twacowfca

That's a great memo. And I think IRR is the correct metric by which to judge the performance of someone like an individual investor, who is completely in control of his/her own capital. IRR, or something that's abstractly similar (ROIC, ROE, etc.), is what we all use to judge all of these companies we're investing in. Why wouldn't we use it on ourselves? The time weighted metric just seems like a way to avoid the truth. Most individual investors are absolutely not fully control of their own capital. You can't change when you receive your salary, or when you get an inheritance or a gift etc. If you got a big gift in 2009 you just got lucky, while if you got it in 2007 you got unlucky. If you don't try to time the market does it make sense to try to measure that? Agree with this, that is unless people are literally hoarding money, storing it away without ever intending to use it that timing is really out of our control. I have no idea how I did in 2015, calculating it will be a mess because money was moving in and out throughout the year. We purchased a house halfway through the year and I sold some stocks to facilitate the purchase. Would I have done better if I hadn't sold them? Maybe, but then again I wouldn't be living where I want to. In my view the purpose of money is to work for you, and in this case investing enabled us to buy a place we wanted. I'd like to think I can control the timing of my account, but I can't. When we found a house I couldn't wait until the year end to make performance nice and tidy. We bought a cottage. My total losses could have been even worse. I probably would have lost the value of what we spent using the same percentages. Not whining about my first world problems, thats for sure. Stocks will come back. About + 25% while holding 50 % of the portfolio in cash most of the year. That's an amazing risk adjusted return, but it's totally misleading taken out of context. Most of that return was from the recovery of a large, leveraged position that had gone south the year before.

Yup! The 10% decrease in WSBASE over the last three weeks, culminated with a 6% drop in the week ended last Wednesday. That is not unprecedented, but the Saint Louis Fed series only records three other declines of similar magnitude over many decades. All three of those huge WSBASE declines were closely associated with corrections in the market in 2010, 2011 and 2014. We more than hedged our market exposure early last week with February SPY puts. Our portfolio value actually increased last week. Nice. I didn't hedge, just went to 60% cash and removed all leverage so it still went down. Might go back in this week, though just as a short term trade. We have also been @ 50% cash most of the time during the last year as WSBASE and and the S&P 500 flattened. Surprisingly, 2015 has been one of our best years ever as we closed out the last of our BRK leaps early in the year with a gain that was almost a double and converted another leap-like total return derivative on our largest holding at near the highest price during the last couple of years to remove that leverage while maintaining the position. We also managed to make a little money on our index options in a market that was flat overall by referencing what was happening to the internal divergences of the indexes. This turnover isn't the usual type of value investing, but those trades were not typical short term herd following trades either. Instead, the trades were anchored to the underlying values of those holdings, buying low and selling high around the underlying intrinsic value. That seems appropriate in a market that is pricey while we also hold a lot of cash. :)

Yup! The 10% decrease in WSBASE over the last three weeks, culminated with a 6% drop in the week ended last Wednesday. That is not unprecedented, but the Saint Louis Fed series only records three other declines of similar magnitude over many decades. All three of those huge WSBASE declines were closely associated with corrections in the market in 2010, 2011 and 2014. We more than hedged our market exposure early last week with February SPY puts. Our portfolio value actually increased last week.

This is where the back of the envelope calculation helps: math so simple all it takes is the back of the envelope to explain it, even if the figures are approximate. I remember reading an 80+ page presentation on Sandridge right after Ward spoke at the FFH AGM a few years ago. After reading it, I was farther away from a thesis using simple math that supported buying the stock than before reading their presentation. Nowhere in those 80 pages was there simple quantification showing what their edge was or how much that edge was worth. Later, a little digging revealed that Chesapeake with acreage not too far away was pumping twice as much oil per well drilled than Sandridge was. A decisive analysis didn't even require the space of the back of an envelope. That one astonishing fact was sufficient to falsify all the BS in their self serving, 80 page report.

Yes. The U.S. Court of Federal Claims has limited jurisdiction to monetary claims brought under federal statute (and various other Government related laws and actions). So the U.S. Court of Federal Claims, for instance, couldn't hear a case that deals with whether a U.S. Government agency overstepped its bounds by sidestepping Delaware corporate law, which is a matter of state law and is not purely a monetary damages issue. That's a good explanation. It may be somewhat similar to the NextWave vs the FCC case that went all the way to the U.S. Supreme Court. NextWave won a ruling that U.S. bankruptcy court was the proper venue for valuing and disposing of the spectrum rights that NextWave bought in a FCC auction, not the FCC which tried to repossess those rights. Will the minnow state of Delaware tweak the dragon's tail???

That's the way the documents read. The $188B the U.S. has put into F&F entitles the U.S. to receive 10% per annum on cumulative preferred shares. Those accumulating dividends that have not been paid compound at 10% per annum, adding to what is owed the U.S. Pro forma, what would be owed the U.S. annually without the sweep is considerably more than $18.8 Billion, and the mountain of arrears in addition to the $188 principal amount is growing at a rate of 10% per annum as we speak. So that's what I was hoping to tease out with my question. Why would the dividends accumulate but for the sweep? Because but for the sweep, the companies were making tremendous profits (even aside from the mountain of non-cash DTAs that were recognized because of that profitability). And the non-2013 profits above understate the companies' cash earning abilities because the DTAs would have kept cash taxes low, which means even more dividend paying capability for the GSEs. Alternatively, I suspect that, to the government, trading DTAs for dividends is probably just as good to them as cash, but that's a leap that doesn't need to be made because cash profitability would have been enough to continue to pay the $18B in dividends. Am I missing something here? Do you have a link to this? I'd be curious to see who that might have been. It looks to me that any settlement is going to have to come from the Administration because the Treasury holds the GSEs by the balls via the covenants in the SPSPA, and I'm not optimistic that this Administration would be willing to make any move unless forced to do so by some development in the legal courts. (Which is why I was asking for the reason you think a settlement might have been in the works.) I think both Pelosi and Reid both issued statements several days ago back pedaling on their previous opposition to any deal that would give something to the public preferred holders or the common holders. When that happened it looked like there might be something nice in prospect for public preferred holders, and I considered getting back in for our fourth possibly multi bagger round trip. However, the Jumpstart bill seems to throw a monkey wrench into the works. With the loss from their balance sheet of the funds taken in the sweep, dividends would not prudently be paid to the public preferred holders until that balance sheet is rebuilt. Profits are now normalizing for F&F, and their latest year's earnings don't even provide enough to pay the annual dividends on the U.S. preferred,according to the chart. Does anyone think the Administration is going to return the swept profits to F&F and restore their balance sheets? In an election year? Would that help their election chances next fall? If the answer is yes, well --- there's this bridge over an important river I would like to sell you. I am not seeking confirmation of my latest view. I would be delighted to hear a credible way the administration can cut a deal now that is favorable to preferred holders. Well theoretically there are 2 ways this can work out for shareholders. 1. The administration sees enough evidence or tries to save face and settle. 2. Gov is forced by court decision to work out settlement or return funds. This of course could be appealed but if any of the courts find the net sweep, delaware preferred law illegal etc funds have to be return regardless of the omnibus bill, what the administration thinks etc correct? It may not be this administration but eventually whoever is the president may not have a say in what $$$ is given back and how much. Is there a good reason why jurisdiction in the U.S. Court of Claims would not trump all other venues?

That's the way the documents read. The $188B the U.S. has put into F&F entitles the U.S. to receive 10% per annum on cumulative preferred shares. Those accumulating dividends that have not been paid compound at 10% per annum, adding to what is owed the U.S. Pro forma, what would be owed the U.S. annually without the sweep is considerably more than $18.8 Billion, and the mountain of arrears in addition to the $188 principal amount is growing at a rate of 10% per annum as we speak. So that's what I was hoping to tease out with my question. Why would the dividends accumulate but for the sweep? Because but for the sweep, the companies were making tremendous profits (even aside from the mountain of non-cash DTAs that were recognized because of that profitability). And the non-2013 profits above understate the companies' cash earning abilities because the DTAs would have kept cash taxes low, which means even more dividend paying capability for the GSEs. Alternatively, I suspect that, to the government, trading DTAs for dividends is probably just as good to them as cash, but that's a leap that doesn't need to be made because cash profitability would have been enough to continue to pay the $18B in dividends. Am I missing something here? Do you have a link to this? I'd be curious to see who that might have been. It looks to me that any settlement is going to have to come from the Administration because the Treasury holds the GSEs by the balls via the covenants in the SPSPA, and I'm not optimistic that this Administration would be willing to make any move unless forced to do so by some development in the legal courts. (Which is why I was asking for the reason you think a settlement might have been in the works.) I think both Pelosi and Reid both issued statements several days ago back pedaling on their previous opposition to any deal that would give something to the public preferred holders or the common holders. When that happened it looked like there might be something nice in prospect for public preferred holders, and I considered getting back in for our fourth possibly multi bagger round trip. However, the Jumpstart bill seems to throw a monkey wrench into the works. With the loss from their balance sheet of the funds taken in the sweep, dividends would not prudently be paid to the public preferred holders until that balance sheet is rebuilt. Profits are now normalizing for F&F, and their latest year's earnings don't even provide enough to pay the annual dividends on the U.S. preferred,according to the chart. Does anyone think the Administration is going to return the swept profits to F&F and restore their balance sheets? In an election year? Would that help their election chances next fall? If the answer is yes, well --- there's this bridge over an important river I would like to sell you. I am not seeking confirmation of my latest view. I would be delighted to hear a credible way the administration can cut a deal now that is favorable to preferred holders.

That's the way the documents read. The $188B the U.S. has put into F&F entitles the U.S. to receive 10% per annum on cumulative preferred shares. Those accumulating dividends that have not been paid compound at 10% per annum, adding to what is owed the U.S. Pro forma, what would be owed the U.S. annually without the sweep is considerably more than $18.8 Billion, and the mountain of arrears in addition to the $188 principal amount is growing at a rate of 10% per annum as we speak. I think there was a deal in progress because certain leading Democrats issued clarifications recently that they were no longer adamantly opposed to giving the public preferred holders anything in some sort of reorganization. F&F used to be the Democrat's champion cash cow to fund their political campaigns. The former chairman of Fannie Mae led Obama's fundraising in his 2008 campaign. It seems that the Jumpstart bill puts that in check. But that's not checkmate. However, with the Jumpstart bill, I don't see a clear way for a significant recovery for preferred shareholders until 2018 at the earliest if ever. I appreciate thoughtful comments, not wishful thinking about possibly favorable court decisions. How might a favorable settlement happen in view of the Government's preferred shares being ahead of the other shares, assuming there's not a dramatic, favorable court ruling for other shareholders.

The US Court of Claims should wind up with jurisdiction, notwithstanding mosquito bites in other courts. In the unlikely event that plaintiffs get a favorable ruling, it is very likely that the ruling will be that the sweep is legal, but the plaintiffs have a claim. That claim would be based on what would have occurred had the sweep not happened. 10% annual compounded interest on a growing principal amount is beyond the normalized dividend capacity of F&F in various future interest rate scenarios. And, F&F would not be able to pay dividends to other preferred shareholders until their capital built up to levels much higher than before the crisis. Plus, no more goosing their results with mark to myth accounting. In the meantime the the ten percent dividend arrears the U.S. is due keeps on compounding and likely adding to the principal amount owed the U.S. in the years ahead that may not be highly profitable. That compounding freight train will keep pulling ahead of the normalized earnings of the dynamic DUO of F&F.

Whether or not we would have heard of him is irrelevant, a) Munger's ideas would be the same and worthy of study. b) He would be a billionaire c) Buffett would not be as rich, his presumed purchase of excellent companies at fair prices would have happened much later, if you believe what he says. d) Almost certainly they would have met anyway: super astute investors from the same neighborhood in Omaha, the world isn't that big. Agreed netnet. Also, we would have almost certainly have heard of him. The man is no investing slouch: Charles Munger Partnership Annual Percentage Change Partnership (%) S&P 500 (%) 1962 30.1 -7.6 1963 71.7 20.6 1964 49.7 18.7 1965 8.4 14.2 1966 12.4 -15.8 1967 56.2 19.0 1968 40.4 7.7 1969 28.3 -11.6 1970 -0.1 8.7 1971 25.4 9.8 1972 8.3 18.2 1973 -31.9 -13.1 1974 -31.5 -23.1 1975 73.2 44.4 Average return 24.3 6.4 Standard deviation 33.0 18.5 [Compound annual return 19.8 4.9] [$1 at inception becomes $12.57 in Munger Partnership and $1.96 in S&P 500] From: http://www.fool.com/EveningNews/FOTH/1999/foth990415.htm Those massive drawdowns in 73 & 74 would have wiped out most highly leveraged funds like his. Charlie was a member of the Pacific Coast stock exchange and he had a light leash that resulted in his loans not being called. As withwith the Buffett partnerships, he may not have reported results to his partners until sometime after EOY 1974 when the markets had turned up in 75. Therefore, a contra factual scenario would be that he could easily have been wiped out during that bear market.

The Jumpstart GSE Act that's part of the omnibus spending agreement recently agreed between Democrats and Republicans in congress looks like the nail in the coffin that will keep the corpse of F&F from rising from the dead to benefit private shareholders. The key provision prohibits the administration from selling its preferred shares before 2018. Selling or exchanging the preferred shares would be a necessary part of a recapitalization that could benefit other shareholders. But, that's not the worst of it. The fact that congress now in the Jumpstart GSE Act specifically refers to the Government's 2012 amendment to the preferred stock agreements that swept all the profits of F&F to the US Treasury without the new act's reversing the sweep, is a huge negative for other shareholders. That's because that new law about to be passed by congress is now interpreted to passively acquiesce to the sweep of the profits into the US Treasury. That's a huge strike against the one remaining lawsuit by F&F shareholders still remaining before a court. I hate to say it after my initial enthusiasm as the original poster that stimulated all the interest in F&F preferred, but chance of substantial recovery now seems to be a long shot, a very long shot, at least until 2018.

I think the risk that the same logic could be applied to Fannie and Freddie on economic loss analysis is close to zero. Correct me if I'm wrong, but you're saying one of two things: (1) Fannie & Freddie would have been worthless without the initial bailout of 2008, or (2) Fannie & Freddie would have been worthless without the initial bailout of 2008 and therefore any subsequent events are linked back to the initial bailout of 2008 Since no one outside of Washington Federal is saying that there was an illegal exaction or Takings Clause violation from the 2008 bailout, it doesn't seem like (1) applies. The only possibility for the government to use this language is to argue (2) -- however, that's a difficult row to hoe. Imagine, then, if the government were to confiscate value from GM tomorrow (or even AIG tomorrow) -- if the logic of (2) is correct, then the natural extension would be that once the government has saved your company from bankruptcy, all future actions the government takes are either permissible or require no payment. In the Fannie & Freddie case, if you follow Wheeler's logic: The correct method of analyzing the damages caused by the Third Amendment is to ask the question of what the preferred (and/or common) be worth "but for the [Third Amendment]." In our instant case, we can see exactly what happened in the years following the Third Amendment -- namely, record profitability, so the damages aspect is pretty clear to me. I'm sympathetic to that argument, but I'm not the judge. There is ample precedent for disregarding future improvements that might have accrued to equity after the government judges that a company is bankrupt. This happens frequently with insolvent banks seized by the Feds and then quickly married off to a new owner. If that bank turns around, the gains generally belong to the new owner. There is no Cpt11 in these situations allowing time for equity to recover while being protected from creditors claims.

Seems odd to me. The reason no damages were awarded because the judge says that Greenberg failed to show the harm to shareholders given that the alternative was an AIG bankruptcy with no government support; however, that wasn't the only alternative. The alternative was that AIG receive support under similar terms given to other massively troubled financial institutions at the time. I haven't read the full docs - just an article or two covering the decision so it could be the judge is giving credit to the gov't claims that no bailout would have happened without the equity kicker, but it seems like a strange line of reasoning assuming that bankruptcy was the only other alternative just because the government said so... The issue here isn't that the interest rate was too high -- the issue here is that the Federal Reserve did not have to authority to extract an equity payment based on its statutory authority under 13(3). Once it's established that the government did something wrong, which it did, then the question turned to "what was the harm?" In this case, the question was "but for the loan, what would shareholders have gotten?" And the answer was nothing -- and the interest rate was irrelevant to whether AIG would have gone bankrupt absent the loan. I heard someone mention that this could be construed as "The Fairholme Ruling" -- doesn't hurt AIG but helps FNMA. The bottom line is that the government acted illegally by exacting value from the shareholders. The reason they don't have to pay anything in AIG is that "but for" the loan, the AIG shareholders would have gotten nothing -- in the Fannie Mae situation, "but for" the 2012 Amendment, the FNMA shareholders would have been significantly better off financially. My take on yesterday's ruling is 180 degrees away from all the other posts. The judge's ruling was that the takeover of AIG by the FED was illegal but that there is not a valid claim because absent the takeover, the company would have been worthless. AIG's recovery of value after the takeover apparently was not sufficient to trump the fact that the stock would have been worthless without that intervention. That doesn't seem just to me, but there seems to be a large amount of risk that the same logic could be applied to Fannie and Freddie. Am I missing something here?

Yes, that's one way this could work out, but the US government has always fought tooth and nail for everything it can get in the US court of claims. If they fight as I expect they will, absent a politically motivated settlement, I think the most likely outcome after years of litigation will be that the judge will go back to the documents that governed the original conservatorship and use the terms that applied to the rate on the government's preferred and the disagreeable consequences that kicked in when dividends were not paid as scheduled. One might assume that all the profits that were earned in recent years and taken in the USGov's sweep could have been instead paid in dividends, but, in hindsight, that brings up a solvency issue. A lot of the earnings in recent years had to do with accounting adjustments in things like DTA. If those non cash earnings had been used to pay dividends, there would have been little cushion on their BS, and they would have been one slip away from insolvency, as they are now as a result of what has been taken in the sweep. If this case slowly works its way through the court of claims, eventually that's what the government could argue, and judges have not been unsympathetic to the US Gov in that venue.

the problem is the likely extended time frame in the Court of Claims and the fact that the longer it takes, the more overwhelming the possible compounding as explained above. I still think a political solution is the most likely outcome, but it may be unrealistic to assume that will be more than a fraction of the value of making the private preferred holders whole.

Sorry for the lack of clarity. The point I was trying to make is that if the U.S. Court of Claims should rule tha holders of the private preferred have a claim as a result of the U.S. taking of all the F&F profits, what might be the amount of just compensation for that claim even if there is a final ruling that the taking should stand. The logical way to go that would be to turn back the clock to see what the consequence would have been if there had never been the sweep of profits and that the status quo before that had been unchanged. That would have been to calculate the amount of the unpaid dividends of 10% per annum that should have been paid but were not. But then there should be an interest rate applied to those unpaid balances that would have accumulated and grown with compounding after they were not paid on time. Then the question arises: what interest rate should be applied to those missed payments? It's been sometime since I read the documents, but I think there were rather draconian consequences for preferred dividends on the U.S. Gov pref that were passed. perhaps something like an additional 10% to be assessed on the balances of dividend arrears.

Oops. I should have said, "will overcome the monetary loss of the taking." It's possible to imagine what Bruce describes, but turning F&F into a fixed income arbitrage focused company goes against the public purpose for their creation. Doing that in an opaque way on a small scale is what got them in trouble. Will that happen before pigs fly?

The whole thing is a pretty good read. I'm starting to wonder what's in the Treasury privilege log that's so important. I mean, it's a privilege log. What's the point in fighting so much over what is, presumably, a non-important document? http://gselinks.com/Court_Filings/Fairholme/13-465-0159.pdf Thanks for your posts, Merkhet. They are the best on this thread. Realize the game now is delay, this way, then that way, beginning wih technicalities before addressing substantive issues. The time frame for these maneuvers is not merely months but years. Liquidation analysis will likely produce a zero for common shareholders and very little if anything for preferred holders because a complete victory that would overturn the taking would likely mean a return to the status quo ante. Run the numbers realizing that compounding the government's 10% dividend on their preferred will overtake the accretion of normalized earnings going forward in a time frame measured in years. Normalized earnings in the future will be a lot less than the extraordinary earnings produced in the rebound from the financial crisis.

Many thanks.

Are the slides Prem showed at the recent AGM available?

Hear! Hear!

+1 Quiz: which of the following will increase your life expectancy more? A) Get a thorough physical exam every five years. B) Buy a new car.

WSBASE has been volatile since Yellen became Fed Chairman. Coincidentally, there have been spikes upward on more than one occasion immediately before an important announcement by The Fed. WSBASE has spiked down and then back up within the same range, since the above graphs were posted a few weeks ago. On average, WSBASE has been flat for almost a year, with no sustained trend. In the past few years since the financial crisis, a pullback and a leveling off in WSBASE triggered a significant correction on two occasions after a lag of a few weeks. The recent action of WSBASE suggests that The Fed may be concerned with stabilizing the US stock market while no longer injecting money into the banking system.

I largely agree with you on the limited impact of commodities and energy. The other thing to mention is that after a 50% decline, commodities' impact on the CPI index is significantly more muted going forward. I disagree with you on wages though - the positive wage print in January was largely due the CPI deflator that they use as the denominator and not because there was a large rise in the nominal pay. Walmart wages may be a bellweather for future wage increases, but I think walmart wages are a very small piece of the wage picture and don't mean much in isolation. We need a tighter labor market for there to be a sustained increase and I tend to believe that there is still quite a bit of slack. I agree though - we won't see sustained deflation unless if it makes it's way into housing. I think the biggest impediment to the inflation story in the near term will likely be the strength of the dollar. Just like oil, this will translate into pricing decreases through almost everything that is purchased outside of services. I think dollar strength and the price of oil will contribute to deflation through calendar year 2015 and possibly into 2016 depending on the status of our record oil supplies in storage and the continuing strength of the dollar. It will need to enter the housing market to extend beyond that. I tend to agree with Gio on this one though - I think something as simple as a stock market decline could be the trigger. After 6 years of being told to ignore risks, investors have levered up their exposure to equities through margin debt while US equities are priced for perfection. A strong dollar and potentially increasing wages will weigh on corporate margins that are currently significantly above their historical trend. Paired with extremely high stock valuations and the potential for rising rates and you have a stock market disaster - declining margins and declining multiples could easily spell a 50% decline. Magniffy this by the margin debt and we could see some spectacular blow ups that have larger economic implications that affect wages and employment. This is simply speculation - I just get the feeling investors aren't the only ones who've been ignoring risks and that the implications of a risk-off environment will be felt far beyond the stock market. Full disclosure: I recently purchased 1 year put options on the S&P at 1900. Would you kindly share how much you paid and how much S&P was then?

I came across that gem about resveratrol when I tapped into the messaging back and forth of the scientists who conducted the study. The study rests showed a modest benefit when the rats were given a relatively small amount if resveratrol. That benefit disappeared when a somewhat larger amount was given. The response to those predetermined amounts were reported in the peer review journal. Apparently, the researchers, who may have been interested in the possibility of developing a prescription drug based on resveratrol, were surprised at the adverse results after increasing the dose. They decided to do a side experiment with an even larger dose. That's when all the rats experienced premature death, all from cancer.