Opinion: Some thoughts on the Legg Mason Annual Press Symposium

Thanks to reader hpm for referring me to the transcripts of the December 3rd Legg Mason Annual Press Symposium. The format was that of a roundtable, with Bill Miller being one of the participants. I would put this low on the list of reading materials given that there wasn't much insight--at least for me. Anyway, I have some dissenting views on some of the points that were mentioned. Several individuals are quoted below so don't assume all the words are from Bill Miller.


On Asset Values

MILLER: The problem is collateral values and asset values. That's housing and all of the related securities relating to that, and all the securities out there in the system. You know, if the stock market were back where it was a year ago, there wouldn't be a recession. You know, things would be looking fine. Wealth would be up, you know, everything would be looking okay.

So I think it's getting collateral values stabilized and rising. And, you know, Ken and I had a discussion about this, this morning. The Fed's been extremely creative, but they haven't accomplished the job yet, so they haven't done enough yet to do that, and I think there's more to go in that.

I have some serious issues with this thinking. What if some of these assets were in a bubble? What if some assets will never go up to what it was? I think Bill Miller, and others, may be making a mistake overlooking the possibility that some assets were inflated. Regardless of what anyone does, certain amount of wealth destruction would occur. The bond market looks irrational but it may actually be marking down these assets and looking at big losses on some of these assets.


Government To The Rescue?

MACK:And Bill was just, you know, just saying that - - . I mean, what more from each of you, and it looks like all of you are looking to the government to solve this economic problem, instead of the economy, itself, in some respect, at least - - stage of this evolution. So
what more does the government need to do, to give you confidence that, in fact, that the economy is going to...

I think the panel is misguided in believing that the government can solve some of these problems. I sort of alluded to this in a prior post about Bill Miller but to repeat, I think he is too optimistic and putting way too much faith in the government. This is a serious risk that Bill Miller is taking. I think it is far more prudent to be skeptical or stay neutral. Just remember, a lot of people who entered the market early this year, when some, including Miller claimed it was the bottom in financials, have been burnt badly.

Why The FedRes Was Slow

MILLER: I agree they're doing a lot more now, but it's a mystery to me, and I would gather to the markets, why they haven't done even more than that already because it's very clear what needs to be done, and it looks like they're waiting to see if the measures they've taken will be sufficient because they don’t want to take more dramatic measures, and that's certainly an institutional, psychological constraint, but it seems to me they ought to keep the objective in mind, which is, you know, to get the system flowing again, and not worry too much about precedent.

It's pretty obvious why they are cautious. First of all, they are running out of ammunition. Rates have been dropping faster than any of the plunges experienced by one Wile E. Coyote. The situation is becoming more political so the laissez-faire, some would argue reckless, behaviour of Paulson and Bernanke, among others, will be tougher in the future. Getting support from Congress and Senate is tough (witness the TARP bailout bill which initially failed.) If they choose not to get money from the Treasury, they need to print money, which they have been cautious about. Do keep in mind that gold is still hovering over $800. If the FedRes went any faster, there is the risk of a run on the country itself (i.e. on the US$).

High Bonds Yields

UNRECOGNIZED VOICE: Well, distressed [referring to bonds] because of these forced liquidations, or are they distressed because of financial stress? If they're, and I think that's put up there, distressed because of financial reasons, then, 1931. If they're distressed because there's forced selling, then, that'll end.

This is a good point and worth thinking about. Why are bond yield spreads so high (although on a raw yield basis, they are not that high)? If bonds are correct with their prices, then we are looking at a very nasty economic scenario. But if it is due to forced selling, it's not so bad.

Extreme Government Intervention?

MILLER: I think the issue here is mostly political psychological, and not economic because, you know, there's not an investor on this panel, and there's not, you know, if you talk to Warren Buffet, there's virtually no investor out there who doesn’t believe there are extraordinary long term values in credit, in equities, across the States. The issue is, and so, from my standpoint, purely economically, the Fed should buy everything in sight.

They should - - the Hong Kong - - buy stocks. Buy junk bonds because the taxpayer is going to make a killing on that, and all they're doing is just taking, you know, future tax receipts and putting them to work, and if I were the treasury, I'd issue like - - 100 year bonds. Sure, issue 100 year bonds. Issue all the bonds you can at 70 basis points, and go buy Hersh's dividend paying stocks. The taxpayers will make a killing on that.

So that's, you know, that's sort of a radical thing, but, A, that would solve the problem, and B, it would make economic sense, but it's politically, obviously,
very difficult.

I have to disagree with Miller here. I know there are a lot of people who share similar views as him, including the Japanese government, which is planning to buy stocks on their markets. I'm a liberal and in favour of far more government intervention and regulation than most on the right. But even I would have to say that it is not the job of a government to become a hedge fund and start buying stocks for profit. Even if Buffett, who I respect and thinks has a good handle on bottom-up valuations, thinks valuations are attractive, I would not want the government attempting to buy stocks (or other assets such as junk bonds or corporate bonds.) There are many problems with this.

First of all, it distorts the pricing signals of markets. One of the beauties of a free market is that it provides signals on its own. They are not always correct but it's not controlled by one person or party.

Secondly, if the government started buying stocks, among other assets, it will essentially nationalize business. This further propagates the strategies of the fake free marketers, who tend to believe if private profit on the upside and government bailout on the downside. Coversely, it also takes us further towards the strategy of Communists who think governments can run certain businesses better than the private sector.

These actions also increase corruption in society. We can already see how the criminals and the fraudsters were drawn to some of the prevalent bubbles of the last few years (housing and Wall Street (particularly secrutization of assets) are good examples.) Who decides which stocks to buy? And why? Why buy S&P 500 instead of S&P 600 (small caps)? Does anyone seriously want Barack Obamba (or Stephen Haper in Canada) and his cabinet (Treasury secretary in the US; finance minister in Canada) deciding which stocks or bonds to buy? Or how many clear-thinking people outside the Wall Street crowd want a central banker to decide what to buy? In case many haven't forgotten, just imagine if Alan Greenspan, who can't see a bubble, even if he was slipping downhill, was at the helm decide which stocks to buy? It wouldn't surprise me if he bought up every single stock until its P/E hit 20.

Lastly, this is nothing more than a transfer of wealth from the average citizen to the wealthy. Roughly 10% of the wealthiest in America own 85% of the stock market. Bailing out this wealthy crowd while indebting future generations is not a sound strategy for anyone not named Mr. Wealthy.


The Unfolding Mark to Market Disaster

MILLER: The one thing which completely baffles me, from a policy standpoint, is the issue of market to market accounting, and not the issue of the transparency. I'm all in favor of showing the values on the balance sheets of the banks, more transparency, that whole thing.

The issue is tying capital requirements to trading prices of the securities, and, you know, the whole thing about the so-called fair value accounting standards - - the former head of the FDIC said if we had these standards in 1982 or 1990, we'd have zero banks, and every bank would be nationalized. So why they persist in this, why they don't say, you know, we're going to continue to show the marks, but we're not going to require - - have capital requirements tied to those - - . We'd take a moratorium to study that for some period of time.

That would make just a monstrous difference, I think, and the whole thing is sort of a semantic muddle, in the sense of they call it fair value accounting. The fair value of an asset is the present value of the future free cash flows of the asset. That's what the value is. The price of the asset and the value, there are no necessary relationship, and the price, as, again, all people in the panel believe, the prices of most of these assets are way, way out of fair value.

But they have a pro-cyclical policy that requires banks to, in essence, take and blow holes in their capital base at the bottom, when they need capital, and then, by the same standard, write their capital up when the securities up at the peak of a cycle, and then, so their returns on capital collapse, and they'll be under pressure to put that money to work when asset values drop. That's just a lunatic policy and why they persist in that, I have no idea.

I stopped harping on this point because, I think, many realize it was a disaster. As I said almost an year ago, when all is said and done, mark to market accounting would be flagged as one of the worst accounting policies in human history. Efficient market proponents, who still seem to dominate academia and the accounting professions, will take a massive body blow. Only the rating agencies would suffer a bigger blow once the verdict is in.

Unfortunately it's too late to do much on this front. Those in power really won't do anything. Or else they will lose face and, it seems to me, that's all they have.

Cash On the Sidelines?

LEECH: But there is, I think, net cash and margin accounts now, for the first time in history. You have money market funds that are at so much - - you can buy almost half the stock in New York Stock Exchange. So there's a huge amount of cash sitting out there on the sidelines.

I have seen this being mentioned before but I'm not sure how true this is. Is there actually a large amount of cash sitting on the sidelines? I also wonder if this is a misleading statistic that doesn't account for debt and asset losses. For instance, if Americans have $1000 in cash but increased their debt by $1000 in the last few years, it may not be as good as it seems.

If the cited cash figure is indeed correct then this is bullish for asset markets.

One Scary Thought

OTTER: I'm sorry, Jack Otter [phonetic] from Best Life. Bill just pointed out something that, in a way, is a little bit scary, which is that so many asset managers think everything is really cheap right now. And to quote Jeremy - - , again, you know, he said the - - Ball in 1930 was really well attended, but by '34, not many people showed up for it.

This was a question from the audience but I share similar concerns. Perhaps I'm overly conservative due to my losses from Ambac but whatever it is, how can we be sure that we are not looking at 1930 right now? For those not familiar, the stock market plunged around 48% by 1930 but it rebounded and then continue collapsing, only to seal its fate as the worst bear market (if you adjust for inflation, the 70's bear market was worse for investors supposedly.) I'm not predicting a Great Depression or anything like that (unless we get trade war or a physical war) but what seemed cheap in 1930 turned out to be a disaster. Similarly, 1974 was the bottom but stocks basically went nowhere until 1982. We will know if the situation is bad when bears start taking losses.