TwoCitiesCapital

I've seen you make this point before. I see the logic behind it, but as you said Congress has had almost 5 years since the NWS to pass a bill. Why does Mnuchin personally need to give them even more time? Is there that much of a difference between 5 and 6 years? I don't see much of a difference between Mnuchin waiting until 2018 to take action and say "you asked me to wait but you're not actually getting anything done" and doing it sooner. In fact, sooner has more justification to avoid the companies hitting zero capital in 9 months. Edit: I get the feeling this has been addressed before. I've read the last 400 pages of posts at one time or another but I don't remember all of them. I'm thinking the answer to my question is "politics" and I don't understand that realm very well. It could simply be because the gov't has been "paid-off" yet. Mnuchin may not seek to reverse the NWS or the senior preferred. He might simply call it quits after the Senior Preferred with an implied 10% dividend has been paid off. I think we still have one or two more payments to be made before that occurs. At that point, it's pretty easy for him to say, "Well, we've been paid back and Congress has failed at coming up with an alternative, so we're just going to remove the risk from tax payers and allow these companies to recap and operate as private entities."

I've been "adding" too. I have been slowly selling FNMAJ (par $25 trading at $5.50 - $6.30) to purchase FMCCJ (par $50 trading at $8.50 - $9.50). Post conversion, I have ~11% more notional exposure for a 12-15% reduction in capital at risk. I'm pretty happy with this outcome as these are now held in a tax-free account where capital loss is a MAJOR concern given how valuable decades of tax free compounding could be. Heads I win more; tails I lose less.

Picked up a token position in LB. This is mostly therapeutic for me. I recall looking at buying LB back in 2008/2009 when it traded for $9-$10 a share. It was LB or Excel Maritime in dry bulk that were contending for my capital. I ended up picking up Excel Maritime as I thought it had better asset coverage and increased earnings potential. Excel Maritime eventually went bankrupt. LB, on the other hand, absolutely ripped hitting a high of $100 in 2015 and having paid out more than the initial purchase price would have been in dividends over that period of time. Now that LB is down 50+% from the highs, I purchased a token position to feel a bit better about my very poor decision to lose money instead of making many multiples on my money.

It seems like one more quarter before the pressure is really on given that the full amount will be repaid and tax payers are basically 100% responsible for any losses taken. Coudn't have asked for a better time for Mnuchin to move into the office.

Every investment has the potential to be a zero. The question is what is the probability? Most members in on the trade obviously believe that the probability is more remote than you want seem to think it is.

Seems reasonable to have a portion of your cash in non-financial portions of the economy. Collectibles is one way to achieve that. I'm not an expert on collectibles, so I stray from that arena, but I do tend to keep a portion of my money aside for small time, opportunistic endeavors. Something like floating cash to buy pre-sale concert tickets for re-sale or flipping used luxury watches. These things don't scale well, but they offer me the opportunity to put some money to work at higher returns than I can consistently achieve in the market while being largely uncorrelated with financial assets.

You have no choice but to bail out banks in a fractional reserve system because if you don't the money supply contracts and you get a recession/depression. Its as if the banks are holding a match to the money supply and saying to you: Let us fail and we will burn it. For instance in 1995, M1 was 1200 billion and the monetary base was 400 billion. If every single bank throughout the whole US failed simultaneously, M1 would shrink from 1200 to 400 and you would have a Depression that would make the Great Depression look like a fun picnic. This is why central banks MUST intervene!! Because the dynamics that play out when this happens: Massive unemployment, bankruptcies are too painful. However in a fully reserved system, it doesn't matter if every single loan throughout the entire country defaults at precisely the same time. You won't get a Great Depression. Employment won't be affected. So there is absolutely no need for any bailouts or central bank intervention. I don't know if I buy this argument. If every single bank failed in a single reserve system, you're still going from 400 to 0. You'd have massive disruptions in spending patterns (hits to top and bottom lines) and asset ownership (as collateral is transferred to debt holders) which would have significant implications for further declines in inflation, wages, asset values, etc. etc. etc. I'm pretty sure in ANY system, the bankruptcy of all banks is disastrous. But how much below 0 can you go as a country? Or can you only hit 0 and the drop from 400 to 0 is the same as a drop from 1200 to 0?

All positives from the perspective of ending the conservatorship....and the NWS if you believe that the companies are indispensable/irreplaceable given the size/scall. So, it's just a matter of determining how they handle the NWS and recapitalization for those in the latter boat.

I know someone who wrote a script to evaluate this. The correlation between number of posts and returns is almost 1 to 1. The more posts the worse the return. Your best bet is to just look at ideas with zero or a handful of responses. If there is a lot of discussion move on. This does seem to be the case for long-only strategies, but I've actually made quite a bit of money on some of the names most extensively discussed by using basic option strategies (covered calls, covered puts). I use the discussions to get a basic understanding of the thesis and as a barometer of hype/panic to know when to sell options. I've made close to 25-30% in just the last 6 months selling 1-2 month puts @ 30-40% below current prices on Sears after panics began because following the thread gave me confidence that: 1) People were being overly pessimistic 2) Eddie has a history of bailing it out/pulling rabbits out of his hat and 3) Bankruptcy wasn't immediately imminent even if Eddie failed to act in a month or two If you were long the stock, you lost money. But there are other ways to profit from an idea even if it's just determining that it's not as good or as bad as everyone says it is at a given time. Similarly have been making money on VRX with options and with Altius by trading the swings in the stock. All three are heavily discussed and have done terribly from a multi-year, long-only perspective, but there was still quite a bit of money to be made by trading the sentiment in each one.

I was discussing further with a colleague today, and another point we came across is that it appears that the margin story is just for the U.S., right? We aren't seeing a similar trend in "permanently elevated" margins in Europe or Asia? If this was the result of technological change, I'd expect it to be more evenly distributed as it's not just the U.S. that innovated productive technology. If it's a function of rates, the disparity can be simply traced to the difference in corporate structures where the U.S. was more likely to lever up while global counterparts remain more conservatively financed. Debt to equity ratios across U.S. companies remain higher than European counterparts and interest coverage ratios remain lower. The U.S. and Europe would both be the beneficiaries of some technological wave, but they wouldn't equally benefit from 3 decades of falling rates of European companies remained less leveraged than their U.S. counterparts.

Political ill-will. Politics has nothing to do with good outcomes, logic, or solutions. It has everything to do with getting your way and/or making sure your opponent suffers. Self interest. The NWS is immensely profitable for the government right now, why give it up? Mnuchin works for the government now and Trump, who will need every penny he can get hold of for his projects? Why give away the goose who lays golden eggs now every 6 month? I would expect the governement trying to dump FNM/FRE when the housing market goes bad and these entities become liabilities for them. If this was the real line of reasoning, then tax reform would be off the table entirely.

I think the dominant factor is the increase in number and size of competitively advantaged companies. If there were no competitively advantaged firms, lower interest rates would not have much impact on profit margins, because they would be competed away and the benefits passed on to consumers. Think retailers as an example. Profit margins have been high even before the 2008 crisis, when the economy is robust and employment levels are very high. So your argument that a stagnating economy leading to employees not demanding high wages contributing to higher margins does not hold water. Vinod Inflation adjusted wages are flat-to-down since 2000. An economy at full employment where every individual earns 50% of what they used to might represent "robust employment" but would still qualify as stagnation. We have had an economy where "robust employment" has fluctuated up and down over the past 17 years, but real wages remain below their 2000 peak. That is stagnation. Edit: A minor correction. Just checked the hard data - real wages have grown. 2015 matched the 2000 peak and 2016 was 2.6% above the 2000 peak. So in 16 years, real wages grew 2.6%, or 0.16% annually. I think that still qualifies as stagnation.

Good article. I'm too lazy to create a WP account to ask the author the following question, but I'll throw it out here: So in winner-takes-all economy competitors cannot destroy the margins of AAPL/FB/MSFT/GOOGL. But that does not prevent competitors from trying. And when AAPL/FB/MSFT/GOOGL invest into trying to capture the market of FB/MSFT/GOOGL/AAPL, doesn't that drop their margins, since they can't win and they are just throwing money into the wind? I guess the answer could be that they spend only a small percentage of money trying to break into another winner's market. But is that really true? Didn't Google spend a lot on G+? Another answer could be that their winner margins pre-attacks-on-other-winners are so high that even the money wasted does not lower margins to past averages. I'd also add that what these companies are dominant in is not what drives revenue. Facebook is dominant in social networking - but it's not social networking that drives revenues. It's advertising. Google dominates search. But search doesn't drive revenues. It's advertising. So while both Google and Facebook dominate their respective fields, they're still both in competition with each other for online ad dollars and I imagine that the price they charge for those ads is very much determinant on what others are charging for a similar quality product (similarly targeted, effective, etc.). They may dominant in their freely available products, but they are NOT dominant in the product they charge for. I also struggle with the winner take all argument...naturally, it is supported that we are in a winner take all environment with his chart of the top 20% and bottom 20%. But shouldn't the losses of the bottom 20% offset a large portion of the additional gains by the top 20% thereby neutralizing the impact on margins in aggregate? We'd have to see a revenue weighted chart to be sure, but I don't immediately buy that firms in the top 20% are carrying the whole index while ignoring the drag from the bottom 20%. My expectation that the main factor has been those mentioned in the article - lower interest rates allowing greater financing by debt which is tax efficient, increases leverage, and came at no additional carrying cost as rates fell and more debt could be rolled at lower and lower rates. Pair this with the limited ability for workers to demand higher wages in a stagnating economy and you get corporations that were able to maximize leverage to increase revenues while keeping a fairly flat cost structure while globalization allowed them to grow revenues elsewhere even as the U.S. stagnated. Revenues go up and cost structure remains flat = higher margins. So, what happens in a rising rate environment. Corporations are forced to roll record debt levels at higher and higher rates increasing the carrying impacting the bottom line. They'll also be issuing less debt and likely cutting CapEx as they are forced to pair down leverage to service the higher debt cost instead of borrowing to invest in growth. Negative impact to the bottom line is medium term as maturities roll to higher cost and the negative impact to the top line is a bit longer term as corporate investment is cut in favor of pairing down leverage to maintain the bottom line. Further, in a rising rate environment (a symptom of inflation), you'd expect the labor market to be tighter and for employees to have more job mobility and negotiating leverage to push pay up. So the corporate cost structure would rise for overhead as well also negatively impacting the bottom line and providing a higher bar for additional investment/growth. I really think the elevated margins of today are simply a symptom of the 30 year bull market in rates and the stagnation of the U.S. economy since 2000. I don't expect the economy to remain stagnated forever nor do I expect interest rates to remain in a perpetual decline so I would argue that margins will meaningfully revert when one or both of the reverse trends takes place.

Political ill-will. Politics has nothing to do with good outcomes, logic, or solutions. It has everything to do with getting your way and/or making sure your opponent suffers.

Yes, basically. Except it's the breach of implied covenant for the dividends and not the breach of K for liquidation preference. I hold preferred shares purely because of the political / rational solution which seems inevitable. But am I reading you correctly that you believe the appeals decision in aggregate was a net positive for pref holders? What kind of political/rational solution do you anticipate? It is almost a decade that they have been in conservatorship and nothing has taken place. Democrats want to kill Fannie and Freddie, reason for sweep and so do many of the Republicans. Are you hoping Mnuchin will do something on his own without congress? It appears that hedge funds own mostly pref shares and are most in news, so a political solution that benefits them would be highly unlikely. Do you agree? What would transpire a favorable political solution to pref shareholders after a decade? As someone who has worked extensively with retail investors, it seems very few even understand the difference between common and preferred shares. I don't think it really matters which part of the capital structure benefits more because 90% of the population can't tell you the difference to begin with.

Obviously dated in its application and meaning. Would have been more appropriate when he was growing up and social constructs were different, but agree that it's a bit uncouth in today's culture - especially with the whole "rape culture" that's been big in the news.

Can you talk a little about PEFIX? PIMCO/RAE fundamental index for emerging markets. Uses a Total Return Swap proxy for Research Affiliates' value weighted emerging market index and then invests the collateral in fixed income instruments to beat the Libor+spread on the TRS. Very similar to PIMCO's StocksPlus fund (also a high performing fund), but for emerging market, value weighted exposure instead of cap-weighted S&P. Was heavily overweight Brazil and mineral companies last year and was up ~50% as EM rallied. Top 1% of EM performers last year so may not do as hot this year and I've taken some gains, but ultimately I like the structural potential of returns from both fixed income and equities and its' value focus. Will probably be a long-term holding to get diversified EM exposure along with the single names I select. I used to hold that. Think I "traded" out of it at one point after a quick inconsequential gain. I'm sure to my detriment. I think I also got spooked out about PIMCO's use of derivatives generally, at some point. Certainly anytime you have leveraged exposure and then invest the collateral, it has the potential to go disastrously wrong. The long-term returns of the StocksPlus fund gives me some confidence that they are able to manage those risks appropriately. The key is to make sure the collateral isn't positively correlated with the underlying leveraged exposure. Nothing worse than having your collateral diminish in value just at the the time you need it. A portfolio of highly rated, highly liquid bond securities should be a reasonable hedge to a portfolio of EM equities. It's not like they're investing it all in EM fixed income as an offset to EM equities. Do you own the institutional version? Is there somewhere where you can get if for less than the $1m minimum? I do own the institutional shares. It's through my 401(k) at the moment, but most retirement accounts allow you to waive investment minimums or significantly lower them to $5,000-$10,000 so purchasing in an IRA/401(K) etc should help out with that.

I think 2:1 is a pretty low ratio for what most preferred shareholders would expect. Obviously, it's going to depend on where the common trades, but as of right now, I wouldn't be happy with anything less than 7-10:1. Could be willing to go lower if much of the uncertainty regarding their future, court rulings, and recap are ruled out, but that would also result in a higher common $ which makes a lower conversion ratio make sense.

Can you talk a little about PEFIX? PIMCO/RAE fundamental index for emerging markets. Uses a Total Return Swap proxy for Research Affiliates' value weighted emerging market index and then invests the collateral in fixed income instruments to beat the Libor+spread on the TRS. Very similar to PIMCO's StocksPlus fund (also a high performing fund), but for emerging market, value weighted exposure instead of cap-weighted S&P. Was heavily overweight Brazil and mineral companies last year and was up ~50% as EM rallied. Top 1% of EM performers last year so may not do as hot this year and I've taken some gains, but ultimately I like the structural potential of returns from both fixed income and equities and its' value focus. Will probably be a long-term holding to get diversified EM exposure along with the single names I select. I used to hold that. Think I "traded" out of it at one point after a quick inconsequential gain. I'm sure to my detriment. I think I also got spooked out about PIMCO's use of derivatives generally, at some point. Certainly anytime you have leveraged exposure and then invest the collateral, it has the potential to go disastrously wrong. The long-term returns of the StocksPlus fund gives me some confidence that they are able to manage those risks appropriately. The key is to make sure the collateral isn't positively correlated with the underlying leveraged exposure. Nothing worse than having your collateral diminish in value just at the the time you need it. A portfolio of highly rated, highly liquid bond securities should be a reasonable hedge to a portfolio of EM equities. It's not like they're investing it all in EM fixed income as an offset to EM equities.

If you do not understand the distinction between those terms this is likely not the discussion for you. Good luck understanding financials in general without that distinction. What a cop out. Illquidity differs from insolvency because it is temporary. I just finished arguing that they were unable to finance their operations in the private markets, which is why I was able to make that statement (I make additional arguments that further supported this posit, with the caveat that my assumptions are correct. Either way, I was clearly making generalizations and not writing a rigorous thesis - Again, context matters). You took this quote out of context, which was vital to being able to make the statement in the first place! If you don't want to or don't think it is worth discussing this (maybe because you don't think I'm qualified to do so), fine, but that's a different statement than what you made. If, like onyx1, you disagree about their access to funding (or any other assumption I made, which are necessary to arrive at my conclusion) then great, we can have that discussion. Maybe I have my history wrong. However, this is a bully move by grabbing a single statement out of context in an attempt to discredit me. Good luck investing with that attitude towards knowledge acquisition. Many of us don't debate the 2008 bailout. It's the unilateral re-negotiation of those terms to sweep 100% of profits and capital when it became clear the companies never needed the bailout and were going to be incredibly profitable that leaves a big stink over the gov't. As it stands, Fannie and Freddie were never insolvent. They had a liquidity need that the gov't provided in a moment of crisis for a STEEP price. Then, years later, it was realized that Fannie and Freddie were nowhere near as impaired as feared and were going to make a boatload even after paying the steep price. That's when the gov't said, "we can't allow that. We're going to steal it all," and then they did. It's this latter part that we take issue with.

Agreed 100%! Last year again they lost money with their equity investments. It’s hard to believe… I still like the business model of course, and I still like management (they have done a great job on the operating side of the business in recent years). But insurance without good investment capabilities is clearly unsatisfactory: they should prove they can be good stock pickers again. Cheers, Gio So, they've become an excellent insurance company but a horrible capital allocator. And I mean REALLY horrible. I've dumped the bulk of my Fairfax stock at this point. Hard to justify the results but, nevertheless, I don't blame them for the hedges. I shared their beliefs and it was a safe bet that simply didn't pan out. It happens. But no way you can justify some of these horrendous stock purchases. A 10 year old should have known several of them were losers with little potential and bad fundamentals. Of course, now that I've sold my shares it's probably a good time for the rest of you to buy. The stock will probably take off! I'm torn - I loved them when they were hedged, but recognized that it severely constrained EPS unless if they were correct. Now, they're completely unhedged at a time that I think it's more obvious than ever that you'd want to be, and I clearly don't understand their investment thoughts/process at all, but EPS has the potential to improve meaningfully now that their investment results may not be constrained...of course, the latter point cuts both ways (EPS can move meaningfully downward too once the billions are invested). I have bought more when prices were around $430-450 USD, but I'm far more uneasy about holding it long-term than I was prior to this year. More shares but in weaker hands I suppose....

how is trump going to find new shareholders to put up serious capital if the old shareholders are screwed? Same as with any other recapitalization or bankruptcy. I think that's a much harder sell. This isn't a typical bankruptcy/insolvency where shareholders hold responsibility for the management they put in place. This is instance where the government, in a crisis, took over control of the company under false pretenses and then unilaterally re-wrote the terms of the agreement of ceding control to screw the shareholders to the maximum amount possible even though hindsight showed shareholders never needed the government to step in to begin with. If the gov't can simply take a company into conservatorship based on concerns of what COULD happen, and then unilaterally turn that conservatorship into a liquidation when that company is still solvent and incredibly profitable, and then keep all those proceeds for itself without ever compensating shareholders, then you have a recipe for there never being a private solution to a crisis/potential crisis again. What shareholder is ever going to take the risk if the government can simply step in and renegotiate terms to sweep all profits to itself with no legal review whatsoever? What shareholder would step into such a politically polarizing company with the knowledge that the administration could simply steal it back at the next hint of any problems whatsoever. This really concerns me as a precedent for any future crisis, nationwide or company specific, where the gov't can simply absorb a company based on assumptions that never play out and never owe shareholders anything for it. I think the bulk of the global investor community would offer a very different account of events. The prevailing view, I think, is: FNMA/FMCC failed in about the most catastrophic way possible and were bailed out by the government (consistent with expectations that the government effectively guaranteed GSE debt). Economically, the equity and prefs were zeros. Had they simply been written off at the time, nobody would have blinked an eye (despite, according to your view, that being an even greater miscarriage of justice). But they weren't and a few hedge funds continue to fight a legal battle to recover a windfall gain. Should the GSEs get restructured into clean start capital structuers, there will be plenty of investors, same as there are in banks, insurance companies and so on - all of which exist with the understanding that the government has wide power to protect its guarantees. The risk of failing during a downturn widely applies to financial companies, and is accounted for in the required return on equity capital. ...except that isn't what happened. I also think your assumption that everyone would have bee ok had they wiped the equity out then isn't the case. I didn't start following until 2012, so I can't say for certain, BUT I imagine there would've been a MUCH higher bar needed for the gov't to actually wipe out 100% of equity interest than was needed for conservatorship. It's one thing to say "something really bad appears to be happening and we're going to take the reigns temporarily to ensure the companies survive" than it is to say "something really bad appears to be happening and we're going to wipe out your interest in the company based on assumptions we're making that we're not going to let play out."

Sigh, great timing... guess I can average down now. Sold all of my common (~30% of my position) and replaced it with a bit more preferred - overall position reduction of around 20% though. Purchased more of the preferred today after the 10-15% drop. Have replaced about 2/3 of the common position that was sold with preferred.

Can you talk a little about PEFIX? PIMCO/RAE fundamental index for emerging markets. Uses a Total Return Swap proxy for Research Affiliates' value weighted emerging market index and then invests the collateral in fixed income instruments to beat the Libor+spread on the TRS. Very similar to PIMCO's StocksPlus fund (also a high performing fund), but for emerging market, value weighted exposure instead of cap-weighted S&P. Was heavily overweight Brazil and mineral companies last year and was up ~50% as EM rallied. Top 1% of EM performers last year so may not do as hot this year and I've taken some gains, but ultimately I like the structural potential of returns from both fixed income and equities and its' value focus. Will probably be a long-term holding to get diversified EM exposure along with the single names I select.

how is trump going to find new shareholders to put up serious capital if the old shareholders are screwed? Same as with any other recapitalization or bankruptcy. I think that's a much harder sell. This isn't a typical bankruptcy/insolvency where shareholders hold responsibility for the management they put in place. This is instance where the government, in a crisis, took over control of the company under false pretenses and then unilaterally re-wrote the terms of the agreement of ceding control to screw the shareholders to the maximum amount possible even though hindsight showed shareholders never needed the government to step in to begin with. If the gov't can simply take a company into conservatorship based on concerns of what COULD happen, and then unilaterally turn that conservatorship into a liquidation when that company is still solvent and incredibly profitable, and then keep all those proceeds for itself without ever compensating shareholders, then you have a recipe for there never being a private solution to a crisis/potential crisis again. What shareholder is ever going to take the risk if the government can simply step in and renegotiate terms to sweep all profits to itself with no legal review whatsoever? What shareholder would step into such a politically polarizing company with the knowledge that the administration could simply steal it back at the next hint of any problems whatsoever. This really concerns me as a precedent for any future crisis, nationwide or company specific, where the gov't can simply absorb a company based on assumptions that never play out and never owe shareholders anything for it.