Good Reading -- December 2009 (part 2)
Merry Christmas and Happy New Year!
Attached
Another great article on health care reform from Atul Gawande, this time discussing health care's unsustainable path and comparing it to agriculture a century ago.
See below for the note on the passing of Christopher H. Browne -- the attached speech from 2000 is should be required reading for all investors.
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Paul Volcker with his usual trenchant, useful commentary.
Is America in a death spiral? I think there are problems galore, but as David Brooks recently wrote, "People are asking anxious questions about America’s future. Will it take years before the animal spirits revive? Can the economy rebalance so that it relies less on consumption and debt and more on innovation and export? Have we entered a period of relative decline? The first thing to say is, let’s not get carried away with the malaise. The U.S. remains the world’s most competitive economy, the leader in information technology, biotechnology and nearly every cutting-edge sector. The U.S. has its problems, but Americans would be crazy to trade their problems with those of any other large nation." See below for a longer debate.
Since the whole Copenhagen climate elephant walk "conference" is in the news, here are two links to excellent articles about climate change in general and the various views of climate change.
Christopher H. Browne sadly passed away on December 13th. His obituary in the WSJ is pasted below. His 2006 book "The Little Book of Value Investing" is excellent and highly recommended to all audiences. It is as concise as promised but full of good stuff.
Recessions have usually produced higher crime rates, and you'd think the current (or technically recent) recession would be no exception. But according the FBI, both violent crimes and property crimes fell in the first half of 2009 as compared to the first half of 2008.
An interactive chart of the past decade in the markets
Paul Volcker: Think More Boldly
The former Fed chairman says the conference proposals don't go nearly far enough to accomplish what needs to be accomplished
Does financial innovation contribute to economic growth?
That became a hot debate at the Future of Finance Initiative after former Federal Reserve Board Chairman Paul Volcker chastised the largely private-sector group for the timidity of its proposals, and said the ATM was the only financial innovation he can think of that has improved society.
What follows are edited excerpts of Mr. Volcker's discussion with The Wall Street Journal's Alan Murray.
ALAN MURRAY: Mr. Volcker, you have heard the reports from all four of these groups and you have heard the priorities that they have agreed on. We would love to hear your responses.
PAUL VOLCKER: Well, you are not going to be very happy with my response. I heard an awful lot of particulars here that I agree with to some degree, but my overall impression is that you have not come anywhere near close enough to responding with necessary vigor or structural changes to the crisis that we have had.
If it is really true that financial weaknesses brought us to the brink of a great depression that would have ended your livelihood and destroyed a lot of the global economy, then let me explain.
You concluded with financial-services executives showing cultural sensitivity and responsible leadership. Well, I have been around the financial markets for 60 years, and how many responsible financial leaders have we heard speaking against the huge compensation practices?
Every day I hear financial leaders saying that they are necessary and desirable, they are wonderful and they are God's work. Has there been one financial leader to stand out and say that maybe this is excessive and that maybe we should get together privately to think about some restraint?
I hear about these wonderful innovations in the financial markets, and they sure as hell need a lot of innovation. I can tell you of two—credit-default swaps and collateralized debt obligations—which took us right to the brink of disaster. Were they wonderful innovations that we want to create more of?
You want boards of directors to be informed about all of these innovative new products and to understand them, but I do not know what boards of directors you are talking about. I have been on boards of directors, and the chance that they are going to understand these products that you are dishing out, or that you are going to want to explain it to them, quite frankly, is nil.
I mean: Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information. I am getting a bit wound up here.
MR. MURRAY:We are happy to have you. You are here to be wound up.
MR. VOLCKER: A few years ago I happened to be at a conference of business people, not financial people, and I was making a presentation. The conference was being addressed by a very vigorous young investment banker from London who was explaining to all these older executives how their companies would be dust if they did not realize the joys of financial innovation and financial engineering, and that they had better get with it.
I was listening to this, and I found myself sitting next to one of the inventors of financial engineering. I didn't know him, but I knew who he was and that he had won a Nobel Prize, and I nudged him and asked what all the financial engineering does for the economy and what it does for productivity.
Much to my surprise, he leaned over and whispered in my ear that it does nothing—and this was from a leader in the world of financial engineering. I asked him what it did do, and he said that it moves around the rents in the financial system—and besides, it's a lot of intellectual fun.
Now, I have no doubts that it moves around the rents in the financial system, but not only this, as it seems to have vastly increased them.
How do I respond to a congressman who asks if the financial sector in the United States is so important that it generates 40% of all the profits in the country, 40%, after all of the bonuses and pay? Is it really a true reflection of the financial sector that it rose from 2½% of value added according to GNP numbers to 6½% in the last decade all of a sudden? Is that a reflection of all your financial innovation, or is it just a reflection of how much you pay? What about the effect of incentives on all our best young talent, particularly of a numerical kind, in the United States?
In Britain, I was just talking to a high-tech company about the immense attraction to go into finance when both Britain and the United States are suffering from a basic inability to produce things competitively, to keep up with the new economy. Is this a result of financial innovation that we should be really worried about?
Let us think about what structural changes are necessary to produce what is the heart of the problem, about too big to fail, moral hazard and the rest. As I say, I agree with many of your individual suggestions, but there were no suggestions in the area of moral hazard. It was suggested to improve regulation, and that may help, but having gone that far, it is better that you talk about some more serious structural changes.
I made a wiseacre remark that the most important financial innovation that I have seen the past 20 years is the automatic teller machine. That really helps people and prevents visits to the bank and is a real convenience.
How many other innovations can you tell me that have been as important to the individual as the automatic teller machine, which is in fact more of a mechanical innovation than a financial one?
A Banker Responds
MR. MURRAY: The financial-innovation point is the one that you are making most strongly, and there was a statement that financial innovation is tied to economic growth, which Mr. Volcker is disputing. Eraj Shirvani [who is managing director of Credit Suisse in the investment-banking division], do you want to take that on?
ERAJ SHIRVANI: It is never fun to take on Paul Volcker, but maybe I can ask a question for clarification.
So, is your hypothesis that corporate bonds, the securitization market—none of these financial innovations have done anything to help the economy? What shocks me about today is the number of people in this room who have all been architects of the economy as we have it today who have now decided that all of a sudden everything they have worked on over the past 30 years is all bad and the pendulum has swung too far.
I worry when we say that nothing good can come from innovation. Have there been excesses? Absolutely. Have there been inappropriate products? Absolutely. Are there investors who should be held accountable for buying things they didn't understand? Absolutely. However, that does not make it right to say that innovation in itself is a bad thing.
Innovate, but...
MR. VOLCKER: I am not sure that I said innovation in itself is a bad thing. I said that I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy. Maybe you can show me that I am wrong. All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without credit-default swaps and without securitization and without CDOs.
I do not know if something happened that suddenly made these innovations essential for growth. In fact, we had greater speed of growth and particularly did not put the whole economy at risk of collapse. That is the main concern that I think we all need to have.
If it is really true that the world economy was on the brink of a great depression that was greatly complicated by financial problems, then we have a rather basic problem that calls for our best thinking, and structural innovation if necessary. I do not want to stop you all from innovating, but do it within a structure that will not put the entire world economy at risk.
MR. SHIRVANI: I would suggest that some of the things that led to where we are today were not innovative products at all. It was funding long-term illiquid assets in short-term repo markets, which is very boring and old. It was the securitizations of mortgages and things that I think you would support, so I am not sure that innovations were at the center of what occurred. But did they potentially hurt it a bit? In some cases, yes. I think we have to be very careful to make sure that we protect some of the bits that are good, and that in this process where we are trying to cleanse ourselves that we do not throw out the baby with the bath water.
Framework for the Future
MR. VOLCKER: Let me just suggest, if I may, the way that I would go about this. I am not alone in this, and in fact I think that I am probably going to win in the end.
First, let us agree that we have a problem with moral hazard. I do not think that there is any perfect answer in dealing with it, but I would suggest that we can approach an answer by recognizing that elements of finance have always been risky and that's certainly true of the commercial-banking system.
I think we need the commercial banking system for more than automatic teller machines. Commercial banks are still at the heart of the system.
In a crisis, everybody runs back to the commercial banks. They, after all, run the payment system. We cannot have this global economy without commercial banks operating an efficient payment system globally as well as nationally. They provide a depository outlet for individuals and businesses, and they are still big credit providers for small and medium-size businesses, but they backstop most of the big borrowers as well. The commercial-paper market is totally dependent on the commercial banking market. They are an essential financial institution that has historically been protected. It has been protected on one side and regulated on the other side.
I think that fundamental is going to remain. People are going to think it is important, it is important, it needs regulation and in extremis it needs protection—deposit insurance, lender of last resort and so forth.
I think that it is extraneous to that function that they do hedge funds, equity funds and that they trade in commodities and securities, and a lot of other stuff, which is secondary in terms of direct responsibilities for lenders, borrowers, depositors and all the rest.
There is nothing wrong with any of those activities, but let you nonbank people do it and you can provide fluidity in markets and flexibility. If you fail, you're going to fail, and I am not going to help you, and your stockholders are going to be gone, and your creditors will be at risk, and that is the way that it should be.
How can I be so blithe about making that statement? We need a new institutional arrangement which I believe has a lot of support. We need a resolution facility. What can that resolution facility do? If one of you fails and has systemic risk, then it steps in, takes you over and either liquidates or merges you, but it does not save you. That ought to be a kind of iron cross.
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Here’s my version of modern American history. Before World War II, you had a country in which most people lived pretty simple lives. Working-class, rented homes. Living without indoor plumbing was not regarded as the end of the world. Getting an education involved finishing high school.
After World War II, the U.S. was the last economy standing, and it boomed, but in the process did we create a false standard of living?
Then came the war and when it was over, the United States was the last economy standing. And it boomed. The government spent a ton of money to send the returning veterans to college, helped them buy their own homes, and created jobs with huge, ambitious projects like the interstate highway system. Meanwhile, the cost of living was pretty low, especially when it came to housing.
So suddenly you had a country in which most families enjoyed an absolutely unprecedented standard of living: A home of your own, a car, a TV. The occasional vacation. Kids in college.
Then in the 70s, things went sour. Prices spiked. Unemployment rose. I think of this as the moment that we realized that the rest of the world had developed economies of their own, although I know it’s more complicated than that.
Middle-class families had an increasingly hard time maintaining their middle-classness. And the way they adapted was to add another paycheck. Wives went to work. Not that there hadn’t been a lot of married women working all along, but the old ideal of the Ozzie-and-Harriet family model went out the window. When young people planned their futures together, it was under the assumption that there would be two incomes.
But as the years went by, even two middle-class incomes weren’t enough. So the families borrowed. They still had homes, but the mortgages were bigger. They had cars, TV’s and credit card debt. Their kids were more determined than ever to go to college, but by the time they got their diplomas, they were in hock to Sallie Mae or one of the other student loan factories.
When the bubble burst last year, I didn’t see it as the end to our economic power. But I did wonder if it was the end of the American Dream, or at least the version we’ve come to regard as practically a national birthright.
David Brooks: I guess I have a different narrative. Some things about the American economy haven’t changed all that much. We work really hard and switch jobs more frequently than anybody else. The average American works 9 weeks longer per year than the average Western European, which is insane but does mean our standard of living is higher.
To me the big thing that’s changed is the cognitive revolution. Because of economic and technological change, there’s greater and greater demand for people who can manipulate ideas and abstractions (except philosophy professors of course).
The problem is that we’ve experienced a cognitive revolution, which has been bad for certain groups of people, namely those without advanced degrees.
This has been good for certain sorts of people, namely those with unique mental skills, the superstars in any field. It’s also been good for women, who can compete equally in a cognitive economy.
It’s been bad for other groups — men without advanced degrees, anybody without advanced degrees, people with decent but fungible mental skills. Suddenly they’ve become commodities with comparable pricing power in the labor market.
The end result is widening inequality, not only of income but of skills, as highly educated people marry each other and pass their skills to their kids. Educated Americans live in a stable Ozzie and Harriet world and the uneducated live in a much more disrupted world.
Nonetheless, people in the educated sector have tremendous cultural influence. Every TV network and publication is competing for their eyeballs. Cultural norms are thus set by the lucky 20 percent. Everybody else (we’re Americans, we don’t acknowledge class differences) measures their lifestyle according to the standards set by those top 20. To get the bigger house (which now seems normal) or the multiple cars or the flat screen, they go into debt. Pretty soon, kablooie.
As the economy recovers the upper middle class will probably be fine. This economy still rewards ideas with income. They will still have tremendous cultural capital, the ability to unwittingly set the norms everybody else must live up to. The consumption merry-go-round will begin again.
Maybe there’s a way out of this boom-bust cycle, but I don’t see it, frankly. This is an energetic country, and so G.D.P. growth will be fine. It’s the throttling back that we’re not so good at.
DECEMBER 16, 2009
Christopher H. Browne: 1946-2009
A Career of Finding Value
By JASON ZWEIG
To thrive as a value investor, Christopher H. Browne once said, you have to "risk being called a dummy from time to time."
Mr. Browne, who died Sunday of a heart attack at the age of 62, was one of the most successful practitioners of buying stocks that the so-called smart money on Wall Street wouldn't touch.
He spent 40 years at Tweedy, Browne & Co., succeeding his father, Howard, as senior partner. The firm and its mutual funds have long been known for finding unpopular stocks at unusually cheap prices.
Mr. Browne helped broaden the investment firm, which manages more than $10 billion, from its roots as a specialty brokerage house. He stepped down as a managing director earlier this year in the aftermath of a severe head injury sustained in a fall in 2007.
In 2001, Mr. Browne raised questions about Conrad Black's company, Hollinger International, which had been subsidizing the press baron's lavish personal life. Tweedy Browne had a sizable stake in Hollinger. Mr. Browne spearheaded a shareholder revolt that eventually led to an investigation by the Securities and Exchange Commission, a fraud conviction and a six-and-a-half-year prison sentence for Mr. Black.
Mr. Black is appealing.
From the 1930s through the 1950s, Tweedy Browne—originally Tweedy & Co.—was the favorite brokerage firm of Benjamin Graham, the founding father of value investing. Its specialty was dirt-cheap shares of closely held companies that rarely traded on major exchanges; Mr. Browne sometimes likened the firm in those days to a "pawnbroker" or "thrift shop."
In the 1950s, Tweedy Browne began to serve Warren Buffett, who in 1965 traded through the firm to amass a controlling position in a tiny textile firm in New Bedford, Mass., Berkshire Hathaway Inc.
Mr. Browne joined his father's firm in 1969, recording trades in Berkshire Hathaway at $25 per share. He came to specialize in such meticulous tasks as scouring financial statements to find stocks selling below the value of their current assets minus all liabilities.
"Investment management is for us a 'grunt work' business," Mr. Browne wrote in a 2001 letter to shareholders. "Were you to visit our offices, you would be reminded more of the reading room in a college library than some frenetic trading room at a major brokerage firm."
Since their inception in 1993, Tweedy Browne's Value and Global Value funds both outperformed market averages.
Mr. Browne's skills didn't come cheap; for years, the Tweedy Browne funds charged above-average expenses. In 1997, Mr. Browne negotiated the sale of a majority stake in the firm to Affiliated Managers Group.
In "The Little Book of Value Investing," published in 2006, Mr. Browne explained how to analyze financial statements and how accounting principles differ across nations.
He wrote that "value stocks are about as exciting as watching grass grow. But have you ever noticed just how much your grass grows in a week?"
Mr. Browne's philanthropic gifts included $10 million to the University of Pennsylvania, his alma mater. He also funded research into HIV and AIDS at Rockefeller University, New York.
—Email remembrances@wsj.com
In its Preliminary Semiannual Uniform Crime Report released today, the FBI indicated that the volume of violent crime in the nation decreased 4.4 percent and the volume of property crime declined 6.1 percent. More than 11,700 law enforcement agencies contributed to this report, which is based on information from law enforcement agencies that provided three to six common months of data to the FBI from January to June of both 2008 and 2009.