Thursday, April 23, 2009

Bill Ackman: The Optimist

Bill Ackman’s friends describe him in two ways. They offer the euphemism that the prominent hedge fund manager “does not suffer from low self-esteem.” Then they observe that he is optimistic—almost clinically so. A pop psychologist might diagnose Ackman with hypomania, a condition notable for persistently elevated moods but without the self-destructiveness of true mania. “He doesn’t register reversals and defeats and hard feelings the way other people do,” says David Klafter, a former colleague.

I ask Ackman about the condition while he is driving in a car with his family. He hasn’t heard of it, but says he is an “extremely resilient person.”

His 11-year-old daughter playfully chides from the backseat, “And you’re modest.”

Ackman is an activist investor, a respectable term for people who in the 1980s were known as corporate raiders. He buys big stakes in companies and then offers his opinions—loudly—on how to improve their operations. Often, Ackman has been a contrarian. He bought shares of Rockefeller Center when Manhattan real estate was on its back in the mid-1990s, and he launched an attack in 2002 on MBIA Inc., the powerful and politically connected bond insurer, when everyone else on Wall Street was convinced the company was gold-plated. In early 2007, he sounded one of the most prescient warnings about the credit bubble and the leveraged complex of American finance.

William A. Ackman, who turns 43 this month, has had the seminal financial career of the past two decades, which is to say that he’s had the seminal American career of the era. Almost immediately after business school, he started a hedge fund to manage millions for wealthy people—with no investing track record. About a decade later, he was forced to shut down. He endured regulatory investigations played out in the klieg lights of the press. He relaunched and clawed his way back to respectability, becoming a member of a new generation of Wall Street wise men. No hedge fund manager or investment banker will be able to replicate his trajectory for at least a generation.

Now he’s gearing up for one of the biggest battles of his professional life. After losing nearly $2 billion in a calamitous bet on the retailer Target Corp.—almost all that investors had given him for the investment—he is waging a proxy fight against the company. He will have a tough sell in the leadup to the annual shareholder meeting in May. Taking on a company as big as Target is almost unheard of. Target decries the contest as “costly and disruptive.”

Irrational Everything

Prof. Daniel Kahneman has dozens, perhaps hundreds, of stories about people's irrational behavior when it comes to making economic decisions. It's no wonder, because for dozens of years he and his late colleague Amos Tversky researched human behavior. Many of their studies concerned the making of financial decisions.

But the story Kahneman recalls when asked about the economic models at the root of the current financial crisis is actually taken from history, not an experiment. It concerns a group of Swiss soldiers who set out on a long navigation exercise in the Alps. The weather was severe and they got lost. After several days, with their desperation mounting, one of the men suddenly realized he had a map of the region.

They followed the map and managed to reach a town. When they returned to base and their commanding officer asked how they had made their way back, they replied, "We suddenly found a map." The officer looked at the map and said, "You found a map, all right, but it's not of the Alps, it's of the Pyrenees."

According to Kahneman, the moral of the story is that some of our economic models, perhaps those of the investment world, are worthless. But individual investors need security - maps of the Pyrenees - even if they are, in effect, worthless.

Wednesday, April 22, 2009

Understanding Socialism

An economics professor at Texas Tech said he had never failed a single student before but had, once, failed an entire class. That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor then said okay, we will have an experiment in this class on socialism.

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A. After the first test the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy.

But, as the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too; so they studied little. The second test average was a D! No one was happy. When the 3rd test rolled around the average was an F.

The scores never increased as bickering, blame, name calling all resulted in hard feelings and no one would study for the benefit of anyone else. All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great; but when government takes all the reward away; no one will try or want to succeed.

Tuesday, April 21, 2009

Warren Buffett on Wells Fargo

Fortune: How is Wells Fargo unique?

Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"

What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?

Almost 20 years ago they were saying the same thing. In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap and you don't have to do dumb things. But periodically banks do it, and they do it as a flock, like international loans in the 80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I know that you can have a model that works fine and Wells has come closer to doing that right than any other big bank by some margin. They get their money cheaper than anybody else. We're the low-cost producer at Geico in auto insurance among big companies. And when you're the low-cost producer - whether it's copper, or in banking - it's huge.

Then on top of that, they're smart on the asset size. They stayed out of most of the big trouble areas. Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things, the house prices can fall to where you get hurt some. But they were not out there doing option ARMs and all these crazy things. They're going to have plenty of credit losses. But they will have, after a couple of quarters of getting Wachovia the way want it, $40 billion of pre-provision income.

And they do not have all kinds of time bombs around. Wells will lose some money. There's no question about that. And they'll lose more than the normal amount of money. Now, if they were getting their money at a percentage point higher, that would be $10 billion of difference there. But they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from their customer base.

Insurance revenues for example, which had double-digit revenue growth in 2008.

And I would say that most of the critics of Wells don't even know they've got that business. That business alone is worth many billions of dollars. And their mortgage business, as you can imagine in this period, I mean, the volume that is poring through there, is huge. The critics have been right on other big banks, so I think they're inclined to sweep Wells in as well to some extent. And if you've been right on Citi and you've been right on BofA, it gets easy to say, well, they're all going to go.

We own stock in four banks: USB, Wells, M&T, and SunTrust. SunTrust I don't know about because South Florida is going to be the last to come back, and they've got a concentration down there. The other three, they're going to have a lousy year, but they'll come out of it with far more earnings power. The deposits are flowing in. The spreads are wide. It's a helluva good business.

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