Wednesday, May 22, 2019

Housing risk in 2006...

"I’m firmly convinced that markets will continue to rise and fall, and I think I know (a) why and (b) what makes these movements more or less imminent. But I’m sure I’ll never know when they’re going to turn up or down, how far they’ll go after they do, how fast they’ll move, when they’ll turn back toward the midpoint, or how far they’ll continue on the opposite side. So there’s a great deal to admit uncertainty about." --Howard Marks (Mastering the Market Cycle)

As I've mentioned before on this blog, I think paying attention to the macro landscape is best done with the mindset of identifying risks, as opposed to making forecasts. Though as the quote from Howard Marks above shows, while it's possible to develop skill at identifying those risks and even knowing when they may be imminent, you still never know precisely when or to what extreme they will manifest themselves. 

As I continue to go back through the old Berkshire Hathaway Annual Meeting transcripts, I've been paying special attention to when Buffett and Munger have identified some of those big picture risks. And the excerpt below, from the 2006 meeting, is a good example. 


CHARLIE MUNGER: I also think that some of the sin that was in the manufactured housing finance a few years ago has shifted into the finance of the stick-built houses. 

There is a lot of ridiculous credit being extended in America in the housing field. And it had a horrible aftermath in the manufactured housing sector, and my guess is there will be some trouble in the stick-built sector in due course. 

WARREN BUFFETT: Well, dumb lending always has its consequences and usually on a big scale, because you don’t see it for quite a while. So, therefore, it’s like a disease that doesn’t manifest itself for a few weeks. 

And you can have an epidemic of something like that, and by the time you know you have an epidemic, you’re very well into it. Well, that’s what happens in dumb financing. 

...You certainly had it in commercial financing in the ’80s, and you had the RTC and the savings and loan crisis and all of that because, literally, one dumb project was put up after another. 

A developer will develop anything he can borrow the money against. It’s that simple. And when the lending institutions pour the money out for something, it will get built. 

And that happened in manufactured housing. It happened in commercial real estate in the ’80s. I think it’s happened in conventional housing here in recent years. 

And if you look at the 10-Qs that are getting filed for the first quarter of some lending institutions, and 10-Ks that were last year, and you look at the balances increasing on loans for interest that’s accrued but was not paid because people had adjustable mortgages, but they’re only adjustable so far, but the lending institutions are taking in the income as if it were paid, you’ll see some very interesting statistics. 

CHARLIE MUNGER: Yes. And some of this dumb lending is being facilitated by contemptible accounting. The accounting profession has not stopped compromising its way into terrible behavior.