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Saturday 20 December 2008
Excessive Optimism the Biggest Mistake of 2008
Normally, the word “I” should have no place in a financial column like Monitor. But once a year I make an exception to the rule, looking back at the columns I’ve written over the last 12 months and seeing what I got right and where I went wrong.
Normally, the word “I” should have no place in a financial column like Monitor. But once a year I make an exception to the rule, looking back at the columns I’ve written over the last 12 months and seeing what I got right and where I went wrong.
I do this usually at New Year, but as I will be away for the next few weeks, this seems a good time to review my hits and misses of 2008.
Certainly, 2008 was a tremendously difficult year for anyone trying to peer into the financial future. There was an awful lot to be wrong about, and I got a lot of it wrong. But although I’ve been criticised by some readers for being too pessimistic, my biggest mistake of the year was being too positive on Hong Kong’s outlook.
On December 31 last year, I wrote “although 2008 could well be another volatile year, asset prices are likely to carry on rising in coming months. In fact, there is a real probability the bull market in Hong Kong stocks and properties could inflate into a full-blown bubble next year.”
The reasoning was simple. With inflation rising and interest rates negative in real terms, I reasoned savers would take their money out of bank deposits, where it was losing value, and invest it in asset markets.
That turned out to be wrong, but in retrospect, only half wrong. As the first chart below shows, the stock market had a terrible 2008. But the story in the property market was different, at least during the first few months of the year.
Between September 2007 and March this year, residential property prices climbed 27 per cent, according to the Centa-City index. That rise carried home values to more than double their 2003 low and did indeed leave the market looking bubbly. Prices have now fallen 21 per cent since June.
Although my initial Hong Kong stock market call was wildly out of whack, I had considerably more success in other areas.
For one thing, I was always sceptical about the commodities boom, arguing that the sharp run-up in prices over the first half of the year had far more to do with financial speculation than robust underlying demand for physical materials.
So last January, with the price of oil touching US$100 a barrel, I noted how “hedge funds have switched from playing the debt markets to trading oil” and warned that when the speculative bubble burst “we could easily see crude drop back to US$75 a barrel”. It was a warning I repeated in May, with the oil price at US$128 and analysts forecasting US$200 before long. Looking back, my predictions for the extent of the likely fall were far too modest. Yesterday, crude oil was trading at just US$40 a barrel.
I was also close to the mark with many of my predictions about the mainland’s markets and economy. During the first half of the year, I warned repeatedly that Beijing’s efforts to prop up the ailing A-share market would fail, and that the market would have to find a natural bottom. Between January and November, the Shanghai composite had dropped 69 per cent.
My warnings that the mainland authorities watch the yuan’s trade-weighted basket rather than its US dollar exchange rate when managing their currency policy, and that they would not hesitate to steer a depreciation should export demand weaken, also proved correct. As the second chart below shows, the yuan’s trade-weighted index has fallen 6 per cent over the last month.
But my best call of the year was probably the warning, first delivered in March, that the hedge fund industry was in trouble and at risk of “a mass deleveraging that will hammer financial markets around the world”. It was a warning I repeated at the beginning of October, arguing that stock markets were in imminent danger of going into a “death spiral”. Over the next few weeks, Hong Kong’s Hang Seng Index plunged 40 per cent.
Hopefully, that timely warning made up for my misguided optimism earlier in the year.
In his first interview since the world financial crisis, Gao Xiqing, the man who oversees $200 billion of China’s $2 trillion in dollar holdings, explains why he’s betting against the dollar, praises American pragmatism, and wonders about enormous Wall Street paychecks. And he has a friendly piece of advice:
Americans know that China has financed much of their nation’s public and private debt. During the presidential campaign, Barack Obama and John McCain generally agreed on the peril of borrowing so heavily from this one foreign source. For instance, in their final debate, McCain warned about the “$10 trillion debt we’re giving to our kids, a half a trillion dollars we owe China,” and Obama said, “Nothing is more important than us no longer borrowing $700billion or more from China and sending it to Saudi Arabia.” Their numbers on the debt differed, and both were way low. One year ago, when I wrote about China’s U.S. dollar holdings, the article was called “The $1.4 trillion Question.” When Barack Obama takes office, the figure will be well over $2 trillion.
During the late stages of this year’s campaign, I had several chances to talk with the man who oversees many of China’s American holdings. He is Gao Xiqing, president of the China Investment Corporation, which manages “only” about $200billion of the country’s foreign assets but makes most of the high-visibility investments, like buying stakes in Blackstone and Morgan Stanley, as opposed to just holding Treasury notes.
Gao, whom I mentioned in my article, would fit no American’s preexisting idea of a Communist Chinese official. He speaks accented but fully colloquial and very high-speed English. He has a law degree from Duke, which he earned in the 1980s after working as a lawyer and professor in China, and he was an associate in Richard Nixon’s former Wall Street law firm. His office, in one of the more tasteful new glass-walled high-rises in Beijing, itself seems less Chinese than internationally “fusion”-minded in its aesthetic and furnishings. Bonsai trees in large pots, elegant Japanese-looking arrangements of individual smooth stones on display shelves, Chinese and Western financial textbooks behind the desk, with a photo of Martin Luther King Jr. perched among the books. Two very large, very thin desktop monitors read out financial data from around the world. As we spoke, Western classical music played softly from a good sound system.
Gao dressed and acted like a Silicon Valley moneyman rather than one from Wall Street—open-necked tattersall shirt, muted plaid jacket, dark slacks, scuffed walking shoes. Rimless glasses. His father was a Red Army officer who was on the Long March with Mao. As a teenager during the Cultural Revolution, Gao worked on a railroad-building gang and in an ammunition factory. He is 55, fit-looking, with crew-cut hair and a jokey demeanor rather than an air of sternness.
His comments below are from our one on-the-record discussion, two weeks before the U.S. elections. As I transcribed his words, I realized that many will look more astringent on the page than they sounded when coming from him. In person, he seemed to be relying on shared experience in the United States—that is, his and mine—to entitle him to criticize the country the way its own people might. The conversation was entirely in English. Because Gao’s answers tended to be long, I am not presenting them in straight Q&A form but instead grouping his comments about his main recurring themes.
Does America wonder who its new Chinese banking overlords might be? This is what one of the very most influential of them had to say about the world financial crisis, what is wrong with Wall Street, whether one still-poor country with tremendous internal needs could continue subsidizing a still-rich one, and how he thought America could adjust to its “realistic” place in the world. My point for the moment is to convey what it is like to hear from such a man, rather than to expand upon, challenge, or agree with his stated views.
About the financial crisis of 2008, which eliminated hundreds of billions of dollars’ worth of savings that the Chinese government had extracted from its people, through deliberately suppressed consumption levels:
We are not quite at the bottom yet. Because we don’t really know what’s going to happen next. Everyone is saying, “Oh, look, the dollar is getting stronger!” [As it was when we spoke.] I say, that’s really temporary. It’s simply because a lot of people need to cash in, they need U.S. dollars in order to pay back their creditors. But after a short while, the dollar may be going down again. I’d like to bet on that!
The overall financial situation in the U.S. is changing, and that’s what we don’t know about. It’s going to be changed fundamentally in many ways.
Think about the way we’ve been living the past 30 years. Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking.
People, especially Americans, started believing that they can live on other people’s money. And more and more so. First other people’s money in your own country. And then the savings rate comes down, and you start living on other people’s money from outside. At first it was the Japanese. Now the Chinese and the Middle Easterners.
We—the Chinese, the Middle Easterners, the Japanese—we can see this too. Okay, we’d love to support you guys—if it’s sustainable. But if it’s not, why should we be doing this? After we are gone, you cannot just go to the moon to get more money. So, forget it. Let’s change the way of living. [By which he meant: less debt, lower rewards for financial wizardry, more attention to the “real economy,” etc.]
About stock market derivatives and their role as source of evil:
If you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit. They are crap. They serve to cheat people.
I was predicting this many years ago. In 1999 or 2000, I gave a talk to the State Council [China’s main ruling body], with Premier Zhu Rongji. They wanted me to explain about capital markets and how they worked. These were all ministers and mostly not from a financial background. So I wondered, How do I explain derivatives?, and I used the model of mirrors.
First of all, you have this book to sell. [He picks up a leather-bound book.] This is worth something, because of all the labor and so on you put in it. But then someone says, “I don’t have to sell the book itself! I have a mirror, and I can sell the mirror image of the book!” Okay. That’s a stock certificate. And then someone else says, “I have another mirror—I can sell a mirror image of that mirror.” Derivatives. That’s fine too, for a while. Then you have 10,000 mirrors, and the image is almost perfect. People start to believe that these mirrors are almost the real thing. But at some point, the image is interrupted. And all the rest will go.
When I told the State Council about the mirrors, they all started laughing. “How can you sell a mirror image! Won’t there be distortion?” But this is what happened with the American economy, and it will be a long and painful process to come down.
I think we should do an overhaul and say, “Let’s get rid of 90 percent of the derivatives.” Of course, that’s going to be very unpopular, because many people will lose jobs.
About Wall Street jobs, wealth, and the cultural distortion of America:
I have to say it: you have to do something about pay in the financial system. People in this field have way too much money. And this is not right.
When I graduated from Duke [in 1986], as a first-year lawyer, I got $60,000. I thought it was astronomical! I was making somewhere a bit more than $80,000 when I came back to China in 1988. And that first month’s salary I got in China, on a little slip of paper, was 59 yuan. A few dollars! With a few yuan deducted for my rent and my water bill. I laughed when I saw it: 59 yuan!
The thing is, we are working as hard as, if not harder than, those people. And we’re not stupid. Today those people fresh out of law school would get $130,000, or $150,000. It doesn’t sound right.
Individually, everyone needs to be compensated. But collectively, this directs the resources of the country. It distorts the talents of the country. The best and brightest minds go to lawyering, go to M.B.A.s. And that affects our country, too! Many of the brightest youngsters come to me and say, “Okay, I want to go to the U.S. and get into business school, or law school.” I say, “Why? Why not science and engineering?” They say, “Look at some of my primary-school classmates. Their IQ is half of mine, but they’re in finance and now they’re making all this money.” So you have all these clever people going into financial engineering, where they come up with all these complicated products to sell to people.
About the $700 billion U.S. financial-rescue plan enacted in October:
Finally, after months and months of struggling with your own ideology, with your own pride, your self-right-eousness … finally [the U.S. applied] one of the great gifts of Americans, which is that you’re pragmatic. Now our people are joking that we look at the U.S. and see “socialism with American characteristics.” [The Chinese term for its mainly capitalist market-opening of the last 30 years is “socialism with Chinese characteristics.”]
It is joking, and many people are saying: “No, Americans still believe in free capitalism and they think this is just a hiccup.” This is like our great leader Deng Xiaoping, who said that it doesn’t matter if the cat is white or black, as long as it catches the mouse. It doesn’t matter what we call this. It’s pragmatic.
With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?
Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. [This is the famous modern “balance of financial terror.” If Chinese officials started pulling assets out of the U.S. and touched off a run on the dollar, their vast remaining dollar holdings would plummet in value.] So we’re trying to help, at least by not aggravating the problem.
But I think at the end of the day, the American government needs to talk with people and say: “Why don’t we get together and think about this? If China has $2 trillion, Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone.” We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.
On what might make the Chinese government start taking its dollars out of America (I began the question by saying that China would hurt itself by pulling out dollar assets—at which he interjected, “in the short term”—and then asked about the long-term view):
Today when we look at all the markets, the U.S. still is probably the most viable, the most predictable. I was trained as a lawyer, and predictability is always very important for me.
We have a PR department, which collects all the comments about us, from Chinese newspapers and the Web. Every night, I try to pick a time when I’m in a relatively good mood to read it, because most of the comments are very critical of us. Recently we increased our holdings in Blackstone a little bit. Now we’re increasing a little bit our holdings in Morgan Stanley, so as not to be diluted by the Japanese. People here hate it. They come out and say, “Why the hell are you trying to save those people? You are the representative of the poor people eating porridge, and you’re saving people eating shark fins!” It’s always that sort of thing.
And how should Americans feel about the growing Chinese presence in their economy? Isn’t it natural for them to worry that China will keep increasing its stake in American debt and assets—or that China won’t, essentially cutting America off?
I can understand why Americans might feel that way. But, talking with my lawyer head once again, it’s not relevant to discuss how Americans “should” think. We should discuss how Americans might think.
This concern is not really about China itself. It could be any country. It could be Japan, or Germany. This generation of Americans is so used to your supremacy. Your being treated nicely by everyone. It hurts to think, Okay, now we have to be on equal footing to other people. “On equal footing” would necessarily mean that sometimes you have to stoop to appear to be humble to other people.
And you can’t think as a soldier. You put yourself at the enemy end of everyone. I grew up during the Cultural Revolution, when people really treated other people like enemies. I grew up in an environment where our friends, our relatives, people I called Uncle or Auntie, could turn around and put a nasty face to me as a small child. One time, Vladimir Lenin told Gorky, after reading Gorky’s autobiography, “Oh my god! You could have become a very nasty person!” Those are exactly the words one of my dear professors told me after hearing what I went through.
But over the years, I believe I learned to be humble. To treat other people nicely. I learned that, from a social point of view, no matter how lowly statured a person you are talking to, as a person, they are the same human being as you are. You have to respect them. You have to apologize if you inadvertently hurt them. And often you have to go out of your way to be nice to them, because they will not like you simply because of the difference in social structure.
Americans are not sensitive in that regard. I mean, as a whole. The simple truth today is that your economy is built on the global economy. And it’s built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and … I won’t say kowtow [with a laugh], but at least, be nice to the countries that lend you money.
Talk to the Chinese! Talk to the Middle Easterners! And pull your troops back! Take the troops back, demobilize many of the troops, so that you can save some money rather than spending $2 billion every day on them. And then tell your people that you need to save, and come out with a long-term, sustainable financial policy.
Although Gao has frequently mentioned Chairman Mao’s maxim—“Go with the Republicans. They’re predictable!”—he obviously was hoping for a “change” agenda under the Democrats:
The current conditions can’t go on. It is time for the new government, under Obama or even McCain, to really tell people: “Look, this is wartime, this is about the survival of our nation. It’s not about our supremacy in the world. Let’s not even talk about that any more. Let’s get down to the very basics of our livelihood.”
I have great admiration of American people. Creative, hard-working, trusting, and freedom-loving. But you have to have someone to tell you the truth. And then, start realizing it. And if you do it, just like what you did in the Second World War, then you’ll be great again!
If that happens, then of course—American power would still be there for at least as long as I am living. But many people are betting on the other side.
Credit Suisse to Use Illiquid Assets to Pay Bonuses
By Christine Harper
Dec. 18 (Bloomberg) -- Credit Suisse Group AG’s investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees’ year-end bonuses.
The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.
“While the solution we have come up with may not be ideal for everyone, we believe it strikes the appropriate balance among the interests of our employees, shareholders and regulators and helps position us well for 2009,” Chief Executive Officer Brady Dougan and Paul Calello, CEO of the investment bank, said in the memo.
The securities will be placed into a so-called Partner Asset Facility, and affected employees at the bank, Switzerland’s second biggest, will be given stakes in the facility as part of their pay. Bonuses will take the first hit should the securities decline further in value.
“It’s monstrously clever,” said Dirk Hoffman-Becking, an analyst at Sanford C. Bernstein Ltd. in London who has a “market perform” rating on Credit Suisse stock. “From a shareholders’ perspective it’s great because you’ve got rid of some of the assets and regulators will be pleased because you’ve organized a risk transfer.”
‘Better Than Nothing’
For employees, “there’s some upside in there and if the alternative is nothing, it’s a lot better than nothing,” Hoffman-Becking said.
Credit Suisse said earlier this month it would eliminate 5,300 jobs and cancel bonuses for top executives after it had about 3 billion Swiss francs ($2.8 billion) of losses in October and November. Unlike larger Swiss rival UBS AG, Credit Suisse hasn’t received a government rescue. Banks and securities firms are struggling to pay employee bonuses after taking more than $800 billion of losses on mortgages and corporate loans.
Writedowns on leveraged finance commitments at Credit Suisse have amounted to 3.5 billion francs since the beginning of the crisis, while the bank marked down its commercial mortgage holdings by 2.9 billion francs.
Outside Investors
Credit Suisse is the first to use the debt to pay employees. Outside investors may also be permitted to invest in the facility, according to the people familiar with the matter, who declined to be identified because the plan hasn’t been made public. The bank will boost the potential for returns by providing leverage to the facility, and will be paid back first, according to the people.
Leveraged-loan commitments on Credit Suisse’s books fell to between 2.5 billion Swiss francs and 3 billion francs by the end of November from 11.9 billion francs at the end of September, Dougan said on a conference call on Dec. 4. He said the bank had also “somewhat reduced” its commercial real estate positions. Credit Suisse had 12.8 billion francs in commercial mortgages at the end of September.
Assets in the facility will remain on Credit Suisse’s balance sheet and will be held in the company’s fund management division, the people familiar with the plan said. The new structure will mean that any mark-to-market losses or gains on the assets will be offset by identical gains, or losses, on the bank’s liability to employees.
Coupon Payments
Employees will receive semi-annual coupon payments on their investment in the Partner Asset Facility at the London Interbank Offered Rate plus 2.50 percentage points. The ultimate value of the facility will be determined over the next eight years as the loans and securities mature or default, the people said.
“Cash payments representing distributions of a portion of the award may be made to participants in the future contingent on the performance of the underlying assets,” Dougan and Calello said in the memo. “Cash distributions will not be made for several years.”
The bank said it expects to begin annual payments after five years.
While Credit Suisse doesn’t say how many managing directors and directors work at the investment bank, the number is in the thousands.
Credit Suisse said it will also change the cash portion of bonuses for all of the bank’s managing directors and for directors in the investment bank. Under the new system, the bank will have the right to recoup some of the cash bonus in the two years after it’s paid if an employee resigns.
Singapore to convene wage council, may cut pensions
SINGAPORE, Dec 16 (Reuters) - Singapore will convene its National Wages Council (NWC) in early January, four months ahead of schedule, in what economists say may be a prelude to a cut in employers' pension contributions.
'Given the weakening economic situation, there is a need for the NWC to take stock of the new situation and review its May guidelines to help companies and workers manage the downturn,' the Manpower Ministry said in a statement on Tuesday.
The ministry did not immediately respond to questions about the detailed agenda for the NWC's January meeting.
'At the last crisis, they cut the CPF (Central Provident Fund) and I won't be surprised if they did it again,' said Joseph Tan, Singapore-based Asia chief economist for private banking at Credit Suisse.
'Between cutting wages and letting people go, the government's preference is to keep jobs.'
The government last cut employers' contributions to the CPF, the retirement fund for Singaporean workers, by 3 percentage points to 13 percent in October 2003 to help firms cope with the effects of the SARS outbreak.
The NWC, which comprises representatives from government, employers and unions, usually meets in May to come out with wage guidelines for the following 12 months.
The cuts were partially restored last year and the employers' contribution rate currently stands at 14.5 percent on the first S$4,500 ($3,049) of an employee's monthly salary.
Singapore fell into a recession in the third quarter and the government has warned that the economy may shrink by one percent next year.
"The thing I didn't do, from Day One, was properly assess the severity of the liquidity crisis… Every decision to buy anything has been wrong." - Bill Miller, manager, Value Trust
The Stock Picker's Defeat
By TOM LAURICELLA DECEMBER 11, 2008
William H. Miller spent nearly two decades building his reputation as the era's greatest mutual-fund manager. Then, over the past year, he destroyed it.
Fueled by winning bets on stocks other investors feared, Mr. Miller's Legg Mason Value Trust outperformed the broad market every year from 1991 to 2005. It's a streak no other fund manager has come close to matching.
Mr. Miller was in his element a year ago when troubles in the housing market began infecting financial markets. Working from his well-worn playbook, he snapped up American International Group Inc., Wachovia Corp., Bear Stearns Cos. and Freddie Mac. As the shares continued to fall, he argued that investors were overreacting. He kept buying.
What he saw as an opportunity turned into the biggest market crash since the Great Depression. Many Value Trust holdings were more or less wiped out. After 15 years of placing savvy bets against the herd, Mr. Miller had been trampled by it.
The financial crisis has created losers across the spectrum -- homeowners who can't afford their subprime mortgages, banks that loaned to them, investors who bought mortgage-backed securities and, as financial markets eventually crumbled, just about everyone who owned shares. But it has also brought low contrarians like Mr. Miller who had been lionized for staying a step ahead of the market. This meltdown has provided a lesson for Mr. Miller and other "value" investors: A stock may look tantalizingly cheap, but sometimes that's for good reason.
"The thing I didn't do, from Day One, was properly assess the severity of this liquidity crisis," Mr. Miller, 58 years old, said in an interview at Legg Mason Inc.'s Baltimore headquarters.
Mr. Miller has profited from investor panics before. But this time, he said, he failed to consider that the crisis would be so severe, and the fundamental problems so deep, that a whole group of once-stalwart companies would collapse. "I was naive," he said.
A year ago, his Value Trust fund had $16.5 billion under management. Now, after losses and redemptions, it has assets of $4.3 billion, according to Morningstar Inc. Value Trust's investors have lost 58% of their money over the past year, 20 percentage points worse than the decline on the Standard & Poor's 500 stock index.
These losses have wiped away Value Trust's years of market-beating performance. The fund is now among the worst-performing in its class for the last one-, three-, five- and 10-year periods, according to Morningstar.
"Why didn't I just throw my money out of the window -- and light it on fire?" says Peter Cohan, a management consultant and venture-capital investor who owns Value Trust shares. Mr. Miller's strategy, he says, "worked for a long time, but it's broken."
Mr. Miller's picks read like a Who's Who of the stock market's biggest losers: Washington Mutual Inc., Countrywide Financial Corp. and Citigroup Inc.
"Every decision to buy anything has been wrong," Mr. Miller said over lunch at a private club housed inside Legg's headquarters. In the 16th-floor dining room, Mr. Miller sat with his back against the wall, a preference he says he picked up as a U.S. Army intelligence officer in the 1970s. "It's been awful," he said.
Mr. Miller is chairman of Legg Mason Capital Management, a group of six mutual funds. He personally oversees Value Trust and the smaller Opportunity Trust. Although Mr. Miller's group accounts for only about $28 billion of Legg Mason's $840 billion in total assets, the firm's reputation is intertwined with that of its marquee star. Legg's stock is down 75% this year. The firm's woes have weighed on private-equity firm Kohlberg Kravis Roberts & Co., which took a $1.25 billion stake in Legg early this year.
Questions now swirl about whether Mr. Miller will quit or be replaced. He says his group's board of directors will decide whether he stays or goes, but he's not planning on calling it quits. Mark Fetting, Legg's chief executive and chairman of the board that oversees Mr. Miller's funds, said he supports Mr. Miller and his plans to improve performance.
Early Bet on RCA
Growing up in Florida, Bill Miller took an early interest in the market. As a high-schooler in the late 1960s, he says he invested the money he earned umpiring baseball games in stocks like RCA, making enough to buy a broken-down Ford. In the mid-1970s, in Germany during his Army stint, he visited a brokerage office in Munich to buy Intel Corp. shares. He studied philosophy in graduate school, but left to join a Pennsylvania manufacturing company where he eventually oversaw its investments.
By the early 1980s, Mr. Miller's then-wife worked at Legg Mason. Through her, Mr. Miller met the brokerage's founder, Raymond "Chip" Mason. Mr. Mason said he was thinking of starting some mutual funds. Mr. Miller jumped. He joined Legg Mason in 1981. Value Trust launched in 1982, with Mr. Miller as co-manager.
In 1984, Mr. Miller paid a visit to influential Fidelity Investments manager Peter Lynch, who suggested Mr. Miller take a look at Fannie Mae. Much like today, the mortgage company had a portfolio full of troubled loans. Traders were betting it would go bust.
Mr. Miller found Fannie's case compelling: The bad loans would soon roll off its books, he recalls, the government-backed company would be able to borrow at preferred rates and its low cost structure could make it hugely profitable. "Is this thing really trading at only two times what it's going to earn in three or four years?" Mr. Miller recalls asking Mr. Lynch in a follow-up phone call.
Mr. Miller figures that by the time he sold out of Fannie in 2005, he had made 50 times his money.
All or Nothing
Such all-or-nothing bets would come to define Mr. Miller's style. He usually holds about three dozen stocks at a time, compared with a hundred or so in a typical mutual-fund portfolio. He has welcomed negative sentiment about companies, which has let him buy stocks as their prices fall, "averaging down" the per-share price he pays. The strategy can net him big stakes in companies -- an enviable position if shares rally and a sticky one if he needs to sell.
When asked how he would know he made a mistake in buying a falling stock, Mr. Miller once retorted: "When we can no longer get a quote." In other words, the only price at which he was unwilling to buy more was zero.
Mr. Miller's swing-for-the-fences approach makes even other value investors flinch. Christopher Davis, a friend of Mr. Miller's and a money manager at Davis Funds, recalls discussing his investment strategy with Mr. Miller in the early 1990s. "One of my goals is to just be right more than I'm wrong," Mr. Davis recalls telling Mr. Miller.
" 'That's really stupid,' " Mr. Miller countered, according to Mr. Davis. "Bill said, 'What matters is how much you make when you're right. If you're wrong nine times out of 10 and your stocks go to zero -- but the tenth one goes up 20 times -- you'll be just fine,' " Mr. Davis recalls. "I just can't live like that."
During the savings-and-loan crisis in 1990 and 1991, Mr. Miller loaded up on American Express Corp., mortgage giant Freddie Mac and struggling banks and brokerages. Financials eventually made up more than 40% of his portfolio.
He looked wrong at first. But these stocks eventually propelled Value Trust to the top of the performance charts. In 1996, Value Trust gained 38%, outpacing the S&P 500 by more than 15 percentage points. By then, Mr. Miller was loading up on AOL, computer makers and other out-of-favor tech stocks.
His good bets more than made up for the bad. Between 1998 and 2002, 10 stocks in the Value Trust portfolio lost 75% or more. Three, including Enron and WorldCom, went bankrupt.
As his winning streak grew, Mr. Miller's name was often preceded in press reports with the word "legendary." He was mentioned alongside the likes of Fidelity's Mr. Lynch. Legg Mason, meanwhile, grew from a regional brokerage house into one of the planet's largest money managers.
In 1999, he cut an unusually lucrative deal with Legg Mason to take the reins of Opportunity Trust, a new fund. The fund's management fees went to an entity half-owned by Mr. Miller. From 2005 through 2007, Opportunity Trust paid the entity $137 million. In 2006, he bought a 235-foot yacht, "Utopia."
Investing is Mr. Miller's obsession, friends say. On visits to Manhattan, he convenes chief executives, stock analysts and other money managers for steak dinner at the Post House to discuss investment ideas. His yacht aside, these friends say, Mr. Miller pays little attention to wealth's trappings: His work shoes are a pair of black loafers, purchased at Nordstrom, that he gets resoled again and again.
In 2006, Mr. Miller's outperformance streak finally broke when he missed out on big gains in energy stocks. His performance suffered again in early 2007, thanks to losses in home-building stocks he had bought following signs of trouble in the real-estate market.
Seen It Before
In the early summer of 2007, two Bear Stearns hedge funds that made big bets on low-quality mortgages imploded. The stock market whipsawed in July and August, as investors worried that housing-market troubles could spread.
Mr. Miller thought investors were too pessimistic about the housing and credit markets. In the third quarter, he bought Bear Stearns. In the fourth quarter, as financial stocks fell, he took positions in Merrill Lynch & Co., Washington Mutual, Wachovia and Freddie Mac.
Explaining his moves to his shareholders in a fourth-quarter update, he compared the period to 1989-90, when he had also bought beaten-down banks. "Sometimes market patterns recur that you believe you have seen before," he wrote. "Financials appear to have bottomed."
In 2008, Mr. Miller continued to accumulate Bear Stearns. At a conference on Friday, March 14, he boasted that he had bought just that morning at a bargain price, north of $30 a share -- down from a recent high of $154.
Bear Stearns collapsed that weekend. In a takeover brokered by the Federal Reserve, J.P. Morgan Chase & Co. acquired the storied investment house in a deal that first valued it at $2 a share.
Mr. Miller and his team spent the following days and evenings trying to figure out what had gone wrong. Mr. Miller, who also owns J.P. Morgan shares, says he called J.P. Morgan Chief Executive Jamie Dimon to run his Bear Stearns valuations past him.
Mr. Miller says the conversation with Bear Stearns's new owner left him satisfied that he'd fairly valued the investment house's troubled mortgage holdings. But his team had missed Bear Stearns's vulnerability to a "run on the bank" collapse: The heavily leveraged firm was borrowing huge sums to function day-to-day, and when lenders walked away, it collapsed. Mr. Miller says he was also surprised that the Federal Reserve would play an active role in a transaction that would let stockholders be largely wiped out.
Mr. Miller worried that Wachovia and Washington Mutual were vulnerable to a similar squeeze on capital. He sold both.
But he didn't abandon financials. During the second quarter, he added to Freddie Mac and insurer AIG. In an April letter to shareholders, he wrote that the rebounding stock and bond markets suggested a corner had been turned. "The credit panic ended with the collapse of Bear Stearns," he wrote. "By far the worst is behind us."
By the end of June, Mr. Miller's group held 53 million Freddie shares -- about 8% of the company.
Financial stocks continued to fall though the spring and summer. Many value investors, such as John Rogers at Ariel Investments, sold or at least stopped buying the sector.
With Freddie and Fannie under particular pressure, some at Legg Mason Capital Management were worried that group-think had set in. "There were hedge-fund guys out there arguing that Fannie and Freddie were going to zero," said Sam Peters, a fund manager in Mr. Miller's group.
Red Team's Report
Mr. Peters, whose fund also owned Freddie Mac, suggested putting together a team of Legg research analysts to argue the case against Freddie. In early-August meetings devoted to the mortgage giant, the so-called "Red Team" said Freddie may need to raise substantial capital, which would massively dilute existing stockholders' shares.
Mr. Peters stopped accumulating Freddie shares. Mr. Miller kept buying them for his Opportunity Trust portfolio.
The risk, as Mr. Miller saw it, was that the housing market could perform worse than he expected. But he dismissed talk that the government could nationalize Freddie and Fannie. He took comfort in Treasury Secretary Henry Paulson's mid-July statement that the government was focused on supporting the agencies in their "current form." If anything, he believed, Freddie would recapture market share as private-sector competitors failed.
By the end of August, declines in AIG and Freddie left Value Trust down 33% over the previous 12 months -- 21 percentage points worse than the S&P 500 over the same period. Mr. Mason, Legg's founder, received complaints from brokers about Mr. Miller. Mr. Fetting, Legg's chief executive, fielded questions about whether Mr. Miller would be replaced.
The news got worse on the weekend of Sept. 6 and 7. The Treasury announced it was taking over Fannie and Freddie, rendering private shareholders' stakes nearly worthless. On Monday, shares in Freddie, which had started the year at $34 and entered the weekend at $5, were trading at less than $1. A government takeover was the one outcome for which Mr. Miller hadn't prepared.
New Rules
He realized then that his old playbook had failed him. He began to bail out of AIG, which insured the debt of many troubled financial firms. How could his group managers invest in financials if "we don't know the rules," Mr. Peters remembers him saying.
In September, the Baltimore police and fire retirement pension board reportedly fired Mr. Miller from their $2.2 billion fund. A representative for the board did not return calls seeking comment.
Mr. Miller and his staff, who invest alongside shareholders in their funds, have also felt the pain. For the first time, Mr. Miller's group fired staff, an experience he calls "devastating." Mr. Miller won't disclose his personal worth or losses.
The fund manager says he's adjusting his stock-picking screens for a new world, in which he expects investors to be risk-averse for several years. He's re-reading a biography of John Maynard Keynes, focusing on the famed economist's experience as a money manager during the 1930s. He says he's scouring markets for industry-leading companies with big dividends. He thinks there are also opportunities in battered corporate bonds.
But improving performance will take a long time, he says. "I can't accelerate it."
Mr. Miller notes that in the final years of his winning streak, people often asked him why he didn't quit while he was ahead. Asked over lunch whether he wished he had stepped aside then, he looked out the window, over Baltimore's Inner Harbor. "That would have been a really smart thing to have done," he said, adding he has no plans to step aside.
"The idea of him retiring to the Riviera just isn't him," says his friend, Mr. Davis. "The money has meaning, but the record is a lot more meaningful."
SEC Report: Employees Browsed Porn, Ran Private Businesses
by Jake Bernstein December 19, 2008
The Securities and Exchange Commission is taking a drubbing these days for its abject failure―despite detailed tips―to catch Bernie Madoff in what appears to be the biggest Ponzi scheme in our nation’s history.
Now, thanks to little-noticed report from the agency’s inspector general, we have a detailed glimpse into other bad behavior by some SEC employees.
The report, released the day after Thanksgiving, reveals that some employees at the agency were clearly preoccupied with matters other than their mission of "protecting investors and maintaining fair, orderly, and efficient markets." The semi-annual report to Congress, which covers the period from this past April to September, details among other things a handful of employees circumventing internal controls to download porn. Let’s pause for some detail:
[Investigators] uncovered evidence that an employee who was still in his probationary period had used his SEC laptop computer to attempt to access Internet websites classified as containing pornography, resulting in hundreds of access denials. The OIG investigation also disclosed that this employee successfully bypassed the Commission’s Internet filter by using a flash drive.
Presumably, that’s not the kind of initiative the SEC is looking for.
There were also more serious misdeeds raised by the report. For example, there is the case of the senior-level commission employee who "clearly and purposefully identified herself as a Commission employee when dealing with brokers about a family member’s account," making the broker in question feel like she was trying to "intimidate and bully him." The OIG referred the matter to management for "disciplinary action, up to and including dismissal." By the end of the period covered in the report, management "had not proposed or taken action."
There are other examples where the punishment was less than fulsome.
Investigators found employees in separate offices operated private photography businesses out of the commission:
An employee repeatedly and flagrantly used Commission resources, including Commission Internet access, e-mail, telephone and printer, in support of his private photography business for several years.
The IG’s office recommended "disciplinary action up to and including dismissal." In turn, the report notes, "management suspended the employee from duty and pay for nine calendar days."
When asked about the report, Deputy Director for Public Affairs John Heine said, "In each of these [cases] there is some sort of response from the Commission. We don’t have anything to say beyond that."
The report reveals also that two commission staffers employed as attorneys didn’t have active bar memberships. One attorney let his bar license lapse in 1994. The report said one of the lapsed lawyers "submitted a declaration in Federal court, in which he stated that he was an attorney employed by the SEC. We referred the potential false statement or perjury to the applicable United States Attorney’s office." (The office declined to prosecute.)
The IG also found that the commission did not have a sufficient system in place to "prevent and detect insider trading on the part of Commission employees or violations of the Commission’s rules."
The agency’s information management also comes in for criticism. An employee survey conducted by the inspector general revealed that employees failed to enter data into a computer system used to manage investigations. The system known as the HUB was launched in August 2007 after the Government Accountability Office had highlighted major problems with the SEC’s previous case management and tracking system. The IG semi-annual report also reveals that the commission lacks "an inventory of its laptops and was unable to trace ownership of laptops to specific individuals."
My idea of a perfect Christmas Is to spend it with you In a party or dinner for two Anywhere would do Celebrating the yuletide season Always lights up our lives Simple pleasures are made special too When they're shared with you
Looking through some old photographs Faces and friends we'll always remember Watching busy shoppers rushing about In the cool breeze of December Sparkling lights all over town Children's carols in the air By the Christmas tree A shower of stardust on your hair
I can't think of a better Christmas Than my wish coming true And my wish is that you'd let me spend My whole life with you
Looking through some old photographs Faces and friends we'll always remember Watching busy shoppers rushing about In the cool breeze of December Sparkling lights all over town Children's carols in the air By the Christmas tree A shower of stardust on your hair
I can't think of a better Christmas Than my wish coming true And my wish is that you'd let me spend My whole life with you
My idea of a perfect Christmas Is spending it with you
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Excessive Optimism the Biggest Mistake of 2008
Tom Holland
19 December 2008
Normally, the word “I” should have no place in a financial column like Monitor. But once a year I make an exception to the rule, looking back at the columns I’ve written over the last 12 months and seeing what I got right and where I went wrong.
I do this usually at New Year, but as I will be away for the next few weeks, this seems a good time to review my hits and misses of 2008.
Certainly, 2008 was a tremendously difficult year for anyone trying to peer into the financial future. There was an awful lot to be wrong about, and I got a lot of it wrong. But although I’ve been criticised by some readers for being too pessimistic, my biggest mistake of the year was being too positive on Hong Kong’s outlook.
On December 31 last year, I wrote “although 2008 could well be another volatile year, asset prices are likely to carry on rising in coming months. In fact, there is a real probability the bull market in Hong Kong stocks and properties could inflate into a full-blown bubble next year.”
The reasoning was simple. With inflation rising and interest rates negative in real terms, I reasoned savers would take their money out of bank deposits, where it was losing value, and invest it in asset markets.
That turned out to be wrong, but in retrospect, only half wrong. As the first chart below shows, the stock market had a terrible 2008. But the story in the property market was different, at least during the first few months of the year.
Between September 2007 and March this year, residential property prices climbed 27 per cent, according to the Centa-City index. That rise carried home values to more than double their 2003 low and did indeed leave the market looking bubbly. Prices have now fallen 21 per cent since June.
Although my initial Hong Kong stock market call was wildly out of whack, I had considerably more success in other areas.
For one thing, I was always sceptical about the commodities boom, arguing that the sharp run-up in prices over the first half of the year had far more to do with financial speculation than robust underlying demand for physical materials.
So last January, with the price of oil touching US$100 a barrel, I noted how “hedge funds have switched from playing the debt markets to trading oil” and warned that when the speculative bubble burst “we could easily see crude drop back to US$75 a barrel”. It was a warning I repeated in May, with the oil price at US$128 and analysts forecasting US$200 before long. Looking back, my predictions for the extent of the likely fall were far too modest. Yesterday, crude oil was trading at just US$40 a barrel.
I was also close to the mark with many of my predictions about the mainland’s markets and economy. During the first half of the year, I warned repeatedly that Beijing’s efforts to prop up the ailing A-share market would fail, and that the market would have to find a natural bottom. Between January and November, the Shanghai composite had dropped 69 per cent.
My warnings that the mainland authorities watch the yuan’s trade-weighted basket rather than its US dollar exchange rate when managing their currency policy, and that they would not hesitate to steer a depreciation should export demand weaken, also proved correct. As the second chart below shows, the yuan’s trade-weighted index has fallen 6 per cent over the last month.
But my best call of the year was probably the warning, first delivered in March, that the hedge fund industry was in trouble and at risk of “a mass deleveraging that will hammer financial markets around the world”. It was a warning I repeated at the beginning of October, arguing that stock markets were in imminent danger of going into a “death spiral”. Over the next few weeks, Hong Kong’s Hang Seng Index plunged 40 per cent.
Hopefully, that timely warning made up for my misguided optimism earlier in the year.
"Be Nice to the Countries That Lend You Money"
by James Fallows
December 2008
In his first interview since the world financial crisis, Gao Xiqing, the man who oversees $200 billion of China’s $2 trillion in dollar holdings, explains why he’s betting against the dollar, praises American pragmatism, and wonders about enormous Wall Street paychecks. And he has a friendly piece of advice:
Americans know that China has financed much of their nation’s public and private debt. During the presidential campaign, Barack Obama and John McCain generally agreed on the peril of borrowing so heavily from this one foreign source. For instance, in their final debate, McCain warned about the “$10 trillion debt we’re giving to our kids, a half a trillion dollars we owe China,” and Obama said, “Nothing is more important than us no longer borrowing $700billion or more from China and sending it to Saudi Arabia.” Their numbers on the debt differed, and both were way low. One year ago, when I wrote about China’s U.S. dollar holdings, the article was called “The $1.4 trillion Question.” When Barack Obama takes office, the figure will be well over $2 trillion.
During the late stages of this year’s campaign, I had several chances to talk with the man who oversees many of China’s American holdings. He is Gao Xiqing, president of the China Investment Corporation, which manages “only” about $200billion of the country’s foreign assets but makes most of the high-visibility investments, like buying stakes in Blackstone and Morgan Stanley, as opposed to just holding Treasury notes.
Gao, whom I mentioned in my article, would fit no American’s preexisting idea of a Communist Chinese official. He speaks accented but fully colloquial and very high-speed English. He has a law degree from Duke, which he earned in the 1980s after working as a lawyer and professor in China, and he was an associate in Richard Nixon’s former Wall Street law firm. His office, in one of the more tasteful new glass-walled high-rises in Beijing, itself seems less Chinese than internationally “fusion”-minded in its aesthetic and furnishings. Bonsai trees in large pots, elegant Japanese-looking arrangements of individual smooth stones on display shelves, Chinese and Western financial textbooks behind the desk, with a photo of Martin Luther King Jr. perched among the books. Two very large, very thin desktop monitors read out financial data from around the world. As we spoke, Western classical music played softly from a good sound system.
Gao dressed and acted like a Silicon Valley moneyman rather than one from Wall Street—open-necked tattersall shirt, muted plaid jacket, dark slacks, scuffed walking shoes. Rimless glasses. His father was a Red Army officer who was on the Long March with Mao. As a teenager during the Cultural Revolution, Gao worked on a railroad-building gang and in an ammunition factory. He is 55, fit-looking, with crew-cut hair and a jokey demeanor rather than an air of sternness.
His comments below are from our one on-the-record discussion, two weeks before the U.S. elections. As I transcribed his words, I realized that many will look more astringent on the page than they sounded when coming from him. In person, he seemed to be relying on shared experience in the United States—that is, his and mine—to entitle him to criticize the country the way its own people might. The conversation was entirely in English. Because Gao’s answers tended to be long, I am not presenting them in straight Q&A form but instead grouping his comments about his main recurring themes.
Does America wonder who its new Chinese banking overlords might be? This is what one of the very most influential of them had to say about the world financial crisis, what is wrong with Wall Street, whether one still-poor country with tremendous internal needs could continue subsidizing a still-rich one, and how he thought America could adjust to its “realistic” place in the world. My point for the moment is to convey what it is like to hear from such a man, rather than to expand upon, challenge, or agree with his stated views.
About the financial crisis of 2008, which eliminated hundreds of billions of dollars’ worth of savings that the Chinese government had extracted from its people, through deliberately suppressed consumption levels:
We are not quite at the bottom yet. Because we don’t really know what’s going to happen next. Everyone is saying, “Oh, look, the dollar is getting stronger!” [As it was when we spoke.] I say, that’s really temporary. It’s simply because a lot of people need to cash in, they need U.S. dollars in order to pay back their creditors. But after a short while, the dollar may be going down again. I’d like to bet on that!
The overall financial situation in the U.S. is changing, and that’s what we don’t know about. It’s going to be changed fundamentally in many ways.
Think about the way we’ve been living the past 30 years. Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking.
People, especially Americans, started believing that they can live on other people’s money. And more and more so. First other people’s money in your own country. And then the savings rate comes down, and you start living on other people’s money from outside. At first it was the Japanese. Now the Chinese and the Middle Easterners.
We—the Chinese, the Middle Easterners, the Japanese—we can see this too. Okay, we’d love to support you guys—if it’s sustainable. But if it’s not, why should we be doing this? After we are gone, you cannot just go to the moon to get more money. So, forget it. Let’s change the way of living. [By which he meant: less debt, lower rewards for financial wizardry, more attention to the “real economy,” etc.]
About stock market derivatives and their role as source of evil:
If you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit. They are crap. They serve to cheat people.
I was predicting this many years ago. In 1999 or 2000, I gave a talk to the State Council [China’s main ruling body], with Premier Zhu Rongji. They wanted me to explain about capital markets and how they worked. These were all ministers and mostly not from a financial background. So I wondered, How do I explain derivatives?, and I used the model of mirrors.
First of all, you have this book to sell. [He picks up a leather-bound book.] This is worth something, because of all the labor and so on you put in it. But then someone says, “I don’t have to sell the book itself! I have a mirror, and I can sell the mirror image of the book!” Okay. That’s a stock certificate. And then someone else says, “I have another mirror—I can sell a mirror image of that mirror.” Derivatives. That’s fine too, for a while. Then you have 10,000 mirrors, and the image is almost perfect. People start to believe that these mirrors are almost the real thing. But at some point, the image is interrupted. And all the rest will go.
When I told the State Council about the mirrors, they all started laughing. “How can you sell a mirror image! Won’t there be distortion?” But this is what happened with the American economy, and it will be a long and painful process to come down.
I think we should do an overhaul and say, “Let’s get rid of 90 percent of the derivatives.” Of course, that’s going to be very unpopular, because many people will lose jobs.
About Wall Street jobs, wealth, and the cultural distortion of America:
I have to say it: you have to do something about pay in the financial system. People in this field have way too much money. And this is not right.
When I graduated from Duke [in 1986], as a first-year lawyer, I got $60,000. I thought it was astronomical! I was making somewhere a bit more than $80,000 when I came back to China in 1988. And that first month’s salary I got in China, on a little slip of paper, was 59 yuan. A few dollars! With a few yuan deducted for my rent and my water bill. I laughed when I saw it: 59 yuan!
The thing is, we are working as hard as, if not harder than, those people. And we’re not stupid. Today those people fresh out of law school would get $130,000, or $150,000. It doesn’t sound right.
Individually, everyone needs to be compensated. But collectively, this directs the resources of the country. It distorts the talents of the country. The best and brightest minds go to lawyering, go to M.B.A.s. And that affects our country, too! Many of the brightest youngsters come to me and say, “Okay, I want to go to the U.S. and get into business school, or law school.” I say, “Why? Why not science and engineering?” They say, “Look at some of my primary-school classmates. Their IQ is half of mine, but they’re in finance and now they’re making all this money.” So you have all these clever people going into financial engineering, where they come up with all these complicated products to sell to people.
About the $700 billion U.S. financial-rescue plan enacted in October:
Finally, after months and months of struggling with your own ideology, with your own pride, your self-right-eousness … finally [the U.S. applied] one of the great gifts of Americans, which is that you’re pragmatic. Now our people are joking that we look at the U.S. and see “socialism with American characteristics.” [The Chinese term for its mainly capitalist market-opening of the last 30 years is “socialism with Chinese characteristics.”]
It is joking, and many people are saying: “No, Americans still believe in free capitalism and they think this is just a hiccup.” This is like our great leader Deng Xiaoping, who said that it doesn’t matter if the cat is white or black, as long as it catches the mouse. It doesn’t matter what we call this. It’s pragmatic.
With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?
Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. [This is the famous modern “balance of financial terror.” If Chinese officials started pulling assets out of the U.S. and touched off a run on the dollar, their vast remaining dollar holdings would plummet in value.] So we’re trying to help, at least by not aggravating the problem.
But I think at the end of the day, the American government needs to talk with people and say: “Why don’t we get together and think about this? If China has $2 trillion, Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone.” We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.
On what might make the Chinese government start taking its dollars out of America (I began the question by saying that China would hurt itself by pulling out dollar assets—at which he interjected, “in the short term”—and then asked about the long-term view):
Today when we look at all the markets, the U.S. still is probably the most viable, the most predictable. I was trained as a lawyer, and predictability is always very important for me.
We have a PR department, which collects all the comments about us, from Chinese newspapers and the Web. Every night, I try to pick a time when I’m in a relatively good mood to read it, because most of the comments are very critical of us. Recently we increased our holdings in Blackstone a little bit. Now we’re increasing a little bit our holdings in Morgan Stanley, so as not to be diluted by the Japanese. People here hate it. They come out and say, “Why the hell are you trying to save those people? You are the representative of the poor people eating porridge, and you’re saving people eating shark fins!” It’s always that sort of thing.
And how should Americans feel about the growing Chinese presence in their economy? Isn’t it natural for them to worry that China will keep increasing its stake in American debt and assets—or that China won’t, essentially cutting America off?
I can understand why Americans might feel that way. But, talking with my lawyer head once again, it’s not relevant to discuss how Americans “should” think. We should discuss how Americans might think.
This concern is not really about China itself. It could be any country. It could be Japan, or Germany. This generation of Americans is so used to your supremacy. Your being treated nicely by everyone. It hurts to think, Okay, now we have to be on equal footing to other people. “On equal footing” would necessarily mean that sometimes you have to stoop to appear to be humble to other people.
And you can’t think as a soldier. You put yourself at the enemy end of everyone. I grew up during the Cultural Revolution, when people really treated other people like enemies. I grew up in an environment where our friends, our relatives, people I called Uncle or Auntie, could turn around and put a nasty face to me as a small child. One time, Vladimir Lenin told Gorky, after reading Gorky’s autobiography, “Oh my god! You could have become a very nasty person!” Those are exactly the words one of my dear professors told me after hearing what I went through.
But over the years, I believe I learned to be humble. To treat other people nicely. I learned that, from a social point of view, no matter how lowly statured a person you are talking to, as a person, they are the same human being as you are. You have to respect them. You have to apologize if you inadvertently hurt them. And often you have to go out of your way to be nice to them, because they will not like you simply because of the difference in social structure.
Americans are not sensitive in that regard. I mean, as a whole. The simple truth today is that your economy is built on the global economy. And it’s built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and … I won’t say kowtow [with a laugh], but at least, be nice to the countries that lend you money.
Talk to the Chinese! Talk to the Middle Easterners! And pull your troops back! Take the troops back, demobilize many of the troops, so that you can save some money rather than spending $2 billion every day on them. And then tell your people that you need to save, and come out with a long-term, sustainable financial policy.
Although Gao has frequently mentioned Chairman Mao’s maxim—“Go with the Republicans. They’re predictable!”—he obviously was hoping for a “change” agenda under the Democrats:
The current conditions can’t go on. It is time for the new government, under Obama or even McCain, to really tell people: “Look, this is wartime, this is about the survival of our nation. It’s not about our supremacy in the world. Let’s not even talk about that any more. Let’s get down to the very basics of our livelihood.”
I have great admiration of American people. Creative, hard-working, trusting, and freedom-loving. But you have to have someone to tell you the truth. And then, start realizing it. And if you do it, just like what you did in the Second World War, then you’ll be great again!
If that happens, then of course—American power would still be there for at least as long as I am living. But many people are betting on the other side.
Credit Suisse to Use Illiquid Assets to Pay Bonuses
By Christine Harper
Dec. 18 (Bloomberg) -- Credit Suisse Group AG’s investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees’ year-end bonuses.
The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.
“While the solution we have come up with may not be ideal for everyone, we believe it strikes the appropriate balance among the interests of our employees, shareholders and regulators and helps position us well for 2009,” Chief Executive Officer Brady Dougan and Paul Calello, CEO of the investment bank, said in the memo.
The securities will be placed into a so-called Partner Asset Facility, and affected employees at the bank, Switzerland’s second biggest, will be given stakes in the facility as part of their pay. Bonuses will take the first hit should the securities decline further in value.
“It’s monstrously clever,” said Dirk Hoffman-Becking, an analyst at Sanford C. Bernstein Ltd. in London who has a “market perform” rating on Credit Suisse stock. “From a shareholders’ perspective it’s great because you’ve got rid of some of the assets and regulators will be pleased because you’ve organized a risk transfer.”
‘Better Than Nothing’
For employees, “there’s some upside in there and if the alternative is nothing, it’s a lot better than nothing,” Hoffman-Becking said.
Credit Suisse said earlier this month it would eliminate 5,300 jobs and cancel bonuses for top executives after it had about 3 billion Swiss francs ($2.8 billion) of losses in October and November. Unlike larger Swiss rival UBS AG, Credit Suisse hasn’t received a government rescue. Banks and securities firms are struggling to pay employee bonuses after taking more than $800 billion of losses on mortgages and corporate loans.
Writedowns on leveraged finance commitments at Credit Suisse have amounted to 3.5 billion francs since the beginning of the crisis, while the bank marked down its commercial mortgage holdings by 2.9 billion francs.
Outside Investors
Credit Suisse is the first to use the debt to pay employees. Outside investors may also be permitted to invest in the facility, according to the people familiar with the matter, who declined to be identified because the plan hasn’t been made public. The bank will boost the potential for returns by providing leverage to the facility, and will be paid back first, according to the people.
Leveraged-loan commitments on Credit Suisse’s books fell to between 2.5 billion Swiss francs and 3 billion francs by the end of November from 11.9 billion francs at the end of September, Dougan said on a conference call on Dec. 4. He said the bank had also “somewhat reduced” its commercial real estate positions. Credit Suisse had 12.8 billion francs in commercial mortgages at the end of September.
Assets in the facility will remain on Credit Suisse’s balance sheet and will be held in the company’s fund management division, the people familiar with the plan said. The new structure will mean that any mark-to-market losses or gains on the assets will be offset by identical gains, or losses, on the bank’s liability to employees.
Coupon Payments
Employees will receive semi-annual coupon payments on their investment in the Partner Asset Facility at the London Interbank Offered Rate plus 2.50 percentage points. The ultimate value of the facility will be determined over the next eight years as the loans and securities mature or default, the people said.
“Cash payments representing distributions of a portion of the award may be made to participants in the future contingent on the performance of the underlying assets,” Dougan and Calello said in the memo. “Cash distributions will not be made for several years.”
The bank said it expects to begin annual payments after five years.
While Credit Suisse doesn’t say how many managing directors and directors work at the investment bank, the number is in the thousands.
Credit Suisse said it will also change the cash portion of bonuses for all of the bank’s managing directors and for directors in the investment bank. Under the new system, the bank will have the right to recoup some of the cash bonus in the two years after it’s paid if an employee resigns.
Singapore to convene wage council, may cut pensions
SINGAPORE, Dec 16 (Reuters) - Singapore will convene its National Wages Council (NWC) in early January, four months ahead of schedule, in what economists say may be a prelude to a cut in employers' pension contributions.
'Given the weakening economic situation, there is a need for the NWC to take stock of the new situation and review its May guidelines to help companies and workers manage the downturn,' the Manpower Ministry said in a statement on Tuesday.
The ministry did not immediately respond to questions about the detailed agenda for the NWC's January meeting.
'At the last crisis, they cut the CPF (Central Provident Fund) and I won't be surprised if they did it again,' said Joseph Tan, Singapore-based Asia chief economist for private banking at Credit Suisse.
'Between cutting wages and letting people go, the government's preference is to keep jobs.'
The government last cut employers' contributions to the CPF, the retirement fund for Singaporean workers, by 3 percentage points to 13 percent in October 2003 to help firms cope with the effects of the SARS outbreak.
The NWC, which comprises representatives from government, employers and unions, usually meets in May to come out with wage guidelines for the following 12 months.
The cuts were partially restored last year and the employers' contribution rate currently stands at 14.5 percent on the first S$4,500 ($3,049) of an employee's monthly salary.
Singapore fell into a recession in the third quarter and the government has warned that the economy may shrink by one percent next year.
"The thing I didn't do, from Day One, was properly assess the severity of the liquidity crisis… Every decision to buy anything has been wrong." - Bill Miller, manager, Value Trust
The Stock Picker's Defeat
By TOM LAURICELLA
DECEMBER 11, 2008
William H. Miller spent nearly two decades building his reputation as the era's greatest mutual-fund manager. Then, over the past year, he destroyed it.
Fueled by winning bets on stocks other investors feared, Mr. Miller's Legg Mason Value Trust outperformed the broad market every year from 1991 to 2005. It's a streak no other fund manager has come close to matching.
Mr. Miller was in his element a year ago when troubles in the housing market began infecting financial markets. Working from his well-worn playbook, he snapped up American International Group Inc., Wachovia Corp., Bear Stearns Cos. and Freddie Mac. As the shares continued to fall, he argued that investors were overreacting. He kept buying.
What he saw as an opportunity turned into the biggest market crash since the Great Depression. Many Value Trust holdings were more or less wiped out. After 15 years of placing savvy bets against the herd, Mr. Miller had been trampled by it.
The financial crisis has created losers across the spectrum -- homeowners who can't afford their subprime mortgages, banks that loaned to them, investors who bought mortgage-backed securities and, as financial markets eventually crumbled, just about everyone who owned shares. But it has also brought low contrarians like Mr. Miller who had been lionized for staying a step ahead of the market. This meltdown has provided a lesson for Mr. Miller and other "value" investors: A stock may look tantalizingly cheap, but sometimes that's for good reason.
"The thing I didn't do, from Day One, was properly assess the severity of this liquidity crisis," Mr. Miller, 58 years old, said in an interview at Legg Mason Inc.'s Baltimore headquarters.
Mr. Miller has profited from investor panics before. But this time, he said, he failed to consider that the crisis would be so severe, and the fundamental problems so deep, that a whole group of once-stalwart companies would collapse. "I was naive," he said.
A year ago, his Value Trust fund had $16.5 billion under management. Now, after losses and redemptions, it has assets of $4.3 billion, according to Morningstar Inc. Value Trust's investors have lost 58% of their money over the past year, 20 percentage points worse than the decline on the Standard & Poor's 500 stock index.
These losses have wiped away Value Trust's years of market-beating performance. The fund is now among the worst-performing in its class for the last one-, three-, five- and 10-year periods, according to Morningstar.
"Why didn't I just throw my money out of the window -- and light it on fire?" says Peter Cohan, a management consultant and venture-capital investor who owns Value Trust shares. Mr. Miller's strategy, he says, "worked for a long time, but it's broken."
Mr. Miller's picks read like a Who's Who of the stock market's biggest losers: Washington Mutual Inc., Countrywide Financial Corp. and Citigroup Inc.
"Every decision to buy anything has been wrong," Mr. Miller said over lunch at a private club housed inside Legg's headquarters. In the 16th-floor dining room, Mr. Miller sat with his back against the wall, a preference he says he picked up as a U.S. Army intelligence officer in the 1970s. "It's been awful," he said.
Mr. Miller is chairman of Legg Mason Capital Management, a group of six mutual funds. He personally oversees Value Trust and the smaller Opportunity Trust. Although Mr. Miller's group accounts for only about $28 billion of Legg Mason's $840 billion in total assets, the firm's reputation is intertwined with that of its marquee star. Legg's stock is down 75% this year. The firm's woes have weighed on private-equity firm Kohlberg Kravis Roberts & Co., which took a $1.25 billion stake in Legg early this year.
Questions now swirl about whether Mr. Miller will quit or be replaced. He says his group's board of directors will decide whether he stays or goes, but he's not planning on calling it quits. Mark Fetting, Legg's chief executive and chairman of the board that oversees Mr. Miller's funds, said he supports Mr. Miller and his plans to improve performance.
Early Bet on RCA
Growing up in Florida, Bill Miller took an early interest in the market. As a high-schooler in the late 1960s, he says he invested the money he earned umpiring baseball games in stocks like RCA, making enough to buy a broken-down Ford. In the mid-1970s, in Germany during his Army stint, he visited a brokerage office in Munich to buy Intel Corp. shares. He studied philosophy in graduate school, but left to join a Pennsylvania manufacturing company where he eventually oversaw its investments.
By the early 1980s, Mr. Miller's then-wife worked at Legg Mason. Through her, Mr. Miller met the brokerage's founder, Raymond "Chip" Mason. Mr. Mason said he was thinking of starting some mutual funds. Mr. Miller jumped. He joined Legg Mason in 1981. Value Trust launched in 1982, with Mr. Miller as co-manager.
In 1984, Mr. Miller paid a visit to influential Fidelity Investments manager Peter Lynch, who suggested Mr. Miller take a look at Fannie Mae. Much like today, the mortgage company had a portfolio full of troubled loans. Traders were betting it would go bust.
Mr. Miller found Fannie's case compelling: The bad loans would soon roll off its books, he recalls, the government-backed company would be able to borrow at preferred rates and its low cost structure could make it hugely profitable. "Is this thing really trading at only two times what it's going to earn in three or four years?" Mr. Miller recalls asking Mr. Lynch in a follow-up phone call.
Mr. Miller figures that by the time he sold out of Fannie in 2005, he had made 50 times his money.
All or Nothing
Such all-or-nothing bets would come to define Mr. Miller's style. He usually holds about three dozen stocks at a time, compared with a hundred or so in a typical mutual-fund portfolio. He has welcomed negative sentiment about companies, which has let him buy stocks as their prices fall, "averaging down" the per-share price he pays. The strategy can net him big stakes in companies -- an enviable position if shares rally and a sticky one if he needs to sell.
When asked how he would know he made a mistake in buying a falling stock, Mr. Miller once retorted: "When we can no longer get a quote." In other words, the only price at which he was unwilling to buy more was zero.
Mr. Miller's swing-for-the-fences approach makes even other value investors flinch. Christopher Davis, a friend of Mr. Miller's and a money manager at Davis Funds, recalls discussing his investment strategy with Mr. Miller in the early 1990s. "One of my goals is to just be right more than I'm wrong," Mr. Davis recalls telling Mr. Miller.
" 'That's really stupid,' " Mr. Miller countered, according to Mr. Davis. "Bill said, 'What matters is how much you make when you're right. If you're wrong nine times out of 10 and your stocks go to zero -- but the tenth one goes up 20 times -- you'll be just fine,' " Mr. Davis recalls. "I just can't live like that."
During the savings-and-loan crisis in 1990 and 1991, Mr. Miller loaded up on American Express Corp., mortgage giant Freddie Mac and struggling banks and brokerages. Financials eventually made up more than 40% of his portfolio.
He looked wrong at first. But these stocks eventually propelled Value Trust to the top of the performance charts. In 1996, Value Trust gained 38%, outpacing the S&P 500 by more than 15 percentage points. By then, Mr. Miller was loading up on AOL, computer makers and other out-of-favor tech stocks.
His good bets more than made up for the bad. Between 1998 and 2002, 10 stocks in the Value Trust portfolio lost 75% or more. Three, including Enron and WorldCom, went bankrupt.
As his winning streak grew, Mr. Miller's name was often preceded in press reports with the word "legendary." He was mentioned alongside the likes of Fidelity's Mr. Lynch. Legg Mason, meanwhile, grew from a regional brokerage house into one of the planet's largest money managers.
In 1999, he cut an unusually lucrative deal with Legg Mason to take the reins of Opportunity Trust, a new fund. The fund's management fees went to an entity half-owned by Mr. Miller. From 2005 through 2007, Opportunity Trust paid the entity $137 million. In 2006, he bought a 235-foot yacht, "Utopia."
Investing is Mr. Miller's obsession, friends say. On visits to Manhattan, he convenes chief executives, stock analysts and other money managers for steak dinner at the Post House to discuss investment ideas. His yacht aside, these friends say, Mr. Miller pays little attention to wealth's trappings: His work shoes are a pair of black loafers, purchased at Nordstrom, that he gets resoled again and again.
In 2006, Mr. Miller's outperformance streak finally broke when he missed out on big gains in energy stocks. His performance suffered again in early 2007, thanks to losses in home-building stocks he had bought following signs of trouble in the real-estate market.
Seen It Before
In the early summer of 2007, two Bear Stearns hedge funds that made big bets on low-quality mortgages imploded. The stock market whipsawed in July and August, as investors worried that housing-market troubles could spread.
Mr. Miller thought investors were too pessimistic about the housing and credit markets. In the third quarter, he bought Bear Stearns. In the fourth quarter, as financial stocks fell, he took positions in Merrill Lynch & Co., Washington Mutual, Wachovia and Freddie Mac.
Explaining his moves to his shareholders in a fourth-quarter update, he compared the period to 1989-90, when he had also bought beaten-down banks. "Sometimes market patterns recur that you believe you have seen before," he wrote. "Financials appear to have bottomed."
In 2008, Mr. Miller continued to accumulate Bear Stearns. At a conference on Friday, March 14, he boasted that he had bought just that morning at a bargain price, north of $30 a share -- down from a recent high of $154.
Bear Stearns collapsed that weekend. In a takeover brokered by the Federal Reserve, J.P. Morgan Chase & Co. acquired the storied investment house in a deal that first valued it at $2 a share.
Mr. Miller and his team spent the following days and evenings trying to figure out what had gone wrong. Mr. Miller, who also owns J.P. Morgan shares, says he called J.P. Morgan Chief Executive Jamie Dimon to run his Bear Stearns valuations past him.
Mr. Miller says the conversation with Bear Stearns's new owner left him satisfied that he'd fairly valued the investment house's troubled mortgage holdings. But his team had missed Bear Stearns's vulnerability to a "run on the bank" collapse: The heavily leveraged firm was borrowing huge sums to function day-to-day, and when lenders walked away, it collapsed. Mr. Miller says he was also surprised that the Federal Reserve would play an active role in a transaction that would let stockholders be largely wiped out.
Mr. Miller worried that Wachovia and Washington Mutual were vulnerable to a similar squeeze on capital. He sold both.
But he didn't abandon financials. During the second quarter, he added to Freddie Mac and insurer AIG. In an April letter to shareholders, he wrote that the rebounding stock and bond markets suggested a corner had been turned. "The credit panic ended with the collapse of Bear Stearns," he wrote. "By far the worst is behind us."
By the end of June, Mr. Miller's group held 53 million Freddie shares -- about 8% of the company.
Financial stocks continued to fall though the spring and summer. Many value investors, such as John Rogers at Ariel Investments, sold or at least stopped buying the sector.
With Freddie and Fannie under particular pressure, some at Legg Mason Capital Management were worried that group-think had set in. "There were hedge-fund guys out there arguing that Fannie and Freddie were going to zero," said Sam Peters, a fund manager in Mr. Miller's group.
Red Team's Report
Mr. Peters, whose fund also owned Freddie Mac, suggested putting together a team of Legg research analysts to argue the case against Freddie. In early-August meetings devoted to the mortgage giant, the so-called "Red Team" said Freddie may need to raise substantial capital, which would massively dilute existing stockholders' shares.
Mr. Peters stopped accumulating Freddie shares. Mr. Miller kept buying them for his Opportunity Trust portfolio.
The risk, as Mr. Miller saw it, was that the housing market could perform worse than he expected. But he dismissed talk that the government could nationalize Freddie and Fannie. He took comfort in Treasury Secretary Henry Paulson's mid-July statement that the government was focused on supporting the agencies in their "current form." If anything, he believed, Freddie would recapture market share as private-sector competitors failed.
By the end of August, declines in AIG and Freddie left Value Trust down 33% over the previous 12 months -- 21 percentage points worse than the S&P 500 over the same period. Mr. Mason, Legg's founder, received complaints from brokers about Mr. Miller. Mr. Fetting, Legg's chief executive, fielded questions about whether Mr. Miller would be replaced.
The news got worse on the weekend of Sept. 6 and 7. The Treasury announced it was taking over Fannie and Freddie, rendering private shareholders' stakes nearly worthless. On Monday, shares in Freddie, which had started the year at $34 and entered the weekend at $5, were trading at less than $1. A government takeover was the one outcome for which Mr. Miller hadn't prepared.
New Rules
He realized then that his old playbook had failed him. He began to bail out of AIG, which insured the debt of many troubled financial firms. How could his group managers invest in financials if "we don't know the rules," Mr. Peters remembers him saying.
In September, the Baltimore police and fire retirement pension board reportedly fired Mr. Miller from their $2.2 billion fund. A representative for the board did not return calls seeking comment.
Mr. Miller and his staff, who invest alongside shareholders in their funds, have also felt the pain. For the first time, Mr. Miller's group fired staff, an experience he calls "devastating." Mr. Miller won't disclose his personal worth or losses.
The fund manager says he's adjusting his stock-picking screens for a new world, in which he expects investors to be risk-averse for several years. He's re-reading a biography of John Maynard Keynes, focusing on the famed economist's experience as a money manager during the 1930s. He says he's scouring markets for industry-leading companies with big dividends. He thinks there are also opportunities in battered corporate bonds.
But improving performance will take a long time, he says. "I can't accelerate it."
Mr. Miller notes that in the final years of his winning streak, people often asked him why he didn't quit while he was ahead. Asked over lunch whether he wished he had stepped aside then, he looked out the window, over Baltimore's Inner Harbor. "That would have been a really smart thing to have done," he said, adding he has no plans to step aside.
"The idea of him retiring to the Riviera just isn't him," says his friend, Mr. Davis. "The money has meaning, but the record is a lot more meaningful."
Always With Me, Always With You - Joe Satriani
John Maynard Keynes - The Money Manager
SEC Report: Employees Browsed Porn, Ran Private Businesses
by Jake Bernstein
December 19, 2008
The Securities and Exchange Commission is taking a drubbing these days for its abject failure―despite detailed tips―to catch Bernie Madoff in what appears to be the biggest Ponzi scheme in our nation’s history.
Now, thanks to little-noticed report from the agency’s inspector general, we have a detailed glimpse into other bad behavior by some SEC employees.
The report, released the day after Thanksgiving, reveals that some employees at the agency were clearly preoccupied with matters other than their mission of "protecting investors and maintaining fair, orderly, and efficient markets." The semi-annual report to Congress, which covers the period from this past April to September, details among other things a handful of employees circumventing internal controls to download porn. Let’s pause for some detail:
[Investigators] uncovered evidence that an employee who was still in his probationary period had used his SEC laptop computer to attempt to access Internet websites classified as containing pornography, resulting in hundreds of access denials. The OIG investigation also disclosed that this employee successfully bypassed the Commission’s Internet filter by using a flash drive.
Presumably, that’s not the kind of initiative the SEC is looking for.
There were also more serious misdeeds raised by the report. For example, there is the case of the senior-level commission employee who "clearly and purposefully identified herself as a Commission employee when dealing with brokers about a family member’s account," making the broker in question feel like she was trying to "intimidate and bully him." The OIG referred the matter to management for "disciplinary action, up to and including dismissal." By the end of the period covered in the report, management "had not proposed or taken action."
There are other examples where the punishment was less than fulsome.
Investigators found employees in separate offices operated private photography businesses out of the commission:
An employee repeatedly and flagrantly used Commission resources, including Commission Internet access, e-mail, telephone and printer, in support of his private photography business for several years.
The IG’s office recommended "disciplinary action up to and including dismissal." In turn, the report notes, "management suspended the employee from duty and pay for nine calendar days."
When asked about the report, Deputy Director for Public Affairs John Heine said, "In each of these [cases] there is some sort of response from the Commission. We don’t have anything to say beyond that."
The report reveals also that two commission staffers employed as attorneys didn’t have active bar memberships. One attorney let his bar license lapse in 1994. The report said one of the lapsed lawyers "submitted a declaration in Federal court, in which he stated that he was an attorney employed by the SEC. We referred the potential false statement or perjury to the applicable United States Attorney’s office." (The office declined to prosecute.)
The IG also found that the commission did not have a sufficient system in place to "prevent and detect insider trading on the part of Commission employees or violations of the Commission’s rules."
The agency’s information management also comes in for criticism. An employee survey conducted by the inspector general revealed that employees failed to enter data into a computer system used to manage investigations. The system known as the HUB was launched in August 2007 after the Government Accountability Office had highlighted major problems with the SEC’s previous case management and tracking system. The IG semi-annual report also reveals that the commission lacks "an inventory of its laptops and was unable to trace ownership of laptops to specific individuals."
A Perfect Christmas - Jose Mari Chan
My idea of a perfect Christmas
Is to spend it with you
In a party or dinner for two
Anywhere would do
Celebrating the yuletide season
Always lights up our lives
Simple pleasures are made special too
When they're shared with you
Looking through some old photographs
Faces and friends we'll always remember
Watching busy shoppers rushing about
In the cool breeze of December
Sparkling lights all over town
Children's carols in the air
By the Christmas tree
A shower of stardust on your hair
I can't think of a better Christmas
Than my wish coming true
And my wish is that you'd let me spend
My whole life with you
Looking through some old photographs
Faces and friends we'll always remember
Watching busy shoppers rushing about
In the cool breeze of December
Sparkling lights all over town
Children's carols in the air
By the Christmas tree
A shower of stardust on your hair
I can't think of a better Christmas
Than my wish coming true
And my wish is that you'd let me spend
My whole life with you
My idea of a perfect Christmas
Is spending it with you
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