Friday, March 28, 2008

Even Buffett Isn't Perfect

I gave a talk Wednesday night in White Plains, NY about my forthcoming book, Even Buffett Isn't Perfect. I was quite pleased with the response, so I am posting a short excerpt here. The book is available for pre-order at a significant discount at and, as well as a number of other book sellers.

Buffett firmly believes the rich should pay more tax. So why would he choose to give so much of his money to these various foundations rather than allow the government to take a huge chunk from his estate after his death? The only reasonable explanation is that Buffett is convinced that these foundations will spend his money much more wisely than the government would.

Many of the megarich, including Buffett, favor the estate tax. Yet they continue to take advantage of the loophole in the law that allows them to avoid the tax by giving their money away before they die. What explains this paradox? Perhaps the answer lies somewhere between guilt and altruism. They may feel guilty about having so much money, yet they don't trust the government to spend it wisely. But as conservatives point out, we don't need the estate tax to get the same result. Those who feel guilty are free to give their money to whomever they want--even the government. But they should not force the same on others.

Monday, March 24, 2008

Grand Theft Investment Bank

J.P. Morgan's acquisition of Bear Stearns is starting to look more and more like a crime with the Federal Reserve and Treasury Department guilty of aiding and abetting. Government officials orchestrated grand theft investment bank.

As of yet, of course, there is no definitive deal. Yet Morgan almost got away with "buying" Bear for just $2 per share. The government, it seems, was desperate to close a deal and just as desperate to punish Bear's shareholders. Morgan was smart enough to realize they were the only bidder in the game. They could name any price they liked and that's exactly what they did.

But shares of Bear immediately started trading well above the offer price. And now, after only one week, Morgan decided it needed to allay some of the ill will it's initial offer created. So it decided to increase its offer--by five times! If this does not confirm that Morgan's initial offer amounted to highway robbery, I don't know what does.

With Morgan's new offer the government is still assuming most of the risk by guaranteeing Bear's toxic mortgages. But instead of doing this through Morgan, it could have done the same thing directly through Bear. Either way, the burden to taxpayers is the same. By working through Morgan, however, the government can be sure that Bear's employees and shareholders get absolutely pummeled.

One day a lot of hard questions will be asked about exactly what went on. Harvard professors are probably already working on a case study. Dozens of books will eventually be written on the subject. In the final analysis, it will become evident that, with the government's help, J.P. Morgan almost stole Bear Stearns.

Thursday, March 20, 2008

On the Road in New Orleans and Austin

I was in New Orleans yesterday taking part in a market forecast panel discussion sponsored by the CFA Society of New Orleans. The event was held at the Bourbon House. Vinny Catalano, president and global investment strategist of Blue Marble Research, moderated the discussion. The audience included Don Chance, my financial derivatives professor at Virginia Tech, and Pat Mooney, a former student of mine from a CFA review course I used to teach in Boston. Both are now working in Louisiana.

The other panelists included Mark Freeman, an investment advisor, and Dek Terrell, an economist from Louisiana State University. Interestingly, Dek talked about Louisiana's strong economy. Louisiana, which is heavily dependent on the oil industry, is actually benefiting from the high oil prices that are haunting the rest of the nation. He pointed out that there are pockets of desperation in Louisiana, but for the most part, the state is doing well.

Mark warned the attendees that volatility in the stock market is likely to continue, but he had a favorable view overall.

I focused my discussion on the continuing acceleration in the drop in housing prices. Almost all of the problems we are seeing in the financial sector are related to housing. Until housing prices start falling at a decelerating rate, we will not be approaching bottom. I also warned that high energy prices are taking a big toll on consumers. We are already seeing a decline in gasoline demand due to these prices. However, I said oil prices are more likely to fall than rise. Current prices are more the result of the weak U.S. dollar and less a result of strong demand or limited supply. For more than a week I have been trying to short the USO, an oil ETF, to take advantage of the expected decline. But my brokerage firm claims they have no shares in inventory available to short.

Today I am in Austin and will take part in a similar discussion sponsored by the CFA Society of Austin. This event will take place at the Austin Club. I'm also hoping to visit Roux, a trendy restaurant owned by my cousin Dan Janjigian.

Monday, March 17, 2008

Is Bernanke's Job on the Line?

Over the weekend, the Federal Reserve orchestrated the takeover of Bear Stearns by J.P. Morgan for $2 per share. This is an almost unbelievable development. Bear Stearns, which started 2007 with a $22 billion market capitalization, is now valued at only $250 million! Some observers argue that this is better than the alternative--bankruptcy; but some Bear Stearns shareholders are wondering if that is really true.

There are two big problems leading to this latest crisis in financial markets. The first is falling housing prices. This is something that was easily foreseen. Many well known and respected economists, including Robert Shiller, Gary Shilling, and Nouriel Rubin, have been warning for years that housing prices could not possibly keep appreciating. Simple reversion to the mean dictated that prices had to fall considerably just to get back to long-term trends. Excessively easy access to mortgages created the housing bubble. Now that banks are tightening their lending standards, the air is coming out of the balloon.

The second problem is the Fed. It no longer has the confidence of investors. Instead of providing targeted liquidity to frozen credit markets, the Fed has destroyed the value of the dollar and created a tremendous amount of inflation in dollar-denominated commodities by aggressively cutting interest rates. Foreign tourists are having a ball vacationing and shopping in the U.S., and foreign investors are gobbling up our decimated assets, which are even cheaper than they appear when priced in euros and yens. Americans, however, are paying a steep price.

Treasury Secretary Henry Paulson (jokingly known as Mr. Strong Dollar) is trying to assure investors that we're just going through a blip. He wants us to believe that there is light at the end of the tunnel. Mr. Paulson, along with President Bush, will be out of work in 10 months. How much longer will Ben Bernanke have his job? To be fair, he can't be fully blamed for all of the ills in the economy. Some of the seeds of the current crisis were sown before he took office. Nonetheless, it is starting to look as if Mr. Bernanke's tenure at the Fed will not be setting any records.

Tuesday, March 11, 2008

Physician, Heal Thyself

Saying that Eliot Spitzer is a hypocrite is stating the obvious. Yet it is a little gratifying to see this "holier than thou" crusader get caught in his own ethical lapse. Spitzer made a career of ruining the reputations of numerous businessmen; not by convicting any of them of doing anything criminal, but by threatening to indict their companies if they didn't resign.

Richard Grasso, Ken Langone, and Hank Greenberg are still trying to get their reputations back. Take Grasso for instance. What was his big crime according to Spitzer? He was paid too much. That's undoubtedly true. Personally, I think anyone who gets paid more than me is paid too much, but that doesn't constitute a crime. Spitzer also went after a number of directors at the NYSE, but he decided to give former New York State comptroller H. Carl McCall a pass. Perhaps he felt he needed McCall's support in his ambitious quest to become governor.

Today's Wall Street Journal mentioned a speech Spitzer gave to the New York Society of Security Analysts in 2003. I was there. I remember being disappointed that the NYSSA chose to invite Spitzer to address our membership. I watched as investment professionals fell all over themselves to shake Spitzer's hand, as if doing so somehow certified their high ethical standards. When Spitzer delivered his speech, he joked about indicting people in our profession. It became very evident to me that this man was focused more on promoting his career than he was in protecting investors from criminals. What goes around, comes around.

Monday, March 10, 2008

SIFMA at Wharton

I just returned from the Wharton School at the University of Pennsylvania. The Securities Industry and Financial Markets Association (SIFMA) is holding a one-week conference for its membership. They kicked off the event this morning with a panel discussion entitled "Wall Street Comes to Wharton." I was honored to take part in the discussion, which focused on the economy and the markets. Bob Stovall, Managing Director and Global Strategist at Wood Asset Management, hosted the panel. Other panelists included Sam Stovall, Chief Investment Strategist at Standard & Poor's; Randall Eley, President of the Edgar Lomax Company; and Michelle Girard, Managing Director and Senior Economist at RBS Greenwich Capital.

Housing prices got a lot of attention. All panelists agreed that prices will continue to fall for some time. However, Michelle pointed out that realtors are reporting a pick up in interest from buyers looking for bargains. Nonetheless, I said I was more concerned about the fact that the drop in prices is still accelerating. Although I am hopeful that prices will start falling at slower rates in the very near future, I expect overall housing prices to keep falling throughout 2008 and perhaps into 2009. I also warned that problems could spread in the commercial sector and banks could soon start announcing writeoffs of commercial mortgages.

Sam Stovall talked about historical trends and pointed out that it is rare for stocks to fall as much as they have without a meaningful recovery within a year while the Fed is aggressively cutting interest rates. Sam's point was that it is more risky to be out of the market right now than it is to be in it because stocks could rally strongly and unexpectedly. While I certainly believe stock prices could go lower in the short term, I am more confident that they will be at higher levels 3-5 years out. As a result, I would agree with Sam. Take advantage of strong sell-offs by doing some bargain hunting.

Randall Eley is a value manager who favors large-cap blue chip companies. He, too, has a bullish long-term outlook. Stocks he likes right now include Chevron (CVX), Bank of America (BCA) and Home Depot (HD).

Thursday, March 06, 2008

In Defense of Peter Lynch

Peter Lynch is a legend in the investment world. If you ask investors to name America's all-time best money managers, Warren Buffett would no doubt come out on top. But chances are Peter Lynch would be close behind.

Lynch managed Fidelity's Magellan fund for 13 years. Under his watch, assets under management ballooned to $14 billion. He authored several books on investing and coined the term "ten-bagger," which describes a stock that goes up 10 times in value. He was famous for walking around shopping malls and paying attention to what people were buying. Today, he spends a great deal of time on philanthropy.

Yet the man who is so revered by investors, stands a little tarnished. You see, Lynch accepted gifts from brokerage firms that were seeking Fidelity's business. This is considered a big no-no in the mutual fund industry because gifts from brokers might be construed as bribes. A manager who accepts a gift might feel pressured to channel business in that broker's direction.

Because Lynch managed so much money, you might expect to find that it took hundreds of thousands of dollars in bribes to buy his business. You would be wrong. What is the value of all the gifts Lynch received? A grand total of $15,948! The man who managed billions of dollars on behalf of investors all over the world got into trouble for accepting $15,948 worth of tickets to sporting events and a rock concert. He didn't even use many of the tickets he received.

I have no doubt that Peter Lynch is a man of integrity--an honest man of high ethical standards. Obviously, he would have been smarter not accepting any gifts whatsoever. But there is absolutely no evidence that Magellan shareholders were harmed in any way. On the contrary, Mr. Lynch delivered outstanding market-beating returns to his investors. In my view, if a man like Lynch can get into trouble for something like this, there is something wrong with the system. The government barked up the wrong tree in this case. My respect for Mr. Lynch has not been diminished in the least.

Monday, March 03, 2008

Oil Sets All-Time High

Oil prices set an all-time high today on both a nominal and inflation-adjusted basis. Yet gasoline prices are still below their May 2007 highs. Interestingly, oil prices were much lower last May. But gasoline prices surged anyway due to problems at refineries. Today, however, it is oil, the raw material for making gasoline, that is just starting to push gasoline prices higher.

But oil prices are not climbing because of a lack of supply. Instead, they are rising due to demand for oil futures contracts. Investors are pouring money into the commodity because the Fed is trashing the dollar. Because oil is a dollar denominated commodity, it provides a hedge for investors worried about a falling dollar. They are looking for ways to preserve the value of their dollar denominated assets. Eventually, these higher oil prices will drive up the price of gasoline, too.

In the past, higher gasoline prices had little effect on consumption. This is because it takes time for consumers to adjust their behavior. You don't immediately dump your SUV and buy a Civic just because gasoline prices spike. But if you are convinced that higher gasoline prices are here to stay, the next time you are in the market for a new vehicle, you will consider something more efficient. After several years of watching gasoline prices climb higher and higher, consumers are making the switch.

These days automobile manufacturers can't sell SUVs and pick-up trucks without making large concessions. In fact, GM just reported a 19% drop in light truck sales. Consumers are doing the math and they now want more efficient vehicles. At $3 per gallon, if you drive 12,000 miles per year and get 20 mpg, a 50% improvement in mileage saves you $600 per year. At $4 per gallon, you will save $800 per year. If there are three cars in your family and they rack up a total of 36,000 miles per year, at $4 per gallon, the total savings adds up to $2,400 per year.

The government can take steps to encourage conservation. CAFE standards, however, are not the way to go. A better approach is to put a floor on gasoline prices. While I'm no fan of higher taxes, it cannot be denied that taxes are a great way to affect behavior. If we want to reduce our dependence on foreign oil, we should encourage people to consume less gasoline. The best way to do that is to make driving more expensive. However, any incremental revenue the government generates from a floor on gasoline prices should be used to offset other taxes or to fund research into alternative technologies. Using it for general funding purposes would be nothing but a big waste.