Thursday, March 25, 2010

A Jim-the-Realtor video

Jim the Realtor is a fabulous feed on the Southern Californian residential (and small-scale commercial) real estate market – its directions and its intricacies.

This video is one of his best ever.  It is 9 minutes long and in his usual monotone. 

I wish it were three minutes shorter because I recommend you watch it to the end.  The last two minutes are intriguing. 

 

 

Explanations sought.

 

 

 

John

Saturday, March 20, 2010

Repo 105’s antecedents: Ken Lewis

I agree with Felix Salmon that the former Lehman staffers who defend Repo 105 are psychopaths – certifiably insane.  They state (as if this justifies it) that …

The only people who would worry about using an old trick to reduce leverage from 13.9 to 12.1, are “yappers who don’t know anything.”

For those that don’t know Repo 105 was a sale and repurchase agreement by which Lehman parked about 50 billion in assets (presumably assets they did not want to discuss) overnight via a repo transaction so they would not appear on the balance sheet. 

By now anyone who does not realize that sort of accounting legerdemain is unacceptable is (a) entirely out of touch with reality and (b) self aggrandizing on a magnificent scale.  Both are signs of mental illness.

But unfortunately the Lehman executives do have one point.  Repo 105 type balance sheet faking was “an old trick” and well known to anyone who cared to read balance sheets (very) carefully.*

Let me take you back to 2006 and Bank of America.  Pages 94 and 95 of the 2006 Annual Report show (amongst other things) the average total assets by quarter from the fourth quarter of 2005 to the fourth quarter of 2006 inclusive.  Here are the numbers:

(US dollars - millions) Q4 2006 Q3 2006 Q2 2006 Q1 2006 Q4 2005
Average total assets 1,495,150 1,497,987 1,456,004 1,416,373 1,305,057

Now lets extend this table by including period end assets.  You can find the data here (see page 4 for both fourth quarters and third quarter, and page 4 here for the first and second quarters). 

(US dollars - millions) Q4 2006 Q3 2006 Q2 2006 Q1 2006 Q4 2005
Average total assets 1,495,150 1,497,987 1,456,004 1,416,373 1,305,057
End period total assets 1,459,737 1,449,211 1,445,193 1,375,080 1,291,803
end period less average assets -35,413 -48,776 -10,811 -41,293 -13,254

 

You will notice that the end period assets were always lower than the average assets.  Moreover it was not obvious unless you really looked because the quarterly earnings releases did not include average assets (but you could work it out because they stated return on average assets). 

It was not just 2006 either – this had been happening for a while.  Bank of America was parking its assets off balance sheet at the end of every quarter for some time and had been obscuring the fact

Counterparties

If Bank of America wanted to shove the assets off balance sheet someone (credit worthy) needed to be found to house the assets overnight.  There are not that many parties credit worthy for $50 billion or more of overnight repos. 

Well – being an obsessive reader of bank accounts I found the counterparty.  It was MUFJ.  If you wish to you can show – the same way that MUFJ had end period assets higher than average assets and that the differences and timing roughly match.  Someone had to assist BofA in its financial legerdemain and we know the counterparty.

Once – through an interpreter – I asked senior MUFJ executives about this.  Any nuance in the answer was lost in translation. 

So back to Repo 105

Repo 105 is fraud.  Its a lie to investors and rating and regulatory agencies.  It was also fraud when BofA did it.  But both Lehman and Ken Lewis compartmentalized it as OK.  And it was not the fraud that undid them – it was the overweening arrogance that thought this was alright.  The same overweening arrogance that made Ken Lewis think it was alright to pay a big premium to close for Merrill Lynch (and later force mass dilution of BofA common shareholders). 

But the chief executive (or other executive) who thought this was alright was probably certifiable.  Just as certifiable as the Lehman execs who Felix rightly chastises. 

Do we want to prosecute?

There is a big debate in the blogosphere as to whether anything in the Valukas Report rises to the level of prosecution.

I suspect in a vacuum it does.  But this was a collective insanity every bit as mad as the poisoning craze written about Charles Mackay.  Mass insanity does lower moral culpability and it takes an extraordinary person to stand up to it. 

Besides – if we are going to slap Erin Callan’s wrists in handcuffs then we are going to have to do the same to Ken Lewis and probably have to extradite the top-end of the Japanese establishment who were the counterparties. 

I do not want to go there – and I do not think it would be constructive.

 

 

John

Disclosure:  Long a lot of Bank of America – surprising given this post I guess. 

*It is my burden to read balance sheets like this and to remember details four years later. 

Friday, March 19, 2010

My tipper on Astarra

Tipping the authorities off about Astarra required – as I said – no special genius on my part.  I was tipped by a blog reader who noticed that the Astarra investment committee claimed Charles Provini as a member whilst Provini was the CEO of Paradigm Asset Management.  I have written extensively on Paradigm Asset Management (see here for a decent summary). 

Anyway my tipper has now revealed himself.  He is Dominic McCormick – the chief investment officer of Select Asset Management.  Dominic insists his team deserves any credit.

Dominic (and presumably his team) had many of the issues with Astarra nailed by the time he tipped me off.  I worked out a few more.   

I reported the story to the Sydney Morning Herald who did not think they had enough evidence to run the story.  [They printed nothing until much later.]

Later I worked a few more things out and using connections ensured that the whole story landed directly on the desk of Tony D’Aloisio (the head of our securities regulator). 

Dominic found about half a dozen red flags with Astarra.  He has since listed them in this article without revealing that he was my original tipper.  Dominic’s article shows clearly that there were plenty of reasons not to invest in Astarra – and these reasons are valid reasons to be wary even if you have no strong basis to allege fraud.

The problems are wider than either Dominic or I anticipated.  For instance we knew nothing of ARP Growth – and that may be the most seriously impaired fund of the lot.  It is also the only fund on which I am willing to determine – absolutely – involved fraud.  (I have two wildly different sets of accounts for ARP Growth - at least one of those accounts must be fraudulent.)

The rest of the issues with Astarra I will leave in the capable hands of our regulator and perhaps the class action lawyers.  I want to get back to making money for our clients.

 

 

John

Thursday, March 18, 2010

Barclays: do you employ these psychopaths?

Felix Salmon directs us to a blog post in which former Lehman executives (possibly safely employed by Barclays) talk about the Valukas report. 

http://blogs.reuters.com/felix-salmon/2010/03/17/repo-105-like-whatever/

Felix rightly describes these people as psychopaths. 

I am not going to further roast these executives – I just want to know how much of this culture infected Barclays. 

It remains a source of amazement to me that Barclays came out of the crisis so well.  Sure they got a (real) bargain buying Lehman’s US Broker-Dealer.  But they were hardly Snow White and their leverage levels were way higher than Lehman.  Moreover the crash-or-crash-through attitude of Bob Diamond would not have been out of place at the most aggressive (failed) hedge fund.  [The first post on this blog that got more than 30 readers was on Barclays – and – unlike many of my early posts – it looked very good for a while – but less good in the long run.]

Barclays is here and prospering so my pre-crisis view of the investment banks (that Lehman and Barclays would be the troubled ones) did not turn out precisely right.

 

John

PS.  Sorry for the absence of posts – but I was busy walking from Mallacoota to Wonboyn and there were no people, phones, internet or stock quotes.

Thursday, March 4, 2010

A little follow up for people who want to reinterpret what Buffett said… oh – and a stock reason for looking at all of this…

There are a few comments on the blog that annoy me.  One for instance is repeated below:

A review of the transcript will show that Buffett believes that: a) the legislation must focus on cost, in order to achieve the goal of universal coverage. This has nothing to do with socialized medicine; b) he believes a broader political consensus is required. Everyone is entitled to the their opinion, but not to someone else's.

Buffett clearly said he was for universality of health care.  He would – if given no other choice – vote for the current bill.  Universality – unless someone else has worked out how it happens – involves a person who can’t pay (or possibly won’t pay) being covered by other people.  That can happen via the tax system or via some kind of forced levy on other people.  But it necessarily involves the (partial) socialization of medicine.

He implies however – though does not say so directly – that universality (necessarily involving some socialization of costs) – could be a disaster if costs are not controlled.  I will go further and say that it will be a disaster if costs are not controlled.  Australia has spent the last twenty years on measures that control costs (with considerable success).  In the UK – but to a much lesser extent in Australia – those measures include queue rationing of some services.  Queue rationing known here as “hospital waiting lists” was for a long time one of the dominant issues in State politics.  Queues are less of an issue now than (say) ten years ago – but if you run the expression “hospital waiting lists” through Google News you will still find that it is a political issue.  Anyone who tells you that you can have universal coverage without some queue rationing is lying.  A decent part of the system however is working out what procedures must take place quickly and what procedures can safely wait a while.  In Australia some people are in pain whilst on waiting lists. 

Buffett states clearly that controlling costs will not be done with a bill that pleases everybody.  There are $2.3 trillion of costs – and every bit of those costs has a constituency.  He wants a real analysis of medical spending effectiveness.  He wants experts – and he points favorably at Dr Gawande.  Dr Gawande focuses on things that involve medical incomes (including the use of the Doctor’s pen to order tests and specialist treatment). 

He notes that medical employees as a percent of population are low in the US compared to other jurisdictions and yet medical expenditures are high as a proportion of GDP.  Some of this must be expenditure that does not go to medical staff (he points directly at medical kit).  But some of it must be the incomes of the participants are high relative to the rest of the population.  [Simple math here – less employees – more cost – so more cost per employee.  And I know kit is part of that equation… but kit expenditures are simply not large enough to make up the difference.  And most of the rest of the cost of a doctor is the doctor’s income.]

Buffett does not prescribe how you would crush medical costs as he suggests – but he notes that other countries have done it with universal coverage, providing more doctors, more nurses and more consultations.  He thus thinks it is possible (though politically terribly difficult).  He specifically thinks that this cannot be done by consensus (despite the comment repeated above) because a bill that pleases everyone can’t deal with costs.  [I added – though Buffett did not say – that that implies that the bill cannot be bipartisan.  In the current context that means a filibuster process – though Buffett did not say that either.  Still if there is a way for a non-consensus medical bill which provides universal coverage and cuts costs to be bipartisan show me and I will stand corrected.]

I doubt Buffett – as the world’s second richest man – would find queue rationing acceptable for himself – but that discussion never came up.  If you want to accuse him of hypocrisy go ahead.  When my wife damaged her knee in a skiing accident we queue jumped using supplementary private health insurance.   So accuse me of hypocrisy too.

Buffett obviously knows that a system that radically cuts costs but has the government meet some of those costs will necessarily involve rationing.  He is not a fool.  He just never said how the rationing should take place – preferring to leave that discussion to experts.  That way though he could sound reasonable and friendly whilst proposing reforms that will radically reduce some peoples’ incomes and somewhat limit access to medical care.  And that I guess is Warren Buffett to a tee.  He sounds all genial – but underneath is one of the most hard-headed men you will ever come across.

Why I am interested

This is actually a hard headed investment blog.  And Buffett is right.  Medical reform which does not control costs will be a disaster.  He is also right to finger medical kit.  The current bill does not address costs – so it is not the time to think about this – but some medical kit companies trade at nose-bleed valuations because they can sell growing amounts of high tech kit at high margins.  (Intuitive Surgical is a good example.) 

I am an irregular short-seller of stock in even the finest companies.  When America finally gets serious about controlling medical costs some of these stocks will be fantastic shorts – simply because controlling costs means reducing some people’s incomes and some corporate profits.

And – that is enough reason to take the partisan glasses off and look entirely rationally a the problem.  This bill does not give me a good reason to short Intuitive Surgical.  From the perspective of Warren Buffett however that is why it is not a good bill. 

 

John 

 

Follow up: 

Namazu  - the provider of the comment that annoyed me - suggests we might be arguing over the meaning of socialized.

I think that is probably a fair comment... it is not a word Buffett used.

I consider the mixed market system of Australia partially socialized. By far the bulk of medical costs are picked up by government and are shared through the tax system - but it looks quite different to the UK.  [My UK friends also prefer the Australian system…]

Still – a system where by far the bulk of the costs are picked up by government and shared through the tax system meets my definition of socialized.  [Though people who say keep government hands off Medicare might have a different view…]

Still in many categories (for example pharmaceuticals) the Australian government is effectively the monopoly buyer - and it uses that power to reduce costs. That is a KEY part of the story as to how costs are reduced in almost all other countries.

And yes - it does crush incomes of doctors and corporate profits. 

Wednesday, March 3, 2010

Warren Buffett on Obama’s health reforms

Warren Buffett did one of his regular (extended) interviews with CNBC.  I think he appreciates the charm and attention from Becky Quick – even enough to get up at 5am and go to the steakhouse turned TV studio.  Most of these interviews are Buffett repeating his wholesome (and oft repeated) wisdom.  However he often comes up with a piercing analysis of something topical.  Today it was health care.

We (the US) have a little over 2.5 doctors per thousand.  Much of the world has over 3 doctors per thousand.  We have 11 nurses per thousand – much of the world has more.  We have three beds per thousand – much of the world has 6 or 7 beds per thousand. 

Having said this he points out that costs as a proportion of GDP are considerably higher than the rest of the world.  He then points out some statistics (for example infant mortality) where the US does worse than some other developed countries.  Importantly he points out that these costs are a passed onto other sectors of the economy.  He did not describe them as a “tax” on the rest of the economy – but that is what he meant.

He describes the situation as a “tape-worm” strangling American productivity and he is for health care reform but particularly health care reform that controls costs.  He would – in the absence of other choice – vote for the current bill.  That however is – in his case – very qualified support for the current bill.

The health-care part of the interview is worth watching.

 

 

In the interview he refers (favorably) to an article in the New Yorker by Atul Gawande which compares medical costs in high cost locations and low cost locations.  Dr Gawande describes health care driven by entrepreneurial doctors in an environment of over servicing.  I think the money quote in Gawande’s article is this:

Most Americans would be delighted to have the quality of care found in places like Rochester, Minnesota, or Seattle, Washington, or Durham, North Carolina—all of which have world-class hospitals and costs that fall below the national average. If we brought the cost curve in the expensive places down to their level, Medicare’s problems (indeed, almost all the federal government’s budget problems for the next fifty years) would be solved. The difficulty is how to go about it.

I have written about health care before (but I think Buffett says many things better).  Though in summary the costs of American health care is higher because:

  1. America pays its doctors more than other countries (indeed substantially more than other countries)
  2. There is less control on pharmaceutical expenditure and other medical kit (and Buffett notes that Americans spend a lot on medical kit), 
  3. There is more hospital and health care administration – especially insurance operating - expense than other countries (although anyone who follows the bureaucracy of the National Health might think otherwise), and
  4. There is more litigation and insurance expense than in other countries (though Buffett did not play up this aspect of cost comparisons).

I would love a decent breakdown of those things.  Unless however the costs are addressed health care reform will ultimately be an economic failure

And that is roughly how Buffett thinks about the Obama reforms.  The current health care bill provides universality of health care – but does not address the fundamental cost issues

That however is very difficult.  As Buffett puts it – the current health care bill is about $2.3 trillion annually.  And every one of those $2.3 trillion has a constituency.  Moreover that constituency is organized and are effective lobbyists.  Buffett thinks that there is simply no way to do an effective cost reduction health care bill by consensus.  That is hard to disagree with. 

As he puts it:

Everyone of those dollars is going to somebody and they are going to yell if that dollar becomes 80c or 90c. 

I thought he was being generous.  If American doctors were paid like Australian doctors my guess is those dollars would not become 85 cents.  More like 60 cents or less.  The squealing here was intense – but even after all that trimming doctors remain pretty well paid.  But you can’t get rich doing general practice and even specialist medicine is a ticket to the upper-middle class not to dynastic wealth. 

What allows Australia to pay so little for doctors is a monopoly buyer (the Government) actively suppressing their income.  It is little surprise that doctors do not in general support that bit of the reform agenda.

What ultimately Buffett was saying was that proper health care reform does not and cannot get broad agreement – and hence must be done with the expenditure of significant political capital.  He never says it – but I think he thinks that this would be a good time for the Democrats to outlast a filibuster.  Triangulating Democrats have their place – but not here.

Buffett thinks that if this is not done medical care will remain a growing parasite (“a tape worm”) for the rest of the American economy.  He supports an aggressive and interventionist solution.

Still – if you follow his numbers he thinks the savings are probably 4% of GDP.  The ambitious number in my original post was somewhat larger.  He is probably right on that too.

 

 

John

 

PS.  One of the more amusing things about this interview is Joe Kernan making an ass of himself.  Buffett is clearly saying that – correctly done – socialized medicine will improve the competitiveness of American industry (though the current bill is not a solution to costs).  This is anathema to Kernan’s oft-stated ideology – and Kernan repeatedly tries to restate Buffett’s position to suit his own ideological view rather than Buffett’s clearly enunciated position.  Becky Quick proves again that she is the heavyweight on that show and I can see why Buffett does appreciate her (intellectual) charms.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.