Friday, July 29, 2011

FORTUNE: Inside Pfizer's palace coup

Found via My Investing Notebook.

Did CEO Jeff Kindler get pushed out because he was shaking up the dysfunctional pharmaceutical giant -- or because he's an ineffective leader?

For Jeff Kindler, it was a humiliating moment. The CEO of Pfizer, the world's largest pharmaceutical company, had been summoned to the airport in Fort Myers, Fla., on Saturday, Dec. 4, 2010, for a highly unusual purpose: to plead for his job.

Three stone-faced directors, representing the company's board, sat inside a drab airport conference room as the CEO, trained as a trial lawyer, struggled to argue his most important case. Alerted to this meeting less than 24 hours earlier, Kindler detailed his accomplishments, speaking nonstop for the better part of an hour. He touted his bold reorganizations, praised his administration's sweeping cost reductions, and rhapsodized about his reinvention of Pfizer's crucial research-and-development operations.

But the three board members, Constance Horner, a former deputy secretary at the U.S. Department of Health and Human Services; George Lorch, an ex-CEO of Armstrong World Holdings; and Bill Gray, a former Philadelphia congressman, weren't there to debate the direction of the company. The board had spent a frantic week in an urgent investigation: A revolt had erupted against Kindler among a handful of senior managers, and the directors were trying to figure out what was going on. One possibility: an internal power grab. Another: a CEO who was unraveling.

PBS Series on Niall Ferguson's "The Ascent of Money" (2009)

The Ascent of Money Episode 1: From Bullion to Bubbles

The Ascent of Money Episode 2: Bonds of War

The Ascent of Money Episode 3: Risky Business

The Ascent of Money Episode 4: Planet Finance

Live Q&A with Niall Ferguson, host of THE ASCENT OF MONEY


Book: The Ascent of Money

The Manual of Ideas: Underappreciated Balance Sheet Values

The new issue of The Manual of Ideas is now out. My colleagues – Mike Pruitt and Matt Miller – and I were interviewed in this issue. For more information on this issue or to subscribe, go HERE. To read an excerpt, go HERE.

Evolution: How We Know it Happened & Why it Matters



Related book: Evolution: What the Fossils Say and Why It Matters

Thursday, July 28, 2011

FPA Crescent Fund Q2 2011 Letter to Shareholders

We enjoy the flexibility to invest in various asset classes; yet having the ability to go anywhere loses its advantage if there’s nowhere to go. That’s the position we find ourselves moving closer to today, given that many stocks aren’t particularly cheap. Few industries, countries, or asset classes are out of favor, and even fewer meet our strict risk/reward parameters and fall within our circle of competence. It’s starting to feel like our strategy is merely going to give us more ways to find frustration.


We pay attention to the macro environment because it sometimes allows us to identify significant opportunities and, at other times, to avoid or limit catastrophic risk. From 2005-07, we worried about unsustainable home prices, the over-levered consumer, and fragile financial institutions. Our anticipatory and conservative stance helped protect the portfolio when those fears proved well-founded as the panic of 2008-09 viciously punished the excess of the earlier era.

We still find ourselves worrying today, particularly about unreasonable government budgets that have helped foster unmanageable burdens. Over the past three years we have witnessed a shift in financial obligations from the personal to the public (governments) that has done nothing to enhance the solvency of the overall system, although the optics appear favorable to some.

A country can be viewed as a proxy for the collective economic production of its populace, but if that society finds itself unable to shoulder the debt burden necessary to finance its lifestyle, then simply shifting its financial obligation to the government will eventually bankrupt the nation. We currently bear witness to such a shift. However, it’s easier to determine if an individual or business is bankrupt than to determine a nation’s insolvency (particularly those with access to an established printing press). Many countries walk a fine line that separates the solvent from the bankrupt. Those that tip to the latter will be forced to default and/or dramatically cut programs and services. We expect such action will likely have a significant negative impact on that country’s GDP, and to a lesser degree, on that of its larger trading partners. Companies that do business in those countries will find themselves similarly harmed.

The day of reckoning may not come quickly, as there exists more than one way to default: you can stop paying, or just let inflation erode what you owe in real terms. For example, for the $14.3 trillion dollars the U.S. owes today (ignoring any future borrowing), a 3% inflation rate would reduce the purchasing power of that debt to $10.6 trillion dollars in ten years, but at 5% inflation, the “real” debt would be just $8.8 trillion, and at 10%, it drops to $5.5 trillion. Inflation benefits debtors – at least as far as paying it back is concerned. The ancillary effects can prove dramatic though, as attendant higher interest rates can crowd out spending. How many of you have already seen fewer police on the street, or had your local fire station or library close? It’s terrible; but make no mistake, it can get worse.

Lakshman Achuthan on CNBC



Wednesday, July 27, 2011

Michael Shermer: The Believing Brain



WSJ Book Review: "The Believing Brain"

Thanks to Daniel for passing this along.

Superstitions arise as the result of the spurious identification of patterns. Even pigeons are superstitious. In an experiment where food is delivered randomly, pigeons will note what they were doing when the pellet arrived, such as twirling to the left and then pecking a button, and perform the maneuver over and over until the next pellet arrives. A pigeon rain dance. The behavior is not much different than in the case of a baseball player who forgets to shave one morning, hits a home run a few hours later and then makes it a policy never to shave on game days.

Beliefs come first; reasons second. That's the insightful message of "The Believing Brain," by Michael Shermer, the founder of Skeptic magazine. In the book, he brilliantly lays out what modern cognitive research has to tell us about his subject—namely, that our brains are "belief engines" that naturally "look for and find patterns" and then infuse them with meaning. These meaningful patterns form beliefs that shape our understanding of reality. Our brains tend to seek out information that confirms our beliefs, ignoring information that contradicts them. Mr. Shermer calls this "belief-dependent reality." The well-worn phrase "seeing is believing" has it backward: Our believing dictates what we're seeing.

Mr. Shermer marshals an impressive array of evidence from game theory, neuroscience and evolutionary psychology. A human ancestor hears a rustle in the grass. Is it the wind or a lion? If he assumes it's the wind and the rustling turns out to be a lion, then he's not an ancestor anymore. Since early man had only a split second to make such decisions, Mr. Shermer says, we are descendants of ancestors whose "default position is to assume that all patterns are real; that is, assume that all rustles in the grass are dangerous predators and not the wind."

In addition, as evolved social creatures, we have brains that are attuned to trying to discern the intentions of others—and we look for patterns, there, too, and then try to infuse them with human intention and meaning, or what Mr. Shermer calls "agenticity." Patterns in life are variously ascribed to the work of ghosts, gods, demons, angels, aliens, intelligent designers and federal conspirators. "Even belief that the government can impose top-down measures to rescue the economy is a form of agenticity," the author says.


Book: The Believing Brain

Complexity is the perfect moat.

Found via Claire Barnes.

The most obvious features of recent political and financial "solutions" are their staggering complexity and their failure to fix what's broken. The first leads to the second. Consider the healthcare "reform," thousands of pages of mind-numbing complexity which slathers on thick layers of bureaucratic control on a system which already costs twice as much per capita as competing developed-world systems.

Sadly, the "reform" simply solidifies the Status Quo fiefdoms and cartels that control the U.S. sickcare system.

The healthcare reform fixes nothing, while further burdening the nation with useless complexity and cost. The same can be said of the Dodd-Frank "reforms" of the embezzlement-based U.S. financial system. The original Glass–Steagall Act separating investment banking from depository banking was a few pages in length; by one count, Dodd-Frank requires that regulators create 243 rules, conduct 67 studies, and issue 22 periodic reports.

Complexity works beautifully as self-preservation, because it actually expands the bureaucratic power of fiefdoms and widens the moat protecting cartels. Once the fiefdom expands to manage all those new rules, only a handful of corporations can possibly afford the regulatory reporting burdens. They are thus free to exploit the populace as an informal cartel.

Complexity serves to protect the existing constituencies and cartels; it allows those with the most to lose the cover of "reform." But the reform is only a simulacrum; it claims reform along with its expanded powers, but the result is system that is so complex that it loses all accountability. Complexity is the perfect moat.

Bruce Berkowitz AAII Presentation (June 1, 2011)

WSJ Interviews Bill Gates: Was the $5 Billion Worth It?

Thanks to Will for passing this along.

A decade into his record-breaking education philanthropy, Bill Gates talks teachers, charters—and regrets.

'It's hard to improve public education—that's clear. As Warren Buffett would say, if you're picking stocks, you wouldn't pick this one." Ten years into his record-breaking philanthropic push for school reform, Bill Gates is sober—and willing to admit some missteps.

"It's been about a decade of learning," says the Microsoft co-founder whose Bill and Melinda Gates Foundation is now the nation's richest charity. Its $34 billion in assets is more than the next three largest foundations (Ford, Getty and Robert Wood Johnson) combined, and in 2009 it handed out $3 billion, or $2 billion more than any other donor. Since 2000, the foundation has poured some $5 billion into education grants and scholarships.

Tuesday, July 26, 2011

NYT: Evolution Right Under Our Noses

Found via Hunter-Gatherer.

Dr. Munshi-South has joined the ranks of a small but growing number of field biologists who study urban evolution — not the rise and fall of skyscrapers and neighborhoods, but the biological changes that cities bring to the wildlife that inhabits them. For these scientists, the New York metropolitan region is one great laboratory.

White-footed mice, stranded on isolated urban islands, are evolving to adapt to urban stress. Fish in the Hudson have evolved to cope with poisons in the water. Native ants find refuge in the median strips on Broadway. And more familiar urban organisms, like bedbugs, rats and bacteria, also mutate and change in response to the pressures of the metropolis. In short, the process of evolution is responding to New York and other cities the way it has responded to countless environmental changes over the past few billion years. Life adapts.

NYT: Still Counting Calories? Your Weight-Loss Plan May Be Outdated - By Jane Brody

It’s no secret that Americans are fatter today than ever before, and not just those unlucky people who are genetically inclined to gain weight or have been overweight all their lives. Many who were lean as young adults have put on lots of unhealthy pounds as they pass into middle age and beyond.

It’s also no secret that the long-recommended advice to eat less and exercise more has done little to curb the inexorable rise in weight. No one likes to feel deprived or leave the table hungry, and the notion that one generally must eat less to control body weight really doesn’t cut it for the typical American.

So the newest findings on what specific foods people should eat less often — and more importantly, more often — to keep from gaining pounds as they age should be of great interest to tens of millions of Americans.

The new research, by five nutrition and public health experts at Harvard University, is by far the most detailed long-term analysis of the factors that influence weight gain, involving 120,877 well-educated men and women who were healthy and not obese at the start of the study. In addition to diet, it has important things to say about exercise, sleep, television watching, smoking and alcohol intake.

The study participants — nurses, doctors, dentists and veterinarians in the Nurses’ Health Study, Nurses’ Health Study II and the Health Professionals Follow-up Study — were followed for 12 to 20 years. Every two years, they completed very detailed questionnaires about their eating and other habits and current weight. The fascinating results were published in June in The New England Journal of Medicine.

The analysis examined how an array of factors influenced weight gain or loss during each four-year period of the study. The average participant gained 3.35 pounds every four years, for a total weight gain of 16.8 pounds in 20 years.

“This study shows that conventional wisdom — to eat everything in moderation, eat fewer calories and avoid fatty foods — isn’t the best approach,” Dr. Dariush Mozaffarian, a cardiologist and epidemiologist at the Harvard School of Public Health and lead author of the study, said in an interview. “What you eat makes quite a difference. Just counting calories won’t matter much unless you look at the kinds of calories you’re eating.”

“There are good foods and bad foods, and the advice should be to eat the good foods more and the bad foods less,” he said. “The notion that it’s O.K. to eat everything in moderation is just an excuse to eat whatever you want.”

The study showed that physical activity had the expected benefits for weight control. Those who exercised less over the course of the study tended to gain weight, while those who increased their activity didn’t. Those with the greatest increase in physical activity gained 1.76 fewer pounds than the rest of the participants within each four-year period.

But the researchers found that the kinds of foods people ate had a larger effect over all than changes in physical activity.

“Both physical activity and diet are important to weight control, but if you are fairly active and ignore diet, you can still gain weight,” said Dr. Walter Willett, chairman of the nutrition department at the Harvard School of Public Health and a co-author of the study.

As Dr. Mozaffarian observed, “Physical activity in the United States is poor, but diet is even worse.”


Related previous posts:

The Farnam Street Blog Reviews “Why We Get Fat” by Gary Taubes

Art De Vany’s Essay on Evolutionary Fitness

Related link: Archevore Diet

John Mauldin's Outside the Box: Converging On The Horizon - By Ed Easterling

The end is near! Stock market history and earnings cycle history are converging. As a result, the market is likely to be down for the year 2011 or 2012. If not, then it will have been different this time.

Crestmont’s research focuses primarily on long-term secular stock market cycles and their fundamental drivers. Inside of the secular periods are short-term cyclical cycles, primarily driven by psychology, collective emotion, and reactions to current events. These short-term cycles are part of the market process to incorporate new information and to balance the pressures of buyers and sellers. In the long-run, the short-term cycles are reconciled back to the long-term fundamentals of value.

The stock market remains in a secular bear market. Actually, it is still in the early stages of a secular bear based upon relatively high P/E valuations currently and a relatively low core inflation rate (the driver of P/E over time).

Secular bear markets, albeit fairly flat periods for returns, experience violent interim swings—it’s just the nature of market volatility. Although Crestmont’s research does not explain or predict the short-term movements, it does recognize a fundamental nature and tendency that should be respected. For example, even if we can’t explain why there tends to be short runs of positive years in the market, we should realize that risk increases as we approach the historical limits.

Beware: there are two series of short-term trends that are converging on their limits. They portend increased risk for the stock market (…or new historical precedent). The first is the sequence of market gains and losses; the second is the earnings cycle.

The goals of this discussion are (1) to dispel the notion that P/E is low today and (2) to highlight the risks of a market decline in 2011 or 2012.


Related book: Probable Outcomes

Monday, July 25, 2011

John Mauldin: Kicking the Can Down the Road One More Time

My friends at GaveKal point out that this is “… the sixth time in 18 months European leaders have announced a definitive solution to the Euro crisis. Should this version of the final bailout be taken any more seriously than the first and second solutions to the Greek crisis in May and September 2010 or the Irish bailout of December 2010 or the Portuguese rescue package of March 2011 or the breakthrough vote in the Greek parliament of last month? The supposedly good news for markets was that the -21% haircuts to be imposed on Greek creditors (as estimated by banker groups) were less than half those suggested a few days ago.”

A 21% haircut is a bad joke. If you assume that Greece can afford to spend 10% of their revenues just to pay the interest, which is what they will need to be able to do to get out of their crisis, then the haircuts look more like 75-80%. Sean Egan, the most credible credit analyst in the country, estimated this week that the eventual haircuts on the Greek debt will be 90%.

You can read the release from the EU leaders in its entirety, if you like, at I really have no idea what you should drink as you read it.

Here is what it really says: We are going to keep throwing good money after bad and work as hard as we can to transfer the debt that is on the banks to the ECB and European taxpayers as long as the voters will let us. This first tranche will be another €109 billion. That will last a few years, and Greece will only have to pay about 3.5% on that debt and the rollover debt, and people who expected to be repaid in that period will see payment extended to either 15 or 30 years.

You can call this what you like, and they call it “selective default,” but it is a default. There will be government guarantees on the debt, so the ECB can take it from the banks.

Let’s see what the “voluntary” debt rollovers will look like and what the likely debt destruction will be. This is from Global Macro Monitor.

First, notice that the plan claims haircuts will only be 21%. But that assumes you can sell the new bonds at a 9% interest rate. If the interests rate demanded by the market are 15%, which is closer to reality, the haircuts are closer to 67%, after what appears to be an initial 20% cut. Will any institution not immediately try and get those bonds into the hands of the ECB? This is just ugly.

SocGen's Dylan Grice - Summer Reading List

Via The Tail Chaser blog.

Link to: SocGen's Dylan Grice - Summer Reading List



The Most Important Thing: Uncommon Sense for the Thoughtful Investor

Expected Returns: An Investor's Guide to Harvesting Market Rewards

Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise

Caesar: Life of a Colossus

Mr. Speaker!: The Life and Times of Thomas B. Reed The Man Who Broke the Filibuster

Santangel’s Review: Richard Chandler, Sino-Forest, and how to turn $10 million into $5 billion

A seemingly minor news item on Thursday gave us the opportunity to write about someone we have wanted to discuss for some time. The story was that Richard Chandler, a New Zealand-based billionaire, had purchased over 10 percent of Sino-Forest Corporation. Sino-Forest, of course, is the China-based timber company that plunged 83% last month when Muddy Waters published a detailed report alleging fraud.

Sino-Forest’s stock has moved up since the announcement of Chandler’s new stake, so a few astute folks have already taken an interest. However, we are betting most people just said “who is Richard Chandler?” and went on with their day.

That most people do not know who Richard Chandler and his brother Christopher are is not surprising, as they have been extremely secretive since they started investing in 1986. That is except for a single interview they did with Institutional Investor Magazine back in 2006. Since that article was published, the brothers have gone their separate ways and Richard now operates the Mandolin Fund which is the entity that purchased the Sino-Forest stake.

While we have no horse in the race, we have found the Sino-Forest situation to be fascinating.

Everything you need to know about the debt ceiling in one post - By Ezra Klein and Dylan Matthews

What it is: The debt ceiling is a legal cap on the amount of money the Treasury can borrow to fund existing government functions. It essentially authorizes the Treasury to borrow the money necessary to pay the bills incurred by the federal government.

Where it came from: Before 1917, Congress authorized the Treasury to issue bonds for specific purposes. But that meant approving every bond separately. To fund World War I, Congress decided to give the Treasury more latitude by instituting caps on how much it could borrow through each type of bond, rather than forcing it to get every new bond approved separately. In 1939, this was changed so that most bonds were bound by the same limit, effectively creating the general debt ceiling we have today.

Bureaucracy and overcomplexity: Apollo Asia Fund: the manager's report for 2Q2011

In May, seeking a brief escape from markets and bureaucracy alike, I enjoyed a fascinating tour of Qinghai, the Chinese province which is part of Greater Tibet. I was interested to see how the gathering and trading of cordyceps has exploded in recent years. I first encountered cordyceps, the caterpillar fungus, on another trip to Tibet 10-15 years ago. I was intrigued by its biological lifecycle; Hong Kong Chinese friends were riveted by the revelation that a medicine of such high market value could be picked up from the ground, or bought inexpensively from local traders. Now, thanks to mobile phones, the locals are well aware of its value, and cordyceps has brought a new affluence to those areas blessed with an endowment. Cordyceps gathering attracts such a large percentage of the population that the government talks of protecting the grasslands from destruction - and much is being fenced off (so I had questions about possible vested interests in the fencing of land over which nomads formerly roamed, and in the construction of dismal 'social housing' for Tibetans whose former lifestyle may have become impossible). Trading is however quite legal, and there are two major exchanges, in Yushu and Maixinxian. (If you ever go to Maixinxian, and coincide with the cordyceps buyers, book your hotel room well in advance.) Fakes are common. We did not hear of a futures market... My excuse for talking about this is that the progressive consumption and death of the caterpillar provides an excellent metaphor for the hollowing out of prosperity by bureaucracy: what remains still looks like a caterpillar, but is made up entirely of fungus.

The historian Joseph Tainter has observed that societies often respond to new problems by increasing complexity - eg by adding new layers of regulation - at increasingly marginal rates of return, until the total system costs exceed the benefits. As decline sets in, the cost of maintaining the system becomes unaffordable.

The danger of diminishing or negative return on complex investments also applies to companies. Systems can be over-integrated, if failure in one component shuts down the whole, or if operating flexibility is lost. Streamlining, offshoring, and outsourcing the workforce may leave noone on site empowered to take decisions, or with overall understanding of the system. Business process restructuring based on an ideal concept which overlooks real-life variations and contingencies may prove catastrophic. A recent trip to the UK provided startling examples.

As investors, we must try to avoid companies vulnerable to such pitfalls of overambition and poor execution, and to find those which are resilient to fast-changing external conditions. Wish us luck.


Related book: The Collapse of Complex Societies

How Khan Academy Is Changing the Rules of Education

Found via Simoleon Sense.

For years, teachers like Thordarson have complained about the frustrations of teaching to the “middle” of the class. They stand at the whiteboard, trying to get 25 or more students to learn the same stuff at the same pace. And, of course, it never really works: Advanced kids get bored and tune out, lagging ones get lost and tune out, and pretty soon half the class isn’t paying attention. Since the rise of personal computers in the early ’80s, educators have hoped that technology could solve this problem by offering lessons tailored to each kid. Schools have blown millions, maybe billions, of dollars on sophisticated classroom technology, but the effort has been in vain.

Khan’s videos are anything but sophisticated. He recorded many of them in a closet at home, his voice sounding muffled on his $25 Logitech headset. But some of his fans believe that Khan has stumbled onto the secret to solving education’s middle-of-the-class mediocrity. Most notable among them is Bill Gates, whose foundation has invested $1.5 million in Khan’s site. “I’d been looking for something like this—it’s so important,” Gates says. Khan’s approach, he argues, shows that education can truly be customized, with each student getting individualized help when needed.


Related previous posts:

Salman Khan on Charlie Rose

TED Talk - Salman Khan: Let's use video to reinvent education

Third Point Q2 Letter

Via Paul Kedrosky:

Link to: Third Point Q2 Letter

Hussman Weekly Market Comment: Simple Arithmetic

As I've noted several times in recent months, bond market spreads imply very low near-term (3-6 month) probability of default in any Euro-area country. A sovereign default is much more likely to occur near the end of the next bear market, whenever it occurs, than at the start. As Ken Rogoff and Carmen Reinhart noted in their book This Time It's Different , "Overt domestic default tends to occur only in times of severe macroeconomic distress." The most likely window for a Greek (or other Euro-nation) default will be at a point when France and Germany are experiencing economic downturns sufficient to douse the political will to bail out their neighbors at a cost to their own citizens.

Here in the U.S., total Federal debt to GDP is also approaching 100%, but the debt held by the public (outside of that held by Social Security and the Federal Reserve) amounts to about 60% of GDP and rising, due to recent budget deficits of about 10% of GDP annually. This is presently manageable since so much of that debt is of short-maturity and is being financed at very low interest rates. And though U.S. Federal tax revenues have historically run near 19% of GDP (they're presently only about 16% due to the sluggish economy), those depressed interest rates mean that debt service doesn't consume a huge chunk of revenues just yet.

Still, it's precisely that short average maturity that makes the debt problematic from a long-run perspective, because it can't be inflated away easily. In the event of sustained inflation, the debt would have to be constantly refinanced at higher and higher yields. Contrary to the assertion that the U.S. can easily inflate its debts away, it is clear that sustained inflation would create enormous risks to our long-run fiscal condition by driving interest costs to an intolerable share of revenues. At that point, any shortfall in GDP growth or government revenues would result in a rapid spike in debt-to-GDP (as Greece and other peripheral European nations are experiencing now). Prior to embarking on an inflationary course, the first thing a government would want to do is dramatically lengthen the maturity of its debts.

For Greece, and increasingly for Portugal and Italy, our view continues to be "certain default, but not yet." For the U.S., our view is that, barring significant restructuring of mortgage obligations, our debt problems are more likely to take the form of sluggish economic growth for an extended period of time. I continue to believe that the main window of inflation risk will begin in the back-half of this decade - not yet. Even so, we are already observing a sustained shift away from fiat currencies toward alternatives like gold (though there will certainly be fits and starts to that trend). Meanwhile, bond yields continue to offer very low yields-to-maturity, while credit spreads on corporate debt (even the riskiest types) have been squeezed as thin as they were in 2007. In stocks, on the basis of a wide variety of fundamentals, we expect the total return on the S&P 500 to average about 3.6% annually over the coming decade.

In short, the present menu of investment options provides little basis to expect significant nominal or real returns from long-run, passively-held investments purchased at present levels. I strongly doubt that investors will be deprived of opportunities to accept risk at higher expected returns and lower prices in the coming years. With few exceptions, the markets presently offer all of the risk with weak prospects for long-term return.

Saturday, July 23, 2011

James Grant reviews "The Man and the Statesman"


Friday, July 22, 2011

Jeremy Grantham’s 2Q Letter: Resource Limitations 2: Separating the Dangerous from the Merely Serious

Part 1 of Jeremy Grantham's 2Q Letter is a continuation of last quarter's discussion on running out of resources. Here, he looks at three specific areas: energy, metals, and agriculture.

Howard Marks Memo: Down to the Wire

Found via Market Folly.

Here are the ingredients in the plot: A problem everyone’s aware of. If it isn’t resolved, a shutdown with unspecified but possibly disastrous consequences. A deadline which seems indispensable, since in its absence it appears nothing would be done. And despite the presence of the oncoming freight train, movement toward a solution is deterred by highly entrenched positions. It’s truly white-knuckle time, and if the progress toward a solution continues to lag, the things that must happen won’t.

I’m not talking about the nearly concluded drama at the National Football League, where failure to reach a labor settlement for just a few more days would have caused significant changes in the schedule for the coming year, upsetting the flow of wealth to owners and players and depriving fans of the game they love. I’m talking about the down-to-the-wire battle over the U.S. debt ceiling. I’ve decided to devote a memo to the debt issue and its significance. I especially hope it’ll be helpful to our non-U.S. clients, for whom the lack of progress to date must be absolutely incomprehensible.

Interestingly, the immediate debt crisis is somewhat artificial. It is occasioned now only because of our debt ceiling, which currently limits the net debt of the United States to $14.29 trillion. Such ceilings are far from the norm worldwide. Many other nations seem to function no worse without them.

But the U.S. has the historical accident of a ceiling, and we must deal with it. Because the limitation is set in terms of absolute dollars and not indexed for inflation or growth, we would run into it every few years even if our debt only grew apace with the economy. “In fact, it’s been raised nearly 100 times over the decades.” (Financial Times, July 16) But thanks to the especially rapid growth of our debt relative to GDP in recent years – exacerbated by the Afghan and Iraq wars and the financial crisis – the ceiling has the potential to provide some real excitement every once in a while.

Chanticleer Q2 Letter

Below are a few sections (slightly edited for public viewing) from a letter just sent to the investors of a fund I help manage. If you’re interested in receiving our letters, feel free to email either Matt or me at the email addresses listed HERE.

Chanticleer - 2011 Q2 Letter - Modified for Public Viewing

Bees Solve Complex Problems Faster Than Supercomputers

Found via Tim Ferriss.

In a new study, researchers report that bumblebees were able to figure out the most efficient routes among several computer-controlled "flowers," quickly solving a complex problem that even stumps supercomputers. We already know bees are pretty good at facial recognition, and researchers have shown they can also be effective air-quality monitors.

Bumblebees can solve the classic "traveling salesman" problem, which keeps supercomputers busy for days. They learn to fly the shortest possible route between flowers even if they find the flowers in a different order, according to a new British study.

The traveling salesman problem is a problem in computer science; it involves finding the shortest possible route between cities, visiting each city only once. Bees are the first animals to figure this out, according to Queen Mary University of London researchers.

Bees need lots of energy to fly, so they seek the most efficient route among networks of hundreds of flowers using angles of sunlight, which helps them find their way home, researchers say. To do this, their tiny brains must pack a powerful memory.

Thursday, July 21, 2011

Zhang Xin on Charlie Rose

Debt and Delusion - By Robert J. Shiller

Economists like to talk about thresholds that, if crossed, spell trouble. Usually there is an element of truth in what they say. But the public often overreacts to such talk.

Consider, for example, the debt-to-GDP ratio, much in the news nowadays in Europe and the United States. It is sometimes said, almost in the same breath, that Greece’s debt equals 153% of its annual GDP, and that Greece is insolvent. Couple these statements with recent television footage of Greeks rioting in the street. Now, what does that look like?

Here in the US, it might seem like an image of our future, as public debt comes perilously close to 100% of annual GDP and continues to rise. But maybe this image is just a bit too vivid in our imaginations. Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

That would clearly be nonsense. After all, debt (which is measured in currency units) and GDP (which is measured in currency units per unit of time) yields a ratio in units of pure time. There is nothing special about using a year as that unit. A year is the time that it takes for the earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.

We should remember this from high school science: always pay attention to units of measurement. Get the units wrong and you are totally befuddled.


What is really happening in Greece is the operation of a social-feedback mechanism. Something started to cause investors to fear that Greek debt had a slightly higher risk of eventual default. Lower demand for Greek debt caused its price to fall, meaning that its yield in terms of market interest rates rose. The higher rates made it more costly for Greece to refinance its debt, creating a fiscal crisis that has forced the government to impose severe austerity measures, leading to public unrest and an economic collapse that has fueled even greater investor skepticism about Greece’s ability to service its debt.

This feedback has nothing to do with the debt-to-annual-GDP ratio crossing some threshold, unless the people who contribute to the feedback believe in the ratio. To be sure, the ratio is a factor that would help us to assess risks of negative feedback, since the government must refinance short-term debt sooner, and, if the crisis pushes up interest rates, the authorities will face intense pressures for fiscal austerity sooner or later. But the ratio is not the cause of the feedback.

TED Talk - Kevin Slavin: How algorithms shape our world


The End of the Growth Consensus - By John Taylor

This month marks the two-year anniversary of the official start of the recovery from the 2007-09 recession. But it's a recovery in name only: Real gross domestic product growth has averaged only 2.8% per year compared with 7.1% after the most recent deep recession in 1981-82. The growth slowdown this year—to about 1.5% in the second quarter—is not only disappointing, it's a reminder that the recovery has been stalled from the start. As shown in the nearby chart, the percentage of the working-age population that is actually working has declined since the start of the recovery in sharp contrast to 1983-84. With unemployment still over 9%, there is an urgent need to change course.

Some blame the weak recovery on special factors such as high personal saving rates as households repair their balance sheets. But people are consuming a larger fraction of their income now than they were in the 1983-84 recovery: The personal savings rate is 5.6% now compared with 9.4% then. Others blame certain sectors such as weak housing. But the weak housing sector is much less of a negative factor today than declining net exports were in the 1983-84 recovery, and the problem isn't confined to any particular sector. The broad categories of investment and consumption are both contributing less to growth. Real GDP growth is 60%-70% less than in the early-'80s recovery, as is growth in consumption and investment.

In my view, the best way to understand the problems confronting the American economy is to go back to the basic principles upon which the country was founded—economic freedom and political freedom. With lessons learned from the century's tougher decades, including the Great Depression of the '30s and the Great Inflation of the '70s, America entered a period of unprecedented economic stability and growth in the '80s and '90s. Not only was job growth amazingly strong—44 million jobs were created during those expansions—it was a more stable and sustained growth period than ever before in American history.

Economic policy in the '80s and '90s was decidedly noninterventionist, especially in comparison with the damaging wage and price controls of the '70s. Attention was paid to the principles of economic and political liberty: limited government, incentives, private markets, and a predictable rule of law. Monetary policy focused on price stability. Tax reform led to lower marginal tax rates. Regulatory reform encouraged competition and innovation. Welfare reform devolved decisions to the states. And with strong economic growth and spending restraint, the federal budget moved into balance.

Curse the Geniuses Who Gave Us Bank of America - By Jonathan Weil

Ask anyone what the most immediate threats to the global financial system are, and the obvious answers would be the European sovereign-debt crisis and the off chance that the U.S. won’t raise its debt ceiling in time to avoid a default. Here’s one to add to the list: the frightening plunge in Bank of America Corp. (BAC)’s stock price.

At $9.85 a share, down 26 percent this year, Bank of America finished yesterday with a market capitalization of $99.8 billion. That’s an astonishingly low 49 percent of the company’s $205.6 billion book value, or common shareholder equity, as of June 30. As far as the market is concerned, more than half of the company’s book value is bogus, due to overstated assets, understated liabilities, or some combination of the two.

That perception presents a dangerous situation for the world at large, not just the company’s direct stakeholders. The risk is that with the stock price this low, a further decline could feed on itself and spread contagion to other companies, regardless of the bank’s statement this week that it is “creating a fortress balance sheet.”

It isn’t only the company’s intangible assets, such as goodwill, that investors are discounting. (Goodwill is the ledger entry a company records when it pays a premium to buy another.) Consider Bank of America’s calculations of tangible common equity, a bare-bones capital measure showing its ability to absorb future losses. The company said it ended the second quarter with tangible common equity of $128.2 billion, or 5.87 percent of tangible assets.

Investor Doubts

That’s about $28 billion more than the Charlotte, North Carolina-based company’s market cap. Put another way, investors doubt Bank of America’s loan values and other numbers, too, not just its intangibles, the vast majority of which the company doesn’t count toward regulatory capital or tangible common equity anyway.

So here we have the largest U.S. bank by assets, fresh off an $8.8 billion quarterly loss, which was its biggest ever. And the people in charge of running it have a monstrous credibility gap, largely of their own making. Once again, we’re all on the hook.

As recently as late 2010, Bank of America still clung to the position that none of the $4.4 billion of goodwill from its 2008 purchase of Countrywide Financial Corp. had lost a dollar of value. Chief Executive Officer Brian Moynihan also was telling investors the bank would boost its penny-a-share quarterly dividend “as fast as we can” and that he didn’t “see anything that would stop us.” Both notions proved to be nonsense.

Acquisition Disaster

The goodwill from Countrywide, one of the most disastrous corporate acquisitions in U.S. history, now has been written off entirely, via impairment charges that were long overdue. And, thankfully, Bank of America’s regulators in March rejected the company’s dividend plans, in an outburst of common sense.

Last fall, Bank of America also was telling investors it probably would incur no more than $4.4 billion of costs from repurchasing defective mortgages that were sold to investors. Since then the company has recognized an additional $19.2 billion of such expenses, with no end in sight.

Adam Weiss and James Crichton of Scout Capital Management to Present at the 7th Annual New York Value Investing Congress

Adam Weiss and James Crichton of Scout Capital Management are scheduled as to present at the 7th Annual New York Value Investing Congress. In their December 2010 interview with Value Investor Insight (currently available as the sample issue HERE), they described the types of businesses in which they look to invest:

We’re looking for businesses with low capital intensity, the ability to generate high levels of free cash flow and a privileged business model that enables the company to produce excess capital. We want the financial and business models to be transparent. In terms of competitive dynamics, we want to understand the value of the company’s product or service to customers and the strength of its competitive moat. From an industry perspective, we ideally want to see long-term sustainable growth and secular tailwinds.

One of the quality businesses that meets their criteria for investment is Verisk Analytics (Nasdaq: VRSK). As the newsletter summarizes their thesis:

Operating “literally one of the highest-quality businesses we’ve seen,” says Adam Weiss, the company has the potential to increase revenue at 10-12% per year and free cash flow at a 20% clip. At what he considers a not unreasonable 20x the $2.40 in free cash flow per share he’s estimating for 2012, the shares would trade at $48.

Readers of Value Investing World are eligible for a $1,900 discount to attend the New York Value Investing Congress on October 17 & 18. To qualify for the discount, please use the link below and the discount code N11VIW4. The discount expires on July 29, 2011. Disclosure: Value Investing World receives a referral fee for registrations generated through the link.

Click to register for the 7th Annual New York Value Investing Congress

Wednesday, July 20, 2011

Grant Says U.S. Debt Crisis Contrived, Will Be `Unstuck' (video)

July 18 (Bloomberg) -- James Grant, publisher of Grant's Interest Rate Observer, talks about negotiations between U.S. lawmakers over raising the federal debt ceiling and reducing the budget deficit. Grant also discusses the Treasury market, the gold standard and Europe's sovereign debt crisis. He speaks with Carol Massar on Bloomberg Television's "Street Smart."

Michael Burry Profiled: Bloomberg Risk Takers (video)

Thanks to Kjetil for passing the link below along and Andrew for letting me know when it came on TV yesterday.

July 20 (Bloomberg) -- "Bloomberg Risk Takers" profiles Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge. He forecast that the bubble would burst as early as 2007, and he acted on his conviction by betting against subprime mortgages. The former head of Scion Capital LLC was profiled in Bloomberg columnist and bestselling author Michael Lewis' book "The Big Short".

East Coast Asset Management's Q2 Letter

Found via Market Folly.

CEA Annual Reports 2005-07

From The Big Picture blog.

I decided to look at what President Bush’s Council of Economic Advisors (CEA) were saying in their annual reports for 2005-2007 about the massive real estate bubble, epidemic of accounting control fraud and mortgage fraud, the resultant rapidly developing financial crisis, and the great increase in economic inequality. Here’s what I found on these topics.

Tuesday, July 19, 2011

March 2007 Article: The Plankton Theory Meets Minsky – By Paul McCulley

Watching the on-going meltdown in the sub-prime mortgage market, which is triggering a sharp tightening of underwriting standards to these dicey credits, I was reminded of prescient writings by two serious thinkers: Bill Gross and Hyman Minsky. Both narratives go back a long ways, with something that Bill wrote in August 1980 – 27 years ago! – particularly poignant:


Related book: Stabilizing an Unstable Economy

Related papers:

“Minsky Crisis” – by L. Randall Wray

“Securitization” – by Hyman P. Minsky

“What Do Banks Do? What Should Banks Do?” – by L. Randall Wray

Related link: Simoleon Sense: Hyman Minsky Megapost!

Gundlach: A Debt Ceiling Impasse Could Drive Rates Lower

Failing to raise the debt ceiling would be a “huge financial calamity,” according to Federal Reserve Chairman Ben Bernanke and the general consensus view. But that opinion is “exactly wrong,” at least as far as the Treasury market is concerned, DoubleLine’s Jeffrey Gundlach said in a conference call with investors last Tuesday.

Rates might actually go down, just as they did after the end of QE2, according to Gundlach.

Gundlach is the founder and chief investment officer of DoubleLine Capital, a California-based fixed-income asset manager.

“If there is no debt ceiling passed, it will force the government to essentially implement a de facto austerity program,” Gundlach said. Payments to many government departments would stop, including those to some defense contractors. Coupon payments on the Treasury’s debt, however, would continue, he said.

While Treasury investors might receive a short-term reward if no resolution is reached on the debt ceiling, Gundlach was far less sanguine about the longer-term outlook.

“We are getting close to the end of the road” and must forestall a larger crisis caused by the government’s growing debt burden, he said.


Gundlach advised investors to construct their portfolios to defend against all three of those outcomes. Portfolios should contain inflation hedges, an income stream and protection against potential defaults.

GoodHaven Semi-Annual Report

The Fund’s capital is being deployed judiciously and we still have a chunk of cash – we are optimistic, but cautious. Although our cash position will decrease as we find new and appropriate investments, the world is still a troubled place and we are mindful that many of the causes of the 2008-2009 financial crises have not yet been addressed. Government finances are in shambles. Many European banks are stuffed with sovereign paper of questionable value and many domestic institutions are struggling with troubled assets, depressed markets, and costly legal issues. Most derivatives remain unregulated and unlisted on exchanges, where collateral and counterparty risk might be reasonably gauged. U.S. growth is subdued and the housing ATM shut down long ago. And although interest rates are bumping around historic lows as the Federal Reserve maintains its policy of zero percent, they are almost certain to rise in future years, perhaps meaningfully. Typically, these sorts of conditions do not make for easy sailing in financial assets.

So why are we optimistic? Tough markets and troubling headlines allow us to plant the seeds of capital growth that may be harvested in future years. Rather than dwell on difficult to predict macroeconomic negatives about which we can do little, we focus instead on finding sensible things to do with money other than a near zero interest bank deposit or low-yielding and long-dated bonds having enormous risk of loss should interest rates rise even modestly. Part ownership of a good business, at the right price, is a better way to deal with either inflation or deflation than many of the alternatives. We are mindful that sooner or later, public markets create opportunity for the prepared.

Monday, July 18, 2011

Warren Buffett: 'Disruptive' Debt Limit Debates Are 'Waste of Congress's Time'

Thanks to Matt for passing this along.

As the White House and Congress continue to fight over raising the nation's debt limit, Warren Buffett says it would be better if the U.S. didn't have one at all.

Speaking to NBC's Kristen Welker at the White House today, Buffett said an "artificial" limit of the nation's debt is "disruptive" in Washington.

"All it does is slow down a process and divert people's energy, causes people to posture. It doesn't really make any sense ... To have this artificial limit, which always gets raised in the end, disrupt the activities, in an important way, of Congress, periodically, I think is a waste of Congress's time."

He's not alone. Today the credit rating agency Moody's suggested that eliminating a statutory limit on government debt would help ease uncertainty among bond holders.

Buffett was at the White House today with Bill Gates to speak with President Obama about their Giving Pledge project.

In the brief NBC interview after that meeting, Buffett said he encouraged Obama to continue to push for "something very big."

Forbes: How I Overcame Bipolar II (and Saved My Own Life) – By Michael Ellsberg

Found via Tim Ferriss.

Author’s note and disclaimer: The following piece details my story of overcoming a serious and potentially-fatal mental illness, bipolar II, between the years of 2000-2007. I have decided to write this story now, painful as reliving some of the history is, in order to provide inspiration and information to others currently struggling with mental illness, and to their families and loved ones. I am not a doctor or medical professional. I do not intend this piece to replace the advice of physicians or health care practitioners, nor am I intending to diagnose or prescribe treatment for any illness or disorder. It is my personal story only.

John Taylor on EconTalk

John Taylor of Stanford University talks with EconTalk host Russ Roberts about the state of the economy and the prospects for recovery. Taylor argues that the design of the fiscal stimulus was ineffective and monetary policy, so-called quantitative easing, has also failed to improve matters. He argues for a return to fiscal, monetary, and regulatory normalcy as the best hope for economic improvement. The conversation concludes with a discussion of the impact of the current crisis on economics education.

Mastering the Machine - By John Cassidy

How Ray Dalio built the world’s richest and strangest hedge fund.

Ray Dalio, the sixty-one-year-old founder of Bridgewater Associates, the world’s biggest hedge fund, is tall and somewhat gaunt, with an expressive, lined face, gray-blue eyes, and longish gray hair that he parts on the left side. When I met him earlier this year at his office, on the outskirts of Westport, Connecticut, he was wearing an open-necked blue shirt, gray corduroy pants, and black leather boots. He looked a bit like an aging member of a British progressive-rock group. After a few pleasantries, he grabbed a thick briefing book and shepherded me into a large conference room, where his firm was holding what he described as its weekly “What’s going on in the world?” meeting.

Of the fifty or so people present, most were clean-cut men in their twenties or thirties. Dalio sat down near the front of the room. A colleague began describing how the European Central Bank had just bought some Greek bonds from investors at a discount to their face value—a move that the speaker described as a possible precursor to an over-all restructuring of Greece’s vast debts. Dalio interrupted him. He said, “Here’s where you are being imprecise,” and then explained at length what a proper debt restructuring would entail, dismissing the E.C.B.’s move as an exercise in “kicking it down the road.”

Dalio is a “macro” investor, which means that he bets mainly on economic trends, such as changes in exchange rates, inflation, and G.D.P. growth. In search of profitable opportunities, Bridgewater buys and sells more than a hundred different financial instruments around the world—from Japanese bonds to copper futures traded in London to Brazilian currency contracts—which explains why it keeps a close eye on Greece. In 2007, Dalio predicted that the housing-and-lending boom would end badly. Later that year, he warned the Bush Administration that many of the world’s largest banks were on the verge of insolvency. In 2008, a disastrous year for many of Bridgewater’s rivals, the firm’s flagship Pure Alpha fund rose in value by nine and a half per cent after accounting for fees. Last year, the Pure Alpha fund rose forty-five per cent, the highest return of any big hedge fund. This year, it is again doing very well.

WSJ Interviews Jim Grant

Subscription required.

Jim Grant's father pursued a varied career, including studying the timpani. He even played for a while with the Pittsburgh Symphony. But the day came when he rethought his career choice. "For the Flying Dutchman overture," says his son, "they had him cranking a wind machine."

The younger Mr. Grant, who can be sardonic about his own chosen profession, might say he's spent the past 28 years cranking a wind machine, though it would be a grossly unjust characterization. Mr. Grant is founder and writer of Grant's Interest Rate Observer, perhaps the most iconic of the Wall Street newsletters.

Malcolm Gladwell: When technology fails

Looks like some more great talks will be posted on TED from the Edinburgh conference.

By the end of World War II, the United States military had spent $1.5 billion on the Norden bombsight, a device that promised to be so accurate it was said a plane could drop a bomb in a pickle barrel from 20,000 feet, according to author Malcolm Gladwell.

Speaking Friday on the last day of the TED Global conference, Gladwell said the device, designed by engineer Carl Norden, indeed could allow bombers to hit their targets -- but only under perfect conditions, such as a cloudless sky. In the real world, the sight often failed to find its mark.

In a raid on a German chemical plant, only 10% of thousands of bombs hit the target, said Gladwell, author of "The Tipping Point" and other best-sellers.

He posed the question: Why do people place so much faith in technology such as the Norden bombsight to solve problems?

Today, the U.S. military has a bomb-delivering device that truly can achieve great accuracy -- the drones firing missiles to attack militants in Pakistan and Afghanistan. Yet Gladwell argued that drones aren't necessarily accomplishing more than the flawed World War II-era bombsight; he said suicide attacks against Western targets have increased.

"The issue isn't the accuracy of the bombs you have, but how you use the bombs you have," and whether you should use them at all, he said.

Gladwell's question was one of a series of thought-provoking issues raised at the conference in the Scottish capital.

John Mauldin: Back to the Basics

This week we are going to revisit some themes concerning the problems of the debt and the deficit. I am getting a number of questions, so while long-time readers may have read most of this in one letter or another, it is clearly time for a review, especially given the deficit/debt-ceiling debate. I will probably offend some cherished beliefs of most readers, but that is the nature of the times we live in. It is the time of the Endgame, where things are not as black and white as they have been in the past.

Friday, July 15, 2011

Schroeder: America Will Miss Munger-As-Mencken

Thanks to Matt for passing this along.

Munger is not only a critic and Buffett’s partner, but also a lawyer, real estate investor, CEO and philanthropist. He has used his sharp tongue in service of decisive action to avert intolerable risk. One episode in the late 1980s, when the savings and loan industry was using accounting tricks to create capital out of thin air, sticks out in my mind as perhaps his finest hour.

Bailout and Backlash

The S&Ls were careening toward a crisis of widespread bankruptcies that would destroy depositor savings, require a taxpayer bailout and result in a furious public backlash. Munger, who is chairman and chief executive officer of Berkshire’s savings and loan operation, Wesco Financial, foresaw that Wesco’s better behavior wouldn’t prevent it from being tainted by association.

He not only throttled back Wesco’s lending, but also took an extreme stand to distance Wesco from the other savings and loans by resigning from the U.S. League of Savings Institutions in a letter. In it, he likened the trade association to metastasizing cancer cells and called its lobbying practices “flawed, indeed disgraceful.”

Quixotic Move

It was a quixotic move, one that only a person who was willing to be detested by an entire industry would make. The move also paid off when the S&L crisis erupted and Wesco avoided being splattered with mud. It was Munger’s actions in the S&L crisis that started Berkshire on its road to being held up as the moral exemplar of corporate America. Its reputation was later cemented when Buffett assumed the role of interim chairman of Salomon Brothers Inc. to save the company, in which Berkshire had a major investment, from bankruptcy after Salomon was caught covering up an employee’s rigging of Treasury-bond auctions.

I’ve wondered what makes a man a Munger. He isn’t trying to be a hero. Perhaps a person who feels that something innate in him means he will be disliked finds that easier to tolerate if he provokes the disapproval himself. It’s ironic, or predictable -- maybe even both -- that a man who cultivates enemies with broadsides against the comfortably selfish has won a large audience of fans, and I mean fans in the fanatical sense of the word.