Portfolio manager’s Letter July 2002
Hypocrisy has always been the politician’s favorite virtue and all the screeching and hand ringing currently taking place inside the beltway will certainly produce results. Whether the eventual product of Washington’s deliberations will actually do anything to improve the lot of the American shareholder is an entirely different matter.
One of the central facts that the politicians and commentators have been able completely ignore in the flurry of their self-righteous posturing is that they were present at the birth of the bubble that fathered all this corporate mendacity. Present not only at the birth but cheerleading every move by Alan to pump up the irrational exuberance.
The “Greenspan Put” was an instrument that gave a huge boost to our recent bubble. It was an implied promise that Greenspan would intervene to save the market any time there was an economic crisis. While on the surface this does not seem like a bad idea, it helped to create the impression that the Stock Market was a low risk investment, and thus helped to father the great tech bubble.
It all started in 1987 when Greenspan pumped liquidity into the system during the 87 market crash. For this he was awarded the title of market hero.This was followed in 1994 by our now famous “soft landing” an event praised by the media and politicians alike as the end of those bothersome business cycles. For the market it seemed wonderful, instead of those nasty bear markets all we need was for the FED to tighten gently every three or four years and the market would flatten out for a while then resume it perpetual ascent. Very little pain, lots of gain.
Finally in October 1998 as the market was entering its first serious correction in ten years. Big Al rode to the rescue and lowered interest rates three times. His motivation here is a little murky to me, but I suspect he was beginning to believe his press clippings. The media and politicians were now convinced that Greenspan could deliver us from Bear markets forever. For a man who once was a follower of Ayn Rand I find this to be a little ironic.
So By the late 1990’s the idea of the “Greenspan Put” was firmly in place. What, followed, of coarse was a stampede of cash into high risk stocks and speculative bonds. Easy money is always bad for a financial system, but now we see that were easy money corrupts, really easy money corrupts absolutely.
At one of the Annual meetings I attended (I think is was 1996) Charlie was talking about corporate CEO’s and compared them to ducks. I can not remember the exact quote and would be extremely grateful if some could help me with this, but the gist of his metaphor was that CEO’s in a rising economy were like ducks on a pond.
As the rains came the water would start rise all the ducks would see this as a good thing, and assume that since there were in a position of responsibility, their personal leadership was the cause of the ascent. If the rain continues, the water keeps getting deeper, and soon the all the ducks on the pond begin to think “I must be a pretty smart duck.”
This is one of those things that sticks in your mind and makes you keep going back to Omaha. Anyway it stuck in my mind and ever since, now, whenever I read CEO, I think “duck”. Thank you, Charlie.
So the “Greenspan Put” kept the rain falling, and the water kept rising. All the ducks thought they were getting smarter and smarter. The gap between what the ducks thought and reality became so wide that it fostered acts of superhuman stupidity. One example is all that is necessary to understand enormity of this gap. Bernie Ebbers borrowed $400 Million to buy stock in his company.
That’s 400 with six zero’s, for an equity position that is probably worth about $45.00 in today’s market. What the hell was running though his duck brain? Clearly the water in the pond was going to keep going up forever. Sadly I fear this duck will soon receive the world’s largest margin call from a bankruptcy court.
So what do we do now? I do not have the answer to that question, but for those that are chanting for more regulation, I would like to point out that it was regulatory stupidity that kept the water level rising in the ducks’ pond. It is my opinion that it is foolish to assume that the regulators are going to be any smarter than the ducks. The Federal Reserve Bank was created to assure stability for the banking system and has achieved some measure of success at solving small problems, but these small solutions always seem to lead to bigger problems.
Should the book-cookers be held criminally liable? This question I leave to the courts, but I doubt that throwing the ducks in jail will help prevent damage from future bubbles, clearly, in most cases these particular ducks had no idea what they were doing and so it is unlikely that criminal sanctions would have changed their behavior.
The market itself is not without weapons to deal with havoc caused by the bubble, after all, in most cases in the private sector stupidity is self correcting. First of all, we have the Plaintiff’s Bar. There is no question in my mind that this institution is capable of sucking every ounce blood left in our unfortunate ducks.
Second and much more important is Warren’s solution. The large institutional shareholders need to unite and punish all behavior that damages the interest of shareholders. Already a group that includes Warren, Wally Weitz, Bill Miller, John Bogle, and Christopher Davis exists, if you can believe this story from Investment News.
Such an organization is much more likely to accomplish reform than anything the beltway is capable off. We need to have options expensed and Executives must be made to act like owners. Our legislature has proven in the past that they are not willing to stand up for the interest of shareholders when the money from corporations pours in to support their reelection campaigns.
Finally I think it is important to deal with changes in the policy of the Federal Reserve Board. First of all it should be made clear that it not the FED’s policy to bail out the Stock Market. Further it should become explicit policy of the FED to target bubbles. The bubble was apparent to Greenspan as early as 1997 and surely everyone would be better off if the Fed had acted then.
At the same time, I do not think that it is fair to blame the FED alone for the bubble; it is possible that the bubble money came not only from the domestic money supply but from the evolution of international money flows. Foreign currency was pouring into the U.S. Bond Market in 1999 – 2001, and logically much of that capital eventual found its way into telecom bonds.
Yet these flows would not show up on any of the meters that the FED is currently charged with monitoring. Further any FED move to tighten would have caused this flow of funds to increase, because as the FED tightens two things happen. Rates paid on corporate bonds go up and the Dollar gets stronger both of which make U.S. bonds more attractive to foreign investors.
Thus while domestic money growth is slowing new foreign money is flowing over the transom. This, for awhile, put the FED in the strange position of pumping the tech bubble at the same time in was trying to cool the nations economy.