ERICOPOLY

The positive side is that the further along we get in this deleveraging, the less of it's drag there is ahead of us. What deleveraging? The US is, a little (total debt down from ~390% of GDP to 340%). But the world overall has added 30% to its debt load since 2007. Private sector debt carries higher financing costs than public sector debt. So you may scoff at 390% vs 340%, but I think the difference is more significant than that. Let's say you take a private citizen that was paying 6% interest on his personal debt, and you tell him instead that he only has to pay 3% interest if it is moved to the public sector.

The positive side is that the further along we get in this deleveraging, the less of it's drag there is ahead of us.

I bought a 'Gnaraloo Fatty' several months ago. Nice and stable for beginners. http://www.surfindustries.com/surfboards/gnaraloo_fatty.php I am blessed in that I live less than a mile from Hammonds Beach.

On the other hand... An FFH investor could buy index calls to hedge Fairfax's index hedges. That way, the company is safe and so is the investor.

But look, if people will invest their money in government bonds at 1% interest rates and 20% tax rate, why would they hold back if interest rates were 3% at 73%. In both cases, the after-tax income is 0.8%. It doesn't disrupt their earning and spending power at all. The United States had a top-end tax rate of 70+% for quite a while after WWII.

The bonds being mostly held by Japanese, then most of the interest paid goes back to their tax base. So while it's true that all (current level of) tax revenues would be used just to service the debt, the private sector would see a massive surge in govt bond interest income cash flow. The government could tax this increase of interest income, and put it back into the programs it currently spends money on. So the private sector would in theory see no change in cash flow. Bond holders would get the same as they get today, as would the beneficiaries of government programs. So it would in effect be defaulting on interest payments to it's domestic bond holders, but foreign bond holders wouldn't get hurt (there are so few of them). And it's private bondholders would just keep on seeing the same level of bond income that they see today. Net of tax. I'm not convinced this wouldn't lead to some sort of dumping of bonds by the Japanese. It's just that it appears if you are increasing payments to your own people, that seems to open a door to raising taxes. Just brainstorming. In short, if you pay too much interest to your own people, take it back! Otherwise, it would be somewhat like an economy without taxation if all the money taken in taxes were given right back again. Taxes in Japan are already high, for both individuals (40% for income above $180K) and corporates (around 38%). On top of that there is service tax (which will be increased to 8% in April) and a special surcharge of around 3% for rebuilding program post 2011-earthquake. Interest income is already taxed at around 22%, so increasing it would naturally put off investors investing into bonds. Govt can only tax and take back a certain portion of the interest income, so the deficit will keep growing if the government is using all of its tax revenues to service the interest. Rising interest rates will have a massive impact on the book values of banks(e.g. below) and pension funds (which is already running a deficit due to ageing population and life expectancy rate of 80+). So the choice for pension funds is to sell the existing bonds at a big loss to pick up new bonds at higher yields or hold the existing bonds until maturity with a negative real yield creating bigger hole in the deficit. The country's second-largest bank, Mizuho Financial Group Inc., 8411.TO +0.95% said in May 2013 that a one-percentage-point rise in the yield of the 10-year bond would result in paper losses of ¥100 billion-¥200 billion ($1.1 billion-$2.1 billion) on its loan portfolio Alright, where does the money go? The government starts paying interest income through a firehose onto the private sector. Private sector income is ballooning. Does this show up positively somewhere in the economy? Can the government see rising tax revenues when income is flooding into the private sector (via higher interest). I mean, you suddenly have the situation where all tax receipts go right back to the private sector. Does that... have any... impact? It's not like it won't. People won't have to save as much, for example, if they can reinvest at higher rates. That means pensions won't need to be funded as heavily (for one example). There must be some knock-on effects from the government suddenly flooding the private sector with interest income. Inflation? 22% tax rate on interest income??? Seriously? Interest income is taxed at like 40% top personal federal tax rate in USA, and over 50% top rate in California. Large banks probably pay more like 30%+.

The bonds being mostly held by Japanese, then most of the interest paid goes back to their tax base. So while it's true that all (current level of) tax revenues would be used just to service the debt, the private sector would see a massive surge in govt bond interest income cash flow. The government could tax this increase of interest income, and put it back into the programs it currently spends money on. So the private sector would in theory see no change in cash flow. Bond holders would get the same as they get today, as would the beneficiaries of government programs. So it would in effect be defaulting on interest payments to it's domestic bond holders, but foreign bond holders wouldn't get hurt (there are so few of them). And it's private bondholders would just keep on seeing the same level of bond income that they see today. Net of tax. I'm not convinced this wouldn't lead to some sort of dumping of bonds by the Japanese. It's just that it appears if you are increasing payments to your own people, that seems to open a door to raising taxes. Just brainstorming. In short, if you pay too much interest to your own people, take it back! Otherwise, it would be somewhat like an economy without taxation if all the money taken in taxes were given right back again.

Is there enough liquidity in out of the money puts for a multi billion portfolio? I'm sure there is. They can deal directly with the bank(s). In 2007 they had a multi-billion dollar hedge via call options (a hedge against the market climbing). Or they can deal with BRK. Buffett happily wrote multi-billion dollar puts a few years back. I've spoken to them about this. Apparently, it has more to do with cost than liquidity. Either the time premium or the cost of rolling would be too high to make OTM options competitive. Seems to me the liquidity issue could be solved by a market maker. Certainly when they hedged using S&P options they would have contacted a market maker -- which was costly. Russell is less liquid, and there costly. So they effectively want to do it the way I want them too, but they think the expense outweighs the benefit.

Is there enough liquidity in out of the money puts for a multi billion portfolio? I'm sure there is. They can deal directly with the bank(s). In 2007 they had a multi-billion dollar hedge via call options (a hedge against the market climbing).

--Didier Sornette, world renowned mathematician. Why not? Yes, it certainly could be sustainable. For one thing, you said real growth rate and the 10-15% returns could be nominal. Second, if we are talking about equity returns, then earnings can be reinvested in more shares. So if the P/E is right, you can certainly generate those kind of returns simply from earnings growth per share (thus, it is sustainable in perpetuity).

Russia defaulted back in 1998 and they printed their own currency. However, Russia inherited most of that debt from the Soviet Union -- and it was owned by foreigners. Compare that to Japan where most of the debt is owned by Japanese. Default on yourselves? That would start a banking crisis because the Japanese banks own a lot of it. So in a sense the government debt is assets in the private sector -- default and you have a sudden vanishing of assets, and then maybe the deflation comes back again? So when you default on a foreigner, you get debt service relief. But when you default on your private bondholders, you might get a collapse... or at least it would seem a bigger one (since no/few foreigners are sharing the pain).

10%-20% declines can happen in any given year. So they should be hedged for that all the time, if they are hedged for it now. Don't you see that? They are worried about potential for a far greater decline. They could instead simply express that worry by purchasing puts that are 10%-20% out-of-the-money. That way, they accept the normal 10%-20% decline that any year can bring them, but they are protected in case anything far more severe arises. Well anyway, that's the only irrational thing I see with their hedges. They are hedging against every single penny of potential decline... when honestly, they know that in any give year, at any given time, you could be suffering 10%-20% decline. That's just life in the markets. So that's just what I find frustrating -- you can protect against 1-in-100 year declines without losing most/all of your gains when the market goes up instead. It seems pretty obvious really.

Sure. For equities. However, the bond market might reverse, meaning rates might go higher as deleveraging comes to a conclusion. Then, he'll be sitting on big losses in his bond portfolio. Many people have warned about rates going higher... but they are being ignored by almost everybody. My thinking is that for a few reasons, rate movements have opposite effects on book value and economics. There are a lot of long duration insurance liabilities, so the bond portfolio is probably "overhedged". But for financial reporting, I don't think rates have any effect on the balance sheet value of the liabilities. Also, in banking terminology they seem asset sensitive, so as rates rise their reinvestment opportunities increase faster than insurance rates decrease, and relative cost of float economics improve. Not an insurance expert, so I don't know that prices respond so directly to rate movements like in banking. But in any case, I think consistent with the insurance liabilities, looking at the bonds at cost is the more appropriate way to evaluate Fairfax's book value. Particularly for changes in book value. I understand you in terms of liability management, but a hit to book value is a hit to book value. Similarly, a drop in equities markets merely means that company earnings/dividends can be reinvested into the shares at a higher earnings yield. They still hedge for this though -- but they don't when it comes to bonds.

Sure. For equities. However, the bond market might reverse, meaning rates might go higher as deleveraging comes to a conclusion. Then, he'll be sitting on big losses in his bond portfolio. Many people have warned about rates going higher... but they are being ignored by almost everybody.

Straight from the 2006 Fairfax Annual Report -- copy/paste (with emphasis added in red): At December 31, 2006, as protection against a decline in equity markets, the company had short positions in Standard & Poor’s Depository Receipts (‘‘SPDRs’’) and U.S. listed common stocks of $500.0 and $99.6, respectively (2005 – $500.0 and $60.3, respectively) and equity index swaps with a total notional amount of $681.4 (2005 – $550.0). The company has purchased near dated call options to limit the potential loss on the SPDR short positions and the equity index swaps to $131.1 and $31.6, respectively, at December 31, 2006 (2005 – $112.1 and $110.0, respectively) and as general protection against the short position in common stocks.

It's not as simple as right, right, right, wrong, vs wrong, wrong, wrong, right. They changed how they do things. Back in the 2007 version, they had out-of-the-money index calls to hedge against the possibility of the markets shooting up. This time, they chose not to do that... so, Murphy's Law -- the markets went straight up. That simple change in tactics is what this fuss is mainly about. In both cases, they were hedged. So there is more to talk about than whether or not they are hedging for collapse of equities. You can achieve that without getting run over on the upside.

True-- but if you click the 10y link, you see that they have been about the same. Long term is where it's at. That chart is heavily influence by their decision to buy TIG and C&F, which had little to do with whether they have a hedging strategy or not.

I suppose I'll just go ahead and state the obvious -- the lower the yield, the riskier that kind of thinking becomes... there isn't enough income generated to cushion the blow when you get the price direction wrong.

Rhetorical question? Bonds had a $900 million loss and equities underperformed the hedges by $500 million. These pretty much accounted for the underperformance. Vinod It's a little bit ironic that the bonds are the only thing they didn't hedge, and they're the biggest source of loss generation. They didn't hedge the interest rate risk. I think if they can live with $900 million in losses on bonds, they could also live with some amount of pain from equities losses -- for example, using out-of-the money puts to hedge against major market collapse. I know this is all hindsight, but I think it makes sense.

They have multiple parts: bond income underwriting income equities (hedged against indices) CPI thinging How did all four of them combine to just 2.8%? Did capital bond losses exceed all income generated over the period? Did equities underperform the index? Was there no net underwriting income? Which part was primarily responsible for dragging down the slugging percentage?

The exit tax has an exception (to avoid the tax). People who have been dual citizens since birth do not have to pay the exit tax as long as they are going "back" to that other country. I'm pretty sure I qualify for that as long as I go to Australia. This is because I have Australian citizenship by descent.

Book value was $369.80 back at end of 2009. So take out $40 in dividends paid ($10 per year for 4 years), and you've got $329.80. Compare that to $339 at the end of 2013. Do I have it right? It looks like it's taken 4 years to generate a cumulative 2.8% return.

The MAXIMUM the govt paid was $21,500 per single-family home. Maximum! Quoting: Other programs include:a $5,000 minimum home repair (MHR) grant from FEMA for limited repairs to primary dwellings, and Individual Family Grants (IFGP) combining FEMA and state funds (maximum $21,500) for real and personal property replacement. Yes, they are a guesstimate. Emphasis on guess. You started off in this thread claiming the government would pick up the tab. Not true! The MAJORITY of costs were born by the homeowner. Quoting the article again: The majority of the single-family housing reconstruction funding came through the SBA loan program.

The second major clue from the article is that the majority of single-family reconstruction costs were funded by the SBA loan program. Loans... Majority.... That's the short version.

The article clearly stated that $21,500 was the maximum combined assistance (federal and state) for repairs to a given single-family residence. It also mentioned that further relief was provided in the form of temporary housing, among other things. You are treating all of these costs as if they alltogether provide $50+k towards repairs to the home. The article was clear that not all of the assistance went towards repairs.