Review of Confidence Game: How Hedge Fund Manager Bill Ackman Called Wall Street's Bluff by Christine S. Richard

"A closed mouth gathers no foot." - Bill Ackman's high school yearbook

Confidence Game is the Bill Ackman equivalent of David Einhorn's Fooling Some of the People, except that Einhorn wrote his book and this one is written by a reporter who followed bond insurers and to whom Ackman gave full access to his notes and correspondence about this investment.

My conclusion about Einhorn's book was that going on a crusade against Allied Capital was a mistake for a number of reasons. In the very same ways, Ackman's crusade against MBIA seems like a mistake, even though he was right.

Life is too short to chase after the fraudulent stock shorts. The more crooked the management, the longer the fraud can last. As long as a company (whether fraudulent or just a bad business model) can attract investors fooled by some kind of Batesian mimicry it can persist.  But if a company is unprofitable and it owes more money than it can repay, the creditors can be the catalyst for the short.

The activist shortselling campaigns take a tremendous amount of time and also create a public commitment that is hard to modify or back down from if circumstances change. It seems like Einhorn has perhaps learned this lesson, but Ackman has not. His latest crusade, which seemed extremely misguided, was Herbalife. What if the distraction from the Herbalife campaign contributed to Ackman's debacle in Valeant?

Both Einhorn and Ackman had drawdowns in 2008. It's particularly amazing in Ackman's case because he was more right about MBIA than Einhorn was about Allied, and 2008 was the year that his trade paid off, and his credit default swaps that he bought for (as low as) tens of basis points per year were much higher returning (50x?) than Einhorn's Allied stock short.

As Alice Schroeder said at the time about Ackman's MBIA idea, "If the idea isn't strong enough to move the market, that's a sign its time has not come yet." When I wrote my review of the Einhorn book, a reader commented,

"Look at Ackman and Herbalife. (I think Hempton is right and Ackman is wrong, btw.) A gigantic, public position becomes something from which you can't back down."

An investment idea may be good, but not actionable. Too early means not actionable. I believe that there will be a bear market in U.S. bonds, but probably not yet. Remember the point that one astute investor made in Inside the House of Money:

"A really important lesson in investing is that being either too far in front or too far behind is when you get hurt, whereas being right at the edge of the wave is where the money is made."

Another good point from the same book, from Scott Bessent, who left Chanos to work for Soros in 1991:

"[Y]ou don't have to be skeptical about everything. Maybe the guys at Starbucks really are good managers and it really is one of the greatest concepts ever. Maybe eBay is the perfect business model. Short sellers can't think that way."

I wonder whether Ackman will survive the next bear market? Also, questions for audience: is it possible to be a good investor and not be humble? Is it possible to survive for 50 years as a professional investor and not be humble?

3/5

Who is Buying the Stocks I'm Shorting?

Look at this quote from the WSJ:

Legendary fund manager Marty Whitman is pinning the blame squarely on an "irrational" stock market meltdown for this year's hefty losses at his Third Avenue Value fund.

"As far as we are concerned," Mr. Whitman declares in his latest shareholder letter to investors, "the fund's poor 2008 performance is attributable to an irrational stock market, not any fundamental deterioration in the businesses in which [Third Avenue Funds] has invested."

I don't really know what to say. There is no deterioration in MBI's business? ABK? St. Joe?

What I don't like about Third Avenue is they never learned their lesson. Never started giving much weight to the possibility of a global depression (which is what is actually happening).

Although it does look like they are finally getting rid of JOE. Evidently, they sold out of AMAT in the 4th quarter. I am short AMAT and JOE. If Third Avenue is not going to defend the price any longer then it is probably safe for me to pile on the shorts.

Victory for Bears

With 125bp of rate cuts in 7 trading days, the Fed was able to lift only45 S&P points, and today the markets closed down. That's an important psychological defeat and everyone is going to hear about it when they watch the news tonight.

After today's Fed cut, 15 and 30 year mortgage rates are up. But, regardless of whether Fed cuts push mortgage rates up or down, the bigger issue is tighter lending standards. The real estate bubble was predicated on a near absence of lending standards. Unless those conditions come back, the only direction real estate prices are going is down.

The next (scheduled) Fed meeting (cut) isn't until March 18. That means 48 days without anything bullish to look forward to. (Except government intervention, but after three or four flops in a row, those are wearing thin.)

After a huge, insane rally, the mortgage and bond insurers are flopping again. Here's a great Bill Ackman interview re: MBIA on Bloomberg TV. The other great quote from Mr. Ackman is

"Does a company deserve your highest Triple A rating whose stock price has declined 90%, has cut its dividend, is scrambling to raise capital, completed a partial financing at 14% interest (now trading at a 20% yield one week later), has incurred losses massively in excess of its promised zero-loss expectations wiping out more than half of book value, with Berkshire Hathaway as a new competitor, having lost access to its only liquidity facility, and having concealed material information from the marketplace?"

The problem with these insurers is the correlated risks. The same event - a huge decrease in real estate prices - is going to cause unusually high numbers of simultaneous, unusually high claims. The risk that a $20T asset class decreases in value by say 20% is uninsurable.

I think there is currently no panic in the market and there never has been since the bubble started unwinding, in the sense that nothing has become systematically undervalued yet.

What have looked like "panics" in February, August, and last week have been prices beginning to approach reasonable levels only to have bull market conditioning cause people to buy the dips.

For example, I saw a spreadsheet of REO that a liquidating hard money lender was trying to pitch. It was being talked about at the "fire sale" price of 30 cents on the dollar. Except, none of the properties are worth that much.

However, when people are selling shares of weak financials, homebuilders, and insurers for under $1, I will view that as a fire sale price and cover my shorts.

New Short Possibilities: MBI and NCT

This is from Deep Survival by Laurence Gonzales:

The stages of getting lost apply to more than just hiking in the woods. A company, such as Xerox, ignores cues from a changing world and from inside its own research facility in Palo Alto and nearly destroys itself. In 1959, Xerox introduced its 914 copier. Fortune said it was "the most successful product ever marketed in America." By 1969, Xerox passed $1 billion in sales. In 1971, flushed with success (an emotional state of high arousal), the company's officers were in a state of deep denial. The world was changing and they weren't taking in any new information... Xerox's leaders had decided to take on IBM, despite all the clear evidence that it would most likely kill them to do so. They were like snowmobilers, flushed with emotion, who went up that hill, despite the clear evidence that it would probably kill them. They were bending the map, too...

Xerox spent $1 billion to purchase a computer company... In the meantime, scientists and engineers at PARC were inventing the mouse, Ethernet, the [GUI], the flat-panel display, and the laser printer. Others got rich off of those inventions. Xerox, busy with its mental models that did not match the real world, saw none of that profit.

I was surprised by the magnitude of this decrease in land prices:

The slowdown in housing construction has led to a sharp fall in residential land prices in the [Minneapolis-St. Paul] metropolitan area, according to a midyear market study by Bloomington-based United Properties.

Values for developable residential land in the metro area are down about 35 percent from 2005, United said... some residential developers were carrying 18- to 36-month supplies of land on their books, compared with a typical four- to six-month supply.

SPF's land positions are in markets that were far more overheated than Minneapolis-St.Paul. They have a high degree of leverage, and the recent revelation that their joint ventures are subject to margin calls and recourse to the company is stunning. Only a fool would buy their stock when you are going to be able to buy lots from them and other builders at a pittance.

Another name I am paying attention to is MBI. They are an insurance company that guarantees the performance of "municipal bonds, asset-backed and mortgage-backed securities, investor-owned utility bonds, bonds backed by publicly or privately funded public-purpose projects," etc. Mish has given some great MBI coverage on his blog. See also MBI on Seeking Alpha.

The degree of leverage in bond insurers like MBI is astonishing. From their capital base of approximately $7B, they guarantee the performance of over $600 billion in debt.

The great thing about MBI in terms of blow-up potential is that because of the high leverage, you don't need to be very specific about the possible cause. Will it be a few municipal defaults? That would be enough, and every housing collapse has caused some. Or will it be from the mortgage securities?

Take a look at Newcastle (NCT), a REIT of high-yield, asset-backed bonds. It's run by Fortress Investment Group, which gives me pause. You would think they would know what they are doing, but maybe FIG is using this as a vehicle to dump sludge-quality paper on retail investors.

That seems to be what was happening with Everquest Financial, the fund that Bear Stearns was going to IPO. They were essentially forced to cancel it once people recognized the moral hazard problem.

The stock has a 10.4% dividend, which has attracted quite a few yield-hungry investors and funds. It trades at 1.5x book, and it’s levered almost 10:1. Market cap is $1.45B.

My issue is with the credit quality: the securities have a weighted average rating of BBB+.; 41% is rated BELOW BBB- or is unrated, etc.

Worrisome parts of the portfolio:

• $77M in manufactured housing backed loans.
• $629M in home equity loans rated BBB+.
• $978M in unsecured REIT debt rated BBB-.
• $300M in BB rated commercial loans.
• $1B in subprime loans.

My final thought today is regarding the perception of a "subprime" menace.

It's wishful thinking to believe that the only problems are with low-FICO, "subprime" borrowers. Eventually, the market will realize that these problems extend to alt-a borrowers and beyond.