Felix Salmon

Berkshire’s Welcome Downgrade

Reuters Staff
Mar 13, 2009 10:46 UTC

Well, that didn’t take long. I speculated yesterday that Berkshire Hathaway would be the next company to be downgraded from triple-A; I didn’t think that it would happen within a matter of hours. But Fitch went ahead and did the right thing:

“Fitch views the company’s potential earnings and capital volatility derived from its large, unhedged market exposures as inconsistent with the stability required at the ‘AAA’ level,” the ratings agency said in its statement on Berkshire.
Those exposures include Berkshire’s equity investments, as well as its holdings of derivative contracts tied to equity and credit markets, Fitch said.
Fitch is the first major credit agency to cut Berkshire’s ‘AAA’ rating.

"First", here, has the same meaning as "my first wife", or "the First World War": it implies the existence of a second — and, in this case, a third. Berkshire has often been described as the world’s most successful hedge fund; that’s fine, but hedge funds don’t have triple-A ratings, and neither should Berkshire.

Fitch also made a good point about what you might call "Buffett risk":

Fitch also noted Berkshire remains too closely linked to Mr. Buffett to merit a ‘AAA’ rating.
“Fitch views this risk as unrelated to Mr. Buffett’s age, but rather Fitch’s belief that BRK’s record of outstanding long-term investment results and the company’s ability to identify and purchase attractive operating companies is intimately tied to Mr. Buffett,” it said, referring to Berkshire.

Interestingly, however, if and when S&P and Moody’s follow Fitch’s lead, the Buffett risk might actually be reduced. Market Movers reader Nicholas Weaver explains:

An AAA-rated company, especially a AAA-rated financial company (AIG, the monolines, GE, Berkshire Hathaway) is naturally tempted to commit ratings arbitrage, and all but Berkshire Hathaway have nearly imploded due to this behavior.
Such arbitrage in the short term greatly enriches management, but in the long term can destroy the company. Basically, the lesson is "A company should have an AAA credit rating only as long as it doesn’t actually borrow much against it!"
Why this hasn’t happened to Berkshire is simple: Warren Buffett and Charlie Munger prevented this from happening through tight corporate controls. The only ratings arbitrage that occurs is on the manufacturing companies Berkshire acquired over the years, which allows these companies to borrow for expansion (everybody) or for customer financing (Clayton Homes) at AAA rates.
And they kept this temptation under control simply because they are such huge shareholders that short-term compensation for them simply does not matter, it is dwarfed by their holdings.
But Buffett and Munger can’t live forever. And thus the question for 5 years hence: how does Berkshire Hathaway the company survive when the management no longer has the rather unique compensation strategy thats currently in place?

The answer is that if Berkshire has already lost its triple-A by the time Buffett and Munger depart, then the ratings arbitrage is by definition impossible. Shareholders should welcome a downgrade, because it reduces the incentives for Berkshire’s future managers to play silly ratings games.

Reprinted from Portfolio.com

Treasury: Still Going Nowhere

Reuters Staff
Mar 13, 2009 09:20 UTC

To lose one deputy treasury secretary might be considered a misfortune; to lose two — and both before they are even officially nominated, no less — looks suspciously like carelessness.

George Stephanopoulos has the depressing news:

Democratic sources say that H. Rodgin Cohen, a partner in the New York law firm Sullivan & Cromwell LLP, and the leading candidate for Deputy Treasury Secretary, has withdrawn from consideration.
It’s the third withdrawal of a top Treasury Department staff pick in less than a week…
Democratic sources said that an issue arose in the final stages of the vetting process.
As one source put it, "it’s back to the drawing board."
Cohen had risen to the top after the withdrawal last week of expected deputy treasury secretary pick Annette Nazareth.
Nazareth was forced to withdraw from consideration for the deputy treasury slot because senators made it clear she would face tough questioning over her time at the Securities and Exchange Commission.

Deputy treasury secretary is a huge and important job: it’s the position that Larry Summers held when he appeared on the cover of Time as part of the Committee to Save the World. But it seems that the very experience which qualifies any given person for the job is also liable to disqualify them.

What’s even more depressing than the difficulties filling these positions is the weird way in which the Obama administration is pushing the line that there isn’t a problem here at all:

Obama administration officials have pushed back hard at critics who argue that failure to fill key Treasury Department positions is hampering their response to the economic crisis.
The administration has argued that they have more appointees in place than previous administrations and have done big things: housing, stimulus, and the beginning of their bank plans…
Foreign Policy reported yesterday that Britain’s most senior civil servant, cabinet secretary Sir Gus O’Donnell, claimed it was hard to find anyone to speak to at the US Treasury Department.
He blamed the “absolute madness” of the US system where a new administration had to hire new officials from scratch, leaving a decision-making vacuum.

O’Donnell is right, and the Obama spin doctors are wrong. The fact that Treasury has failed to fill substantially all of its senior political positions, four full months after Geithner was nominated, is a national scandal. We’re not impressed by Geithner’s vague sketch of "the beginning of" his bank plan; we want a bank plan! And we want it a couple of months ago, before Citigroup stock dropped below $1 a share on utter uncertainty about what on earth was going on or might happen.

I’m not sure how much of all this can or should be blamed on Geithner personally, but the fact that economic policy seems to have been taken over by Larry Summers doesn’t help, and Geithner simply doesn’t seem to have the force of personality which will persuade both Wall Street and the general population that he knows what he’s doing. He started off with quite a lot of goodwill, and he’s lost that entirely; now that it’s lost, I don’t think he can regain it. It’s a truly sorry state of affairs.

Reprinted from Portfolio.com

Don’t Watch CNBC

Reuters Staff
Mar 13, 2009 08:45 UTC

Jim Cramer was craven and highly apologetic on the Daily Show last night because he had no choice; he started off by throwing Rick Santelli under a bus, and almost never attempted to defend himself, preferring to go the mea culpa route. This is not new. Even at the top of the market, in May 2007, he was writing this:

Mad Money has spawned legions of haters, people who write about the show and my character in really negative, sometimes pretty nasty ways. These people accuse me of being a clown or an idiot. Usually, I agree with them. When people ask for my autograph, I instantly hate myself.

So well done to Jon Stewart for not letting Cramer’s passivity prevent him from saying what he had to say:

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It’s a long segment (and the one above is just part of the whole interview) so I’ll let Chris Rovzar sum up:

"I understand you want to make finance entertaining, but it’s not a fucking game," Stewart railed. "When I watch that, I can’t tell you how angry that makes me. What it says to me is that you all know. You all know what’s going on. You can draw a straight line from those shenanigans to the stuff that was going on at Bear Stearns and AIG and all this derivative market stuff that is this weird Wall Street side bet." Cramer admitted to many mistakes (and even promised Stewart he would change his show), and pledged that his own "goal should always be to try to expose that there is no easy money." "But there are literally shows called Fast Money!" Stewart shot back. "There’s a market for that," Cramer tried to explain, but was interrupted by the Daily Show host. "There’s also a market for cocaine and hookers!"

In a sense, it’s a shame that Stewart had on his show the most self-loathing of all the CNBC personalities — but then again he, too, had little choice, since Santelli cancelled on him. But the lesson of this interview is that when CNBC is pressed on the way in which it has hurt America, its response is to capitulate and say "well I guess that’s true". Which means that the bigger lesson is simpler still: don’t watch CNBC. Doing so will do you no good at all, and will quite possibly do you a lot of harm.

Incidentally, Barry Ritholtz, a frequent CNBC talking-head himself, tries to mount the defense that Cramer couldn’t by saying that the network has "a plethora of economic voices and market perspectives". Plethora is one way of putting it; cacophony is another. And is in fact the word which is used by the outgoing head of news at CNBC.

CNBC is a cable channel where the closer you get to it, the more unpleasant it seems. I’m a former denizen of the decabox myself, and I can tell you that no good can come from that thing. Don’t watch it.

Reprinted from Portfolio.com

Extra Credit, Thursday Edition

Reuters Staff
Mar 12, 2009 19:09 UTC

Why letting Lehman go did crush the financial markets: A great post from Sam Jones.

Trickle-up bailouts: Bail out the borrowers, not the banks.

What Does It Mean to “Bury” a Bank? Chances are, Richard Shelby doesn’t have a clue.

Panics and Booms, a lesson from 1897: Another one for the plus ça change files.

Cumulative high yield defaults could hit 50%, says Goldman Sachs: With recovery rates as low as 12%.

Reprinted from Portfolio.com

Wealth Destruction Datapoint of the Day

Reuters Staff
Mar 12, 2009 15:42 UTC

For further proof that the world has not lost 40% to 45% of its wealth in "little less than a year and a half", as Steve Schwarzman would have it, one need turn only to today’s news that US household wealth has declined by 20% peak-to-trough.

Interestingly, of the $5.1 trillion in US wealth lost in the final quarter of 2008, "only" $937 billion was in real estate, compared to a fall of $1.46 trillion in pension and life insurance reserves. The loss of home equity is certainly causing a lot of pain, but it’s not obviously greater, on an absolute basis, than the more generalized loss of wealth.

Reprinted from Portfolio.com

Hedge Fund Datapoint of the Day

Reuters Staff
Mar 12, 2009 14:17 UTC

This is how badly the hedge-fund universe is being shaken out these days: John Paulson lost 16% of his assets under management in the second half of 2008, and still managed to rise to 3rd place in the list of biggest hedge-fund managers, from fourth place at mid-year. Or, to look at it another way, $29 billion in funds under management was enough to garner him eighth place in January 2008, but the same number got him the bronze medal this year.

Paulson’s flagship fund returned 38% last year, largely thanks to short bets which paid off when the market tanked in October. Let’s say that his investors saw a 20% return in the second half alone, and that he started the second half managing $34.5 billion. Then by the end of the second half, if he’d had no redemptions, he would have been up to $41.4 billion; in fact, however, he was down, to $29 billion. Which implies that even John Paulson — the one person who seems to be doing unambigously well during this crisis — got a whopping $10 billion of redemption requests in the second half of 2008.

Now some of that will have been due to simple common sense and portfolio rebalancing: if one of your funds does very well while most of the rest lose money, then in order to keep your asset-allocation decisions constant you need to redeem money from the successful fund and invest it in the less successful ones. If you don’t, you end up with too many eggs in one basket.

But I suspect that quite a lot of the requests are a function of a simple need for liquidity: people needing money. It’s the same phenomenon which did for Bernie Madoff: in bad times, you necessarily start to liquidate your (seemingly) good investments. Fortunately for his investors, John Paulson, unlike Madoff, is not a crook.

Reprinted from Portfolio.com

Blogonomics: RSS Redux

Reuters Staff
Mar 12, 2009 12:10 UTC

It’s been 17 months since I published my RSS manifesto, arguing strongly that everybody should serve up full RSS feeds, and nothing since then has changed my mind. But Seeking Alpha’s David Jackson leaves me a comment today, as a follow-up to another comment he posted yesterday, saying that RSS has basically been a failure, and asking "what will make APIs different".

David has a peculiar criterion for success: he seems to think that RSS was meant to be something which lots of people would adopt, and which would generate just as much money, through ads in full RSS feeds, as traditional display ads generate on websites.

Clearly that hasn’t happened. But I was certainly never someone who thought that would happen, and I don’t know anybody else who thought along those lines either.

Here’s David:

If judged by the degree of adoption outside the tech community, RSS has generally been a failure. Perhaps the reason is that readers wanted intelligent aggregation: they want to know which topics are important, and which articles to read on those topics. RSS couldn’t do that, because most RSS readers force the user to browse all the subscribed-to RSS feeds and piece together any themes for themselves.
The winning model turned out to be Techmeme, which does exactly that: it tells me which topics are hot and which articles to read on them. Here at Seeking Alpha, we’ve followed a similar model with our home page: we’ve moved away from a "stream of content" to intelligent clustering of articles by "story".
And what happened to RSS monetization? Feedburner offered ads in RSS, but nobody reported that they made any real money from them.
So the question is: How are APIs different from RSS?

There’s a lot to unpack here. Firstly, the criterion for success of RSS should most emphatically not be "the degree of adoption outside the tech community". There are lots of other criteria which make a lot more sense, but the most simple would probably be just "does serving up full RSS mean that you’re more successful/profitable than if you don’t". And I think the answer there is yes, for reasons which I went into in some depth 17 months ago.

Simply put, the community of RSS users might be small, but it’s vital. If you’re running a content website, you desperately want those readers, because they’re the people who will drive you lots of traffic.

David is quite right that most readers on the internet don’t particularly want to go to the trouble of curating and editing their own collection of RSS feeds: they want editors, at places like Techmeme, to do that for them. And that’s exactly how APIs differ from RSS: using APIs, anybody can put together a website of their own, and publish a range of content from around the internet. With RSS, you’re confined to reading others’ material: you can’t then turn around and publish it yourself. Not unless you like facing a lot of cease-and-desist letters, anyway.

As for RSS monetization, RSS has always been a means to an end. No one has ever got rich from RSS ad revenues — but no one ever expected to, either. The point of RSS is as a tool to drive revenues elsewhere. If you serve up full RSS, then more people will visit your website, and you’ll make more money from selling ads on that website.

What’s more, there’s an easy way to demonstrate this. Right now, Seeking Alpha truncates all of its RSS feeds, making them much less useful than they should be. So go ahead, David, and switch them all to full feeds, and see what happens. I’ll bet your website traffic will grow and not shrink. Why not give it a go?

Reprinted from Portfolio.com

Roquefort Math

Reuters Staff
Mar 12, 2009 11:05 UTC

We’re just ten short days away from R-Day — the day at which tariffs on imported Roquefort surge to 300%, and the incomparable French sheep’s-milk blue becomes, to all intents and purposes, unavailable in the USA. Liz Thorpe of Murray’s Cheese does the math, and explains how a product which wholesales for €5 per pound in Europe becomes a cheese retailing for something in the $60 range by the time it reaches American shores, thanks to this horrible tariff. Isn’t repealing this tariff a no-brainer for the food-friendly Obama administration? Why hasn’t it been done yet?

Reprinted from Portfolio.com

The GE Downgrade Arrives

Reuters Staff
Mar 12, 2009 08:59 UTC

Back in January, when I said it was high time that GE should lose its triple-A credit rating, GE’s stock was trading at a 12-year low of $12.55 a share. Yesterday, when S&P finally made the decision to downgrade the company, GE closed at $8.49, a further erosion of 32% in the share price. Meanwhile, the company’s bonds, which were trading at 326bp over Treasuries in January, have gapped out all the way to 674bp over now. This downgrade only serves to ratify what the market already knew; it was frankly necessary for S&P to preserve what sliver of credibility it still retains.

GE stock is flat today; the downgrade was priced in. But Berkshire Hathaway is down. Could it be next?

Reprinted from Portfolio.com