bradstreet, Wayne Cadwallader & Francis Chou. It was an amazing opportunity to ask questions and listen to answers from some of the best investors in North America! Fairfax Financial Shareholder's Dinner Wednesday, April 21, 2010 Joe Badali's 156 Front Street West Toronto, Ontario Drinks: 6:30pm Dinner: 7:00pm Q & A: 8:00pm-9:30pm RSVP: sanjeevparsad@shaw.ca Admission: $5/head with all proceeds going to the "Crohn's Colitis Foundation of Canada" in memory of Joann Butler Corner Market Capital Corporation will match all admissions We'll also be holding our fund's annual general meeting again immediately after the Fairfax meeting. Details are below: MPIC Funds Annual General Meeting Thursday, April 22, 2010 Roy Thomson Hall Green Room/Pickering Room 60 Simcoe Street Toronto, Ontario Meet & Greet: 1:30-2:30pm Presentation: 2:30pm-3:00pm Q & A: 3:00pm-4:30pm Light Snacks & Refreshments Will Be Served RSVP: sanjeevparsad@shaw.ca See you in Toronto! Cheers!

The question is will inventories stay low as those houses come on the market and when the tax credits stop by June of 2010? The U.S. has spent $21B already on the tax credits before November, and then extended those benefits till April 2010...so say another $20-30B, since they expanded the range of people that can qualify for credits. Will Congress extend them again in June? Cheers!

Part II... But, since 2005, the smoke has cleared from around the firm. Watsa says the period between 1998 and 2005 was tougher than the firm could have imagined. Underwriting losses wiped out $2.9bn in investment income and $2.4bn in realised gains during that period. “In those seven lean years we basically didn’t make much money,” he says. “We made two major acquisitions – TIG and Crum & Foster – and we did them in 1998 and 1999 in the throes of the soft market. It took us longer than expected to turn them around. We thought we could turn them around in three years and it took us more like five or six years. But despite what our detractors might have said, we eventually accomplished our goals.” Watsa says all the firm’s problems of that time are now behind it. He says reserves are strong at Fairfax. He is also is quick to point out that the firm has not lost a single leader from its units in that time. “I try my best to think of that time period as a character building experience for our team because we are trying to build our company over the next 20 years, over the long term. The whole group has been through these turbulent times together so our thinking is focused on the positives now and how in some ways the experience has made us stronger,” says Watsa. Some good news came in June this year, when it was revealed that Fairfax had been cleared in a Securities and Exchange Commission investigation of its use of finite reinsurance. This could help it in its fight against its detractors. In 2006, Fairfax hit back at its accusers. It filed a lawsuit against the hedge funds and the Fitch analyst that had attacked it, claiming it had been the victim of a share price manipulation scheme so that short sellers could profit. Fairfax is seeking $5bn in damages. The case is still winding its way through a New Jersey Court. Taking back control The turnaround in Fairfax’s fortunes since the hard times of 2005 is symbolised by two deals it has done this year. In February, Fairfax completed the acquisition of the 37% of Northbridge that it did not own for C$686m ($650m). It followed this up with the acquisition of the 27.4% Odyssey stake, which cost $1bn. Fairfax initially offered a price of $60 a share for Odyssey but increased it to $65. Fairfax now has complete control over its three main insurance subsidiaries: Northbridge, Crum & Forster and Odyssey Re. In 2008, these subsidiaries’ net earned premiums came to $1.01bn, $878m and $2.03bn, respectively. In the past year, Fairfax also acquired the 33.3% of Advent that it did not already own in a deal that valued the Lloyd’s insurer at around ?94m ($157m), bought all the outstanding shares of Polish reinsurer Polskie Towarzystwo Reasekuracji Spo?ka Akcyjna, and acquired a 15% interest in Alltrust Insurance Company of China for $66m. Watsa says he was eager to seize back full control of Northbridge and Odyssey Re. But the firm is maintaining a cautious approach to its insurance and reinsurance operations, given the market conditions. Fairfax’s combined ratio for the first nine months of 2009 was 99%, basically break even. Fairfax’s gross written premiums fell 3.7% in the third quarter and its net premiums fell 6%. Andy Barnard, president and chief executive officer of Odyssey Re, says the firm is not afraid to shrink premiums further. “Odyssey is a good illustration of Fairfax’s underwriting discipline in the soft market, where we are going to be less aggressive than many other companies. We are prepared to shrink our business,” he told Reactions. But he adds that the flipside of that strategy is a willingness to expand when the markets harden. “The only way you are in a position to expand like that is when you have kept your powder dry when the market is soft so that you are able to focus on the opportunities rather than [making] corrections and changes because you were too aggressive in the soft market,” says Barnard. He concedes that it is a tough market, and gives a gloomy forecast for the medium term. “We see the market today as a fairly competitive place,” he says. “The turn in the market is probably still several years away so we are maintaining a position of caution. We are preparing for several more years of very tight underwriting policy and reduction in our premiums.” Barnard says being a public company helped forge Odyssey’s identity, after being formed in the late 1990s through combining Fairfax’s acquisitions of Skandia America, Compagnie Transcontinentale de Reassurance and TIG’s reinsurance business. But he says being privatised will help Odyssey maintain its discipline, away from the short-term demands of shareholders. “We at Odyssey are very happy to come back under the Fairfax umbrella and return to a private company status within the larger Fairfax group. It helps reinforce the message throughout the company that, as long as the market remains soft, we should be prepared to cut premiums and reduce market share. That is what we have been doing and at this point what we expect to be doing throughout 2010,” he says. A contrary path Watsa and Barnard’s talk of discipline, focusing on underwriting profits and shrinking premiums when pricing is soft sounds just like that peddled by most other executives in the industry. But they believe Fairfax has a unique approach that sets it apart. “We have never focused on operating returns in the same way that almost all other public companies do,” says Barnard. “There are many times when we have sacrificed operating earnings in order to have a superior long-term value investing strategy.” He says this means maintaining large percentages of the firms’ investment portfolios in cash when the investment markets are not offering good opportunities. This enables the companies to put that cash to work when opportunities do arrive. Watsa quotes figures for a selection of reinsurance companies to back up the claim that a total return approach is best. He says between 2002 and 2008 the reinsurers’ average investment income return was about 4% to 4.5%, which is higher than Fairfax’s figure of 3.4%. However, Fairfax did much better on realised gains. Fairfax had a return of 6.1% from realised gains, compared with the average portfolio, which had realised gains of zero to -0.5%. This means on average Fairfax produced a total return of about 9.5%. “It is very much a contrary path,” says Watsa of his strategy. “By focusing on total return using a value-oriented approach we have been able to build shareholders capital more significantly than the rest of the industry.” Barnard says other companies struggle to take a long-term view because of pressure from investors and rating agencies. “Our objective is to grow book value on a compound basis 15% a year,” says Barnard. “Most [companies in] the industry – driven by Wall Street and, to some extent, the rating agencies – struggle with capital gains as a metric that doesn’t easily fit into their formulas. There is a lot of conventional, orthodox thinking that pushes you to focus on just operating returns.” Staying cautious In stark contrast to the situation five years ago, analysts are now asking what Fairfax will do with all its money. Watsa is remaining cautious. “We have got significant amounts of cash in the holding company and we have the ability to invest the money,” says Watsa. “But what the capital in the holding company does is provide us with protection from the unexpected, because who knows what will happen in the next few years? “When we take advantage of opportunities it will not be at the expense of our financial position. So we don’t expect to take our cash down to $500m from the more than $1bn that it is today.” Watsa does not rule out more acquisitions, but says the firm does not need to make any large buys. He says Odyssey Re operates worldwide so does not have a pressing need for an acquisition, and Crum & Forster and Northbridge are already national firms. “We are open to acquisitions but only if they make sense,” he says. “So, yes, we could do another tuck-in acquisition.” Meanwhile, Watsa is confident book value will continue to grow. In the conference call for the company’s third-quarter results, he predicted that five years from now Fairfax’s book value will have soared because of the high-quality common stocks it bought in the last quarter of 2008 and first quarter of 2009. “We expect to hold them at least five years,” he says. “[Considering] the price that we bought a company like Johnson & Johnson at, we think we might hold it for a long period time because it is a compounding machine. We have looked at a lot of companies but we have not come across a company like Johnson & Johnson in terms of the number of years – literally 40, 50 years – that it has been compounding at close to 15%. Very high quality companies were available and we plan to hold them for some time.” The hedges are now back, however, with the firm hedging about 25% of its equity portfolios. This is indicative of the cautious approach that positioned Fairfax so well during the financial crisis. The benchmark worst case that Fairfax looks to protect itself against is a 50% drop in the stock market, combined with a severe natural catastrophe such as a category 5 hurricane hitting Miami or a California earthquake of magnitude 7 or 8. “We are very downside oriented. We look at the worst case,” says Watsa. “Our guiding principle is that we will never bet the company on any acquisition, project or common stock.” Watsa remains cautious about the US economy, especially the amount of public spending. He expects the recession to be prolonged and says the only comparable periods are the debt deflation seen in the US in the 1930s and Japan’s economic difficulties since 1989 that last until today. “We are very strong financially with the cash in the holding company, with our investment portfolios and with that 25% investment hedge,” he says. “But we are concerned about the economy, and we constantly monitor economic indicators, because in the US the government and government stimulus represents only about 20% of the entire US economy, and the remaining 80% of the economy is private – dependent on the spending patterns of businesses and individuals. The test is will the 80% start spending and we will not know that for some time.” But Watsa’s firm is now well set to deal with anything the market throws at it. The company’s long-term approach has paid off enormously. He says Fairfax will keep performing for investors who have a similar long-term view. “Of course anyone can buy our stock,” he says. “But the investors that gravitate to Fairfax are ones that take a long-term view and that is who we are trying to perform for.” By Michael Loney - mloney@euromoneyny.com

Terrific new article on Prem in Reactions magazine! Cheers! Prem Watsa: The man who made a killing from the crisis 24 November 2009 After years of fierce criticism, Prem Watsa’s long-term value investing approach has been fully vindicated. His firm Fairfax has made billions from the financial crisis. Prem Watsa has played the financial crisis beautifully. The chairman and chief executive officer of Canadian financial services firm Fairfax is one of the few people to have made money from the worst economic collapse since the 1930s. While everyone watched in horror as the value of their investments tumbled, Watsa was racking up the profits. Fairfax has made billions through clever use of hedging and credit default swaps. The past two years have provided a resounding vindication of Watsa’s approach. Following what Watsa describes as a “biblical seven lean years” between 1998 and 2005 – when Fairfax made no money in aggregate despite hard market conditions for most of that time, and withstood a barrage of reserve increases, restatements and fierce criticism – his firm is now firing on all cylinders. It had net earnings of $2.8bn after tax between 2006 and 2008, and its book value more than doubled in that time. Fairfax began life in 1985 with total assets of $30m and common shareholders’ equity of $7.6m. Those figures have increased 1,000-fold in the 24 years since. At the end of the third quarter of this year it had $30bn of assets and $7.5bn of common shareholders equity. Fairfax’s book value has compounded at an annual rate of 25% and its common stock price by 23%. Having made a killing off the financial crisis, Watsa has been busy in the past year taking back full control of his biggest subsidiaries, and making strategic investments in insurers and reinsurers around the world. While other firms have been licking their wounds, Fairfax has built up considerable momentum. “Our strategy right through the piece has been to focus on underwriting profit, with good reserving, and manage the float a little better than everybody else,” Watsa told Reactions in an exclusive interview. “That combination has resulted in our return.” The method sounds simple. Watsa’s triumph has been an unwavering commitment to it. Watsa’s focus on the value of investing the float from insurance companies has drawn comparison with Berkshire Hathaway’s Warren Buffett, and earned him the nickname The Buffett of Canada. Watsa describes this year’s third quarter as a “key milestone” in Fairfax’s history. It had net earnings for the quarter of $562m, up from $468m in the third quarter of 2008. This pushed net earnings for the first nine months to $777m, down from $1.13bn in the first nine months of 2008. In addition it brought US reinsurer Odyssey Re fully back under its wing in the third quarter, buying back the 27.4% of the firm it did not own. To do this, it raised $1bn of equity, as well as completing a $250m offering of preferred shares. Fairfax is now in a very strong financial position, with a cushion of more than $1bn of cash and marketable securities in the holding company, and increased annual dividend capacity. Crisis management Not only did Watsa call the impending financial crisis, he nimbly and decisively responded to it. Acting on his fears, Watsa was willing to take an ultra-conservative approach to investing in the years leading up to the financial crisis. “From 2003 we have expressed concern about the US in terms of residential markets, in terms of its real estate markets and in terms of the mortgage-backed securities – the fact that there were thousands of AAA-rated structured product bonds and there were less than 10 fully-fledged companies that were rated AAA. It just didn’t make too much sense for us,” says Watsa. Fairfax held about 75% of its investment portfolio in government bonds and cash. To protect against a possible fall in equity prices, Fairfax hedged its stock holdings against the S&P 500. “We wanted to hedge the fact that stock prices could go down, so in 2004 and 2005 we hedged 25% to 30% of our stock portfolio,” says Watsa. “In 2008 all of the problems became more serious in our minds so we hedged 100% of our common stock portfolio.” The hedges cost Fairfax $296m between 2004 and 2007. Fairfax also bought $341m of credit default swaps, and sat tight as their value fell to $198m at of the end of the second quarter of 2007. Watsa said in his annual letter to shareholders in early 2007 that some people had wondered loudly why the firm was bothering with the costly hedges and credit default swaps. He wrote: “We continue to think that this insurance policy may pay dividends – perhaps sooner than you think!” He was not wrong. The conservative approach paid off handsomely when all hell broke loose in the housing market and eventually triggered the financial crisis. The hedges protected Fairfax from tumbling stock prices and the credit default swaps exploded in value. They were worth $2.1bn by February 2008. The firm posted earnings of $1.1bn in 2007, and bettered that with earnings of $1.5bn in 2008. Fairfax made investment gains of $2.72bn for the whole of 2008, up from $1.6bn in 2007. In 2008, Fairfax boasted by far the biggest change in book value among property/casualty companies analysed by research firm Dowling & Partners. Its book value was up 23%, with HCC trailing far behind in second with 11%. Most firms saw their book values dive. “In 2008 our book value per share went up 23% whereas most companies in the industry – with of course AIG being the biggest – lost a ton of capital,” says Watsa. “By not reaching for yield, and protecting ourselves from a stock market downturn that we had identified for many years, we came through the financial crisis very well.” From bull to bear Fairfax did not just sit back, however. While others panicked, Watsa shifted quickly to bull mode from bear mode. He set to work, throwing off the shackles of Fairfax’s hedges and scooping up stock and bonds at bargain prices. It opportunistically bought $2.3bn of common stocks, and sold its government bond holdings and moved into municipal bonds. At the end of the third quarter, $4.7bn of Fairfax’s $10.9bn bond portfolio was in municipal and tax-exempt bonds, up from just $965m a year before. It moved from government bonds with a pre-tax 2.5% yield to muni bonds with 5.75% yield after tax, and with the added security of 85% of them being guaranteed by Berkshire Hathaway. This change has greatly boosted Fairfax’s tax-equivalent yields and after-tax retention of its interest and dividend income. At the end of the third quarter, Fairfax had about $5.9bn-worth of equities in fair value terms. This is about 25% of Fairfax’s overall portfolio. A lot of this was acquired in the fourth quarter of 2008 and first quarter of this year when the S&P 500 index was between 700 and 900. The index was up to around 1,100 in early November of this year. “In the last six months, many of the stocks we have bought have gone up 50% or 60% from the bottom and now there is a slug of interest and dividend income in our portfolios that will last us for some time, for the next five or 10 years, because we acquired these bonds at very good yields,” says Watsa. Fairfax’s interest and dividend income was up 36% in the third quarter compared with the same period in 2008, and the nine-month figure was up 12.5%. Ending seven lean years The past three years have proved a triumph for Fairfax. The firm – and Watsa in particular – have received a lot of praise for their handling of the financial crisis. It was not always thus. Watsa has a less attractive parallel with Buffett than his strategy of making profits by investing the float of insurance companies. Fairfax enjoyed a fast rise between 1985 and 2000. But then, like Buffett did with Gen Re, Watsa made a number of acquisitions that ran into serious reserving problems. Fairfax – whose name stands for fair, friendly acquisitions – busily snapped up insurance companies in the 1990s. Two of those, US insurers Crum & Forster and TIG, were snapped up at big discounts in 1998 and 1999. They soon revealed themselves to have hidden woes. Fairfax had to increase reserves at the two firms by $600m in the third quarter of 2001. This, coupled with losses from the September 11 terrorist attacks, led to Fairfax’s first ever annual loss, of $346m. That was just the start of the problems. In 2002, most of TIG was placed into run-off, and more reserve increases followed. To raise funds, parts of Odyssey Re were spun off in 2001 and Fairfax bundled four Canadian insurance units together as Northbridge and floated part of that in 2003. In addition, Fairfax listed its shares in the US at the end of 2002. Grave concerns were raised by observers. Analysts and short sellers accused Fairfax of being greatly under-reserved and some even implied the firm could be a candidate for bankruptcy. In 2003, rating agency Fitch highlighted worries about Fairfax’s liquidity and drew attention to inter-company reinsurance deals, which it said were hiding the real state of the company. Around the same time, John Gwynn, a Morgan Keenan equity analyst, claimed that Fairfax’s reserves were $5bn short. After Fairfax reacted with outrage to the claim, the analyst revised the figure to $3bn a few weeks later. The hits kept coming, with Fairfax lurching from one problem to another. In September 2005, Fairfax found itself caught up in New York attorney general Eliot Spitzer’s investigation of finite reinsurance, and was placed under investigation. Fairfax’s problems cumulated in 2005 with a $498m loss and Watsa declaring it the toughest year in Fairfax’s history. Record industry catastrophe losses from hurricanes Katrina, Rita and Wilma pushed its combined ratio for 2005 to 107.6%. To make matters worse, in July 2006 Fairfax announced it was restating its results because of the discovery of various noncash accounting errors. It then restated them for a second time in August that year, after errors were found in the entry of a $1bn contract with Swiss Re that it was commuting. Part II...

Fairfax has said in the past, that if the prices of their bond portfolio drop significantly, then they are comfortable holding them to maturity. I believe most of their bond portfolio is strictly to generate income, so interest rates moving up may create a temporary mark-to-market loss, but the income would still be the same. Cheers!

I had not heard that Gwynn died. Not to belittle anyone's death, but who here believes that Gwynn died of natural causes considering everyone now implicated in the Galleon case? Patrick Byrne has received death threats, but people thought he was crazy. Even I was warned to be careful of these guys! Cheers!

Yes, they've got primarily BRK-insured municipals and quality corporate debt. That should provide them plenty of income in this low interest rate environment, without the volatility and risk of dividend-paying equities. If we were going to see a high-inflation environment, then it might be more of a concern, but I think the risk of sustained hyper-inflation is very, very low. Deflation is more likely than hyper-inflation. Cheers!

So your 'guess' on Stagflation (ie. best case scenario) would then be 3+ years out? Do I understand this correctly? Possibly sooner. If they continue to inflate into 2010 and unemployment continues to rise, then we could be in that environment before the end of 2010. And further to this -- are you then forecasting a total of 4-5 years of <3% GDP? I am saying 4-5 --- as 2009 is almost behind us. [According to the figures I am looking at, 2008 GDP was +2.6%, 2009 at Q3 was -1.7% YOY ... of course the Real GDP #'s are even worse!!]. Yes, I think that is probably correct, but averaged out. We could have a couple of quarters of significant GDP growth, simply because of huge amounts of stimulus and low interest rates. But, the long-term GDP over the next several years should average out to well below 3-4% annualized since they cannot inflate for several years...we just don't have the firepower to do that without creating other enormous problems. Cheers!

It still boggles the mind that the credit rating agencies rate Fairfax less than AA. Cheers!

Parsad, Two quick questions on your response. First, are you saying that you are a neo-classicist (at least with regards to the issue of stagflation in this instance)? And although I realize that this second question may be taking us somewhat off-topic, but what is your take on the criticism that people aren't rational (and utility-maximizing), but rather behavioral? I'm neither classical, neo-classical, nor Keynesian. The study of economics is about as accurate as the study of meteorology...don't bet your life on either one! ;D My main point is that I agree with how the supply/demand curve will move when implementing the current monetary policy and combining that with the current high levels of unemployment. If they continue to inflate then the best case scenario is stagflation. If they stop the stimulus in the next year or two, then there is the very real possibility of a significant deflationary environment. I do not see any return to sustained normal growth...3-4% GDP...in the next 2-3 years. On the question of people being rational...I don't believe they were in March, and I don't believe they are now in November. They were far too pessimistic back then, and are far too optimistic today. Cheers!