txlaw

Even more new developments: http://www.bloomberg.com/apps/news?pid=20601087&sid=aNHg2cyO6dLA&pos=7 http://www.gurufocus.com/news.php?id=86953

Very interesting. Thanks for keeping us updated.

Thanks for posting!

Interesting article on how some CEOs decide to hedge their company stock against losses rather than sell such stock. http://www.businessweek.com/magazine/content/10_10/b4169044647894.htm

Article in BusinessWeek by Alice Schroeder: http://www.businessweek.com/magazine/content/10_10/b4169030631058.htm?chan=magazine+channel_top+stories

Didn't see any postings on this yet. See the following articles: Ackman May Make $170 Million on ‘Grand Slam’ General Growth Bet http://www.businessweek.com/news/2010-02-18/ackman-may-make-170-million-on-grand-slam-general-growth-bet.html Fairholme's Berkowitz Weighs in on Simon's bid for General Growth Properties http://news.morningstar.com/articlenet/article.aspx?id=327031 Brookfield to Battle Simon for Mall Giant http://online.wsj.com/article/SB10001424052748704454304575081943861666942.html (access for WSJ premium members) Brookfield Said to Seek 30% Stake in General Growth http://www.businessweek.com/news/2010-02-23/brookfield-said-to-be-in-talks-for-30-stake-in-general-growth.html It looks like GGP could exit bankruptcy as a stand alone company with some of its unsecured debt converted to equity. If Michael Ashner is as good a real estate investor as people think he is (including me), I have to wonder how FUR is participating in this blockbuster battle.

I'll second that!

I'll say it again. There is a distinction between "tax cuts" and "tax policies" (aka, "tax expenditures"). "Tax expenditures" -- like a mortgage interest deduction, a consumer loan interest deduction, or a tax credit for installing energy efficient windows -- are substitutes for direct government spending. They effectuate government policy in an indirect way and can be a more surgical way to sustain or increase demand. "Tax cuts" -- like a pure cash rebate or an across the board lowering of the tax rates -- are what Koo is clearly against because they leave complete discretion to the tax cut beneficiary to allocate that cash. When everyone is focused on debt minimization, too much of the cash handed back to tax payers leaks out of the system. We don't know for sure whether Koo is against targeted "tax expenditures" based on the interview.

Well, tax deductions, tax credits, and tax rate changes, are very different than rebates. Cash for clunkers was not a tax cut, but it was effectively giving money back to consumers to recirculate into the economy. Credits for putting in energy efficient fixtures are also directly circulated back into the economy. I don't think Koo would be against those sorts of policies -- in other words, I don't think he thinks that all tax policies are equal. But he was very much against the Bush tax rebate, which just handed cash over to people without any sort of requirement or incentive for them to recirculate the cash. I might be wrong on this though; people who have read Koo's book would have a better idea of whether he would only go with government spending. This goes to my point regarding why the U.S. may indeed be different than Japan. We are more likely to cram down creditors and to institute programs to modify loans than Japan (I think). Furthermore, lenders in the U.S. capital markets may be more willing to do debt exchanges and take ownership stakes because they are less risk averse than Japanese lenders. If so, then what we might be seeing is a repeat of Japan but on an accelerated timescale.

I think the key to Koo's criticisms of the Bush tax cuts is that at the beginning of a "balance sheet recession," you have to do everything you can to counter the aggregate demand destruction that is putting the economy into a deflationary spiral downward. Tax cuts represent a leakage to the economy because the money goes back to the banks, and the banks can't lend money out because they are in trouble and because loan demand is collapsing. Therefore, if the government borrows money to pay back to the private sector in tax cuts (we don't want them cutting spending, remember, because the government needs to prop up aggregate demand), it will have much less effect than simply increasing government spending, which is guaranteed to recirculate money into the economy. You have to prop up aggregate demand to stop the deflationary spiral, and Koo believes that there is a risk that even when things appear to have stabilized, the entire private sector is still focused on debt minimization rather than profit maximization, which could potentially put the economy back on the downward path if government spending is reduced. This is where I begin to question the simplicity of Koo's model. Clearly, there is a spectrum of business mentality between "everyone minimizing debt" and "everyone maximizing profit." If the private sector in the U.S. begins to move towards maximizing profit while prudently paying down debt (through cash flow, debt to equity exchange, reorganization, etc.), then perhaps targeted tax cuts or tax credits will help prop up aggregate demand or increase aggregate demand from the lower than normal levels. I think here is where his view is colored by the Japanese experience. He thinks that it will be along time before we get off the path of debt minimization. But maybe things will be accelerated in the U.S. because of our business culture. For example, if the U.S. can have tax cuts targeted towards entrepreneurial small businesses that actually hire people and are trying to grow, then maybe tax cuts at this time are not a bad thing. But we don't want money just going back to the banks.

Relevant Bloomberg article I just saw on idle cash at the banks: http://www.bloomberg.com/apps/news?pid=20601087&sid=ac3OkCtKQWGM&pos=6

There is a short essay that Fisher wrote summarizing his debt-deflation theory that someone posted on this board. I'm sure you can also easily find it by doing a Google search. Maybe just read the Wikipedia article on Minsky? (Not being facetious here. It's a good way to get introduced to the theory.) I haven't studies economics formally either, so I've pieced together my economics knowledge through reading multiple sources (books, magazines, newspapers, board postings, blogs, Wikipedia, etc.). Yup, you're right about that. He also indirectly warned about the securitization market when he talked about the Clayton Homes acquisition and how Clayton had gotten into trouble when the securitization market for manufactured home loans dried up. In one of his recent letters (was it this last one?) he said that that should have been the canary in the coal mine with respect to subprime loans and the securitization market. This is a major problem we have to address about our regulatory system. First, we don't want to have people in positions of power who fundamentally believe in no regulation and who think that whatever is happening in the markets is efficient and that the market will always be self correcting. Second, we have to realize that the market participants who the regulators look to for advice may have their own incentives that conflict with the best interests of the country. The NY Fed had lots of contact with the big bankers involved in the activities that helped precipitate this crisis, but no good came of that. Now, it's entirely possible that these guys they were talking to didn't understand the risks. But it's also possible that they simply were not incentivized to disclose these risk because it would have materially affected their businesses (and their bonuses). And of course, sometimes the regulators and those regulated naturally get too close together, especially when those regulated have lots of financial resources. This can blind the regulators to the problems occurring or can cause the regulators to be overly concerned with lessening the impact of regulation on the regulated. There's no easy answer to your concerns. True. It will be very difficult to create jobs. Actually, the best we may be able to do with government spending is to keep the level of unemployment from accelerating, thereby keeping GDP stable. That will buy us time for the private sector to get their houses in order, which we really need because it's the private sector that will create the jobs we need. As many have pointed out above, more targeted spending is desirable. However, Koo has also noted in one of his speeches that the type of spending that will prepare us for the 21st century and lay the groundwork for our economy will probably take lots of time to ramp up. We can't just disburse that money immediately. We have to do detailed analyses of what's the best way to upgrade our infrastructure or invest in alternative energy. In the mean time, you have to have spending that may not be so great for long term competitiveness but that will preserve jobs. That's why we had cash for clunkers and the home buying credit. It's also why the feds disbursed money to the states to keep the state governments from having to layoff a bunch of state employees. My main point about the "jobless recovery" is that just because businesses start getting on sounder footing and start increasing profits does not mean that things will be rosy on the jobs front. And it's really the employment figure that matters the most to me. Remember that Japan had a decade of GDP stagnation but that unemployment stayed very low during that time. That was a victory in my opinion.

Kumar, I believe that Koo had his insight well before we entered into this recession. He came to his conclusions after studying Japan's lost decade. He also mentions in his interview that many mainstream economists, especially in the U.S., ridiculed him for his views until just recently. In addition to looking at the metrics that Woodstove mentions, I think this is where you also have to bring in Irving Fischer's debt-deflation theory and Hyman Minsky's financial instability theory to recognize the signs of a bubble in leverage that could lead to (or that already has led to) a "balance sheet" recession. Ideally, you'd catch this stuff before going into the balance sheet recession, but that was never gonna happen with guys like Greenspan at the helm and with the amount of regulatory capture we had and still have. You also have to do some micro work, where you are scrutinizing companies' balance sheets across the economy. That's why it makes a lot of sense for economists to look to intelligent capital market participants to see what their takes are on the sustainability of what is going on in the economy. You also need these smart market participants' help to figure out what's actually going on in with the plumbing of the financial markets that could possibly cause a blowup and then a downward spiral in the real economy. I'm thinking of smart, honest people like Prem Watsa and the FFH team, who realized the risk of a possible Japanese-style situation occurring in the U.S. and who invested accordingly. And Buffett, of course, who mentioned the possibility of a derivatives blow up. All easier said than done, of course, and with 20/20 hindsight. I suppose you have to look at the metrics mentioned by Woodstove that are found in Koo's book. But note that when a recession is over is also dependent on how we define the word "recession." If we find a "jobless recovery" unacceptable as a society, we will also have to make additional policy decisions with employment in mind because just because companies have repaired their balance sheets and have increased their investment spending does not necessarily mean that this spending will be recirculated in a way that creates job growth.

I actually have not read any of his other stuff. This interview caught my eye when I was sifting through my RSS feeds because I remembered seeing a post on this board discussing his work, which had in turn led me to find a presentation by Koo on the need for fiscal stimulus to break the vicious cycle of debt-deflation. When I read this interview, I knew it was too good not to post here. His book, The Holy Grail of Macroeconomics, is going on my list of things to read, but that list is so vast that it will probably be years before I get to it.

To add some more fuel to the fire regarding our discussions on the macroeconomy and what the right policies should be to get us through this time of sustained deleveraging (see McKinsey study), I am attaching an interview with Richard Koo that I found via Zerohedge. Can't say that I agree with everything he says, but this is definitely a must read if you're interested in macro. So what do you think? Is sustained government spending the answer? Is monetary policy, both regular and extraordinary, useless in this particular situation? Can we distinguish the U.S. situation from the Japanese situation? Hopefully you Austrian economics guys won't go into an apoplectic rage after reading this interview and will provide some well reasoned critiques that don't resort to uncalled for disses and conclusory statements.

Great video. I actually bought a little bit of C right after they sold shares in order to pay back their TARP preferred. Seeing that Berkowitz was in Citi gave me a little more confidence in my decision, and I've been adding to my position. The pig in a python analogy also was my rationale for buying ETFC last year after the debt exchange went through. ETFC's portfolio is in runoff though and won't be replaced with new loans. Instead, once the losses lessen, their core business' earnings potential will show through and should hopefully reflect in the market valuation. It sure feels like I've been waiting a long time for that to happen though -- even though it's been less than a year! I imagine that's what it could feel like waiting for Citi to work out.

Ha! :D I saw that. When the Woz speaks, I listen. Especially when he talks about a potential software glitch causing problems! I'm kind of worried that we're going to find a bunch of problems with the electronics in not just Toyota cars, but other automakers' hybrids as well. These guys were just on the brink of collapse, and they would have been incentivized to keep quiet about any problems during that period of time. I really hope not, though.

Yeah, I think that's right. Convertible debt and a tranche loan.

Whoa, I hadn't seen the annual! -SHLD is top holding as of end of November -- 10.6%! -BRK was 10% of the portfolio at the end of November. Could be more when the BNI deal closes. -PFE has been dramatically paired down. -C at 4.2%! -GGP at 4.2% No wonder in the last interview I saw with him (Fox Business, I think), he mentioned with a smile that there would be a lot to talk about after he disclosed his holdings in a few weeks.

Just want to point out that whether one's home mortgage is nonrecourse or recourse depends on what state one is in. In some states you can just walk away and not worry about being personally liable for a deficiency. However, in other states you can be personally liable for a deficiency. Additionally, whether the mortgage is nonrecourse can also depend on whether it is a purchase mortgage or a mortgage resulting from refinancing. It's all very state specific. --- JEast, I believe you are referring to Fisher's theory on debt-deflation being the cause of great depressions. I think that before the government took the action it did, we were indeed going down the great depression route. Fisher's detailing of his proposed debt-deflationary spiral is remarkably similar to what happened in the last two years. We were at the edge of the precipice, and we luckily got pulled away before we fell into the void. We should thank Ben Bernanke and the Treasury for saving us despite all the criticisms that can justifiably be thrown at them (such as, why did they let us get here in the first place?). I believe that the government took the necessary steps to prevent us from being in a severe depression resulting from a deflationary spiral. However, escaping a depression does not mean that things will be great going forward. Instead of stag-deflation, we might have stagnation plus mild inflation. Or we could have stagflation, as many on this board have suggested. Hopefully, we don't get to a point where we have economic stagnation and hyperinflation. We will definitely have high unemployment and underemployment relative to previous years for a while. Our currency is destined to be devalued, which will reduce our standard of living (but not by as much as some people seem to think). Much of the paper wealth that people believed they had has evaporated, which makes everyone feel less secure, which results in further deleveraging (of personal balance sheets). At this time, very few people and businesses can take advantage of the record low interest rates because they need to de-lever. When interest rates go up -- and they will go up -- it's going to be very tough for people to have the same standard of living that they were used to. Now, that standard of living was perhaps unsustainable, but it's gonna feel horrible for those who thought that that was the norm (having things taken away from us feels disproportionately worse than the good feeling we get from getting an equal amount of stuff). The financing issues we will have could also translate into less entrepreneurial vigor, especially when tax rates go up. My hope is that some systemic reforms (i.e., health care reform) will mitigate the way that the middle class has been hit over the last decade or so and will continue to be hit due to this need to de-lever across the board. Because it ain't looking that great for us in the short to medium term. :-\

Hallelujah! Perhaps there's hope for this administration after all!

I just read that Charlie Rose interview with Volcker, which I hadn't seen until now. It's very interesting. If you haven't already read it, you should. See http://www.businessweek.com/magazine/content/10_02/b4162011026995.htm . I completely agree with Volcker on keeping the commercial banks from getting too involved with what he calls "capital market activities." They would not be allowed to do prop trading, derivatives dealing, energy trading, or merchant banking. They would be allowed to underwrite securities for corporate clients. Not sure whether he'd let them do M&A advisory work or payments transactions (I would). I was actually hoping that Citi would become the prototype for this new approach. That's where I thought they were going with the whole Citi Holdings/Citicorp approach. But I'm beginning to worry now whether Citi will revert back to its bad old ways once the government sells its stake. I'm thinking that the Rubin-ites in the administration are advocating that the government get out as soon as possible, but I'm not so sure that's the best course of action. We'll see. Like many, I think that the bonuses being paid out to these bankers are outrageous. However, I really wish that Congress would focus less on the outrageous bonuses and more on the real issues with financial reform, which are not getting addressed adequately. Many questions need to be asked and answered: What are the most important institutions in our financial system? How can we keep these systemically important institutions from becoming TBTF (or too interconnected to fail)? How much leverage should we allow financial institutions to take on? If securitization and the shadow banking system are here to stay, how do we make these systems more trustworthy and less susceptible to panics? Are there perverse incentives in the system that we should be addressing? For example, does it make sense to allow traditional investment banks and prop trading desks to be joined at the hip? Should we be removing complexity from the financial system and if so, how? What types of "innovative" financial products are truly useful to society, and which just cause more problems than we can handle? Do we need to do more to harmonize financial regulation globally? Can we do anything to make our financial system more transparent and less susceptible to dealmaking done in smoke-filled rooms? Etc., etc., etc. These are important questions that our representatives in government should be working on. I can only hope that they're working on this stuff in the background while the political theater goes on. But I'm not too optimistic about that.

I think Berkowitz thinks the BNI purchase is a great deal. The confusion is stemming from what I think is probably a typo in the article: I can’t see how Burlington Northern was a great deal. The greatness of Berkshire is its deployment of float and profit. They are deploying other people’s money in terms of float - premiums on insurance policies that don’t have to be paid out for years and years. If you are going to use part of that float to pay for an investment, you have to make sure the investment is going to make good money. With Burlington Northern, if you adjust for a buyer with cash and don’t think much more about it, then it was not a great deal. But if you bought it using cheap debt and good chunk of other people’s money and you were highly confident that the company would give you a cost-plus return over a decade, then it’s a good investment. This paragraph is odd because everything after the first sentence indicates that Berkowitz thinks this is a good investment. The "can't" has to be a typo in light of the rest of the interview and the other interviews that Berkowitz has given where he has approved of the BNI deal. Berkowitz's point is the one that I was making a couple of weeks ago. You have to understand that the BNI deal is being financed with very low cost money. It might seem like BRK is paying all cash, but they're really not because the cash and newly issued stock paid to current BNI shareholders will be replaced with low cost float over the coming years. Why do you think the private equity guys are so envious of Buffett? He has permanent capital by having BRK as a public company and by having one of the largest and most well run insurance businesses in the world. What's so ironic about the criticisms of the BNI deal is that for a number of years, almost all the "smart money" was using a ton of debt to finance their investing activities in order to juice their returns on equity. Think about the real estate bubble. Think about the LBO guys levering up acquisition entities to buy public companies in order to flip them after a couple of years. Think about GS and the other prop traders levering up to make trades. But only a few criticisms came out against those folks during the bubble years. It seems the pendulum has swinged such that people are completely ignoring the fundamentals of the BNI deal.

In fairness to Greenwald, he is looking at this deal from a Grahamite perspective and from there, BNI doesn't look particularly cheap. What Greenwald needs to understand is the expectation that Buffett himself has set on Berkshire (return of 10% going forward). Like many have pointed out, at the size Berkshire is now, it's very difficult for him to find a pitch that he can knock out of the park. I think BNI will give him the return he's looking for, but anyone expecting a home run from this deal will be disappointed. I think Greenwald is correct that for almost every individual investor, the price paid was probably too much. But Berkshire is essentially like an endowment fund. The time scale is waaaay longer than ours. And we also need to take into account that Berkshire is essentially earning a spread on low cost float and the cash return on their investment. BNI is a low risk place to put money if there are no other opportunities available. For example, let's say that at some point in time the entire universe of stocks that Berkshire can invest in is overvalued. Well, then Berkshire can just pay down BNI debt or reinvest for growth at an adequate return, earning a nice spread between the cost of float and the economic return of taking such action. BNI is an inflation protected bond that is always available for Buffett to invest in. I'm also not sure that Ben Graham would not have approved of the acquisition if he were alive to see how things have changed. I can't say that I've read Security Analysis, but my understanding is that Graham had a different opinion of utilities versus other businesses. But maybe I'm thinking of Martin Whitman rather than Graham. Finally, I bet that a lot of people would not be criticizing the acquisition if the buyer was an LBO firm that was levering up an acquisition entity to purchase the railroad. They would say, oh look, they are getting a great return on their equity and they will definitely be able to service their debt. But because this is Buffett and insurance leverage, they are quick to criticize. I'm actually more disturbed by Greenwald's view on Comcast than his view on BNI. I believe he is just wrong, and he is not taking into account where the puck is going in the media distribution space. He's certainly not taking a Grahamite approach in his Comcast investment. I think it will work out in the end, but his rationale for why Comcast might be a good investment is just wrong. I wouldn't give Greenwald my money to invest.

Grenville posted this filing on another thread: http://www.sec.gov/Archives/edgar/data/934612/000095015709001025/form425.htm It's an interview between Buffett and the CEO of BNI. Some key excerpts: Well, [bNI] has to do well if the country does well, and the country is going to do well. So, you know, I don’t know about next week or next month or even next year, but if you look at the next 50 years, this country is going to grow, it’s going to have more people, it’s going to have more goods moving, and rail is the logical way for many of those goods to travel, and probably a greater percentage all the time, just in terms of, of cost efficiency, in terms of fuel efficiency, in terms of environmentally-friendly. So there’s no way rail is going to lose share, and I think the pie is going to grow, and I think the rail share of the pie is going to grow. . . . Well, it’s a great business in that you know it’s going to be here forever, to start with. I mean, the hula-hoop business came and, you know, went, and then, you know, the pet rocks and all that kind of thing. And even television set manufacturers have, you know, moved over to Japan. All of that sort of thing. The rail business is not going to go anyplace. It’s going to be right here in the United States. There’s going to be four big railroads that are moving more and more goods. So it’s, it’s, it’s a good business. It, it can’t be, it can’t be something like Coca Cola or Google, because it’s, you know, it’s a public service type business, too, and it has, it has a fair amount of regulation that is part of the picture. But it’ll be a good business over time. It will make sense for this country to want railroads to continue to invest more and more money, in terms of expanding and becoming more efficient. So you’re on the side of society, and society will largely be on your side. Not every day, but most of the time. --------- This interview shows Buffett's rationale for why BNI is a great business. Greenwald is wrong to suggest that it's not a good business and that the purchase is based entirely on energy prices. He is also wrong to criticize BNI for not raising prices enough. After all, a railroad is really a utility business. They can't just raise prices to whatever they want, or they face the risk of being re-regulated to the point where they earn poor returns on capital. But as a utility, they will be allowed to raise prices enough to earn a reasonable return on capital invested back into the business. Whether Buffett payed too much is a legitimate question given the opportunities that could potentially be available in the coming years, but since Berkshire likes "hold forever" businesses and is a massive institution that acts on a much longer time scale than most, this acquisition makes a lot of sense. Actually, Greenwald's analysis of Comcast also seem off the mark. He seems to totally ignore the fact that Comcast is very much like a toll road that is subject to both regulatory risk and technological/business risk. See this paragraph from the Advisor Perspectives interview: The one that we like best, even though they break our hearts with their stupidity, is Comcast, which is trading at a 13% earnings return because they are way over-depreciating. We think they ought to have huge pricing power. To do that, they’ve got to get along with the Telcos, but they are doing everything in their power to alienate them by going after small businesses, which has always been in the bailiwick of the Telcos. Hopefully, just like Coke and Pepsi, they will learn to cooperate. What will happen is that you will have a cable wire into your house, and then everything will be wirelessly distributed. In that world, their costs go to nothing. If they keep their prices up – and they can probably charge $300/month, because it will cover your cell phone, regular phone, internet access, and on-demand programming – and they collaborate, they can charge a lot and make a ton of money. Bruce Greenwald must be out of his mind if he thinks that we'll ever get to a world where Comcast can charge $300 per month for a quadruple play. If they even think about trying that or "collaborating" with the telcos, this Silicon Valley-friendly administration will initiate proceedings to regulate the cable companies on par with the telcos. And that could also catalyze a political movement to turn the telcos and cable companies into regulated dumb pipe providers. Any utility has to walk the line and make sure they don't get into territory where the regulator is forced to crack down. Then there is the rumor going around that Apple is making deals with content providers (such as Disney) to offer subscription packages via iTunes. A deal like that combined with the increasing popularity of sites like Hulu and the increased use of computers connected to one's media screen (think Xbox, PS3, Apple TV, Boxee) threaten to make the cable cash cow much less valuable. And I don't think the cable companies can expect to recoup the revenue lost from defecting cable subscribers by charging an exorbitant amount for internet service. Brian Roberts sees this and understands that it's in his and his shareholders' best interests to diversify into content. He's actually doing the smart thing buying NBC-U. Reminds me a lot of another company that diversified into content called Capital Cities. And what does Buffett think about what Comcast is doing? Well, let's see . . . he just placed the COO of Comcast, the son of Tom Murphy, former CEO of Cap Cities, on the board of Berkshire. Bottom line: Just because Greenwald is a prof at the Heilbrunn Center doesn't mean he knows what he's talking about.