Whitney Tilson & Glenn Tongue "More Mortgage Mess-6 Ways to Profit in these bad times" (John Wiley & Sons, 2009)
"Why sometimes I've believed as many as 6 impossible things before breakfast." -Alice in Wonderland
This past decade has seen a massive, national collective hallucination take place in real estate and related industries that has infected the world financial systems and which will have lasting, if not permanent effects that are now unwinding slowly and with great pain.
Tilson & Tongue dissect this situation with insight, depth, mathematical skill and many original ideas in their new book. They are not timid and dole out giant scoops of blame to myriad guilty parties: the government (who repealed or loosened many laws and regulations), banks, the Fed (who kept interest rates artificially low, allowing real estate prices to bubble ever upward), the GSEs (Fannie Mae & Freddie Mac, who were allowed to speculate wildly), the ratings agencies (Moody's, S & P,), real estate agents & appraisers, and finally greedy homeowners.
Charles Mackay, in his classic 1840's Extraordinary Popular Delusions & The Madness of Crowds, a study of various scams, bubbles and manias including the South Sea bubble, the Dutch tulip mania, and the crusades, makes the point that the most dangerous phrase is always "it's different this time." Yet hope springs eternal and many folks spend their whole lives searching for the greater fool, very easily found in the USA of late.
Of the two T's, Tilson has been the more public figure, starting his first hedge fund in 1999, writing for various web sites, Kiplinger's, Forbes, and Marketwatch. Tongue has been co-manager of T-2 since 2004, having previously run DLJDirect, an online brokerage.
Split into two sections, "What Happened and Why" on mortgages and the wide variety of still worsening effects and "Profiting from the Meltdown,"which talks about stocks, bonds, and provides in-depth analysis of some major holdings at T-2 Partners, including Warren Buffett's Berkshire Hathaway, Wells Fargo, American Express, and a few smaller, lesser known stocks.
Inspiration and a lot of the information in their book comes from Amherst Securities' Sean Dobson, who taught the T-2 principles from his massive proprietary mortgage and related securities data bases.
"The US housing market had experienced a bubble of enormous proportions, and countless mortgages were defaulting at unprecedented, catastrophic rates," T-2 explains.
Pretty much any boom time in the USA (or the world, for that matter) is at least partly driven by some sort of scam, especially when uninformed people arrive late to a party already drunk.
Alan Greenspan's Fed, instead of "removing the punch bowl," as former Fed Chairman William Mc Chesney Martin described the chairman's job as being, dumped bottle after bottle of Ever clear into the bowl, resulting in a drunk, clueless populace who kept muttering their ever hopeful mantra, "real estate always goes up, if even a little..."
Then, if that wasn't bad enough, Wall Street, got involved: packaging mortgages, many written to sub-prime and no documentation clients that would never have qualified for loans in eras with more conservative lending standards, often driven by congressional and Presidential quotas to "get more people into houses," usually with no regard for the viability of the loans.
These were sold to individuals, mutual funds, institutions, and sovereign wealth funds around the world, rubber-stamped by ratings agencies as AAA, super-safe ratings that bore no relationship to actual risk assessment and cost them their previously sterling reputations.
Regarding options ARM loans, T-2 writes, "If one were to design a loan that would blow up the maximum number of homeowners the moment home prices stopped rising, an option ARM would be it." In their perverse, self-defeating styles, the states of California and Florid had by far the most ARM loans written.
"Florida has always been susceptible to the Wild West mentality. If it's too good to be true, we're going to be involved in it." -Florida state treasurer Alex Sink in George Packer's "The Ponzi State," The New Yorker 2/9/2009
This book is so dense with information, synopsizing is daunting but are two major points:
* After a decade of using their wildly overvalued houses as ATMs, extracting about $3 trillion (about 25% of the aggregate value of residential US housing), Americans, by 2007, had more debt (10.6 trillion) than equity (8.5 trillion) in their houses for the first time ever
* The collapse of lending standards, loaning more and more money to people with ever lower down payments wildly increased the risk of home owners who are underwater on their homes, losing their jobs and or unable to sell their homes, just walking away from their debts.
* As you may recall from the tech/internet/NASDAQ debacle, when bubbles burst, prices often crash well below the trend line and far well below fair value, which indicates real estate prices still have a long ways to fall, even without factoring in the eventual rise of interest rates, further foreclosures, rising unemployment and other negative factors that will contribute to their fall.
Which banks fail may well be a factor of clumping, luck, and randomness more than skill, in that the banks that survive are in a race to outrun their foreclosure and loan losses.
Tilson & Tongue dissect their holdings in Wells Fargo in depth and point out that we are "in the fifth inning" with there are many shoes left to drop (to mix metaphors) including commercial real estate defaults, as commercial is 40% of WFC's loan book. Wells' acquired sub-prime exposure via the acquisition of Wachovia, more lay offs in areas like Michigan, California, and Florida are also big factors. Wells Fargo sounds like both a great bargain, trading at 3 or 4 times normalized earnings and the next Citibank or Bank of America, a prime bankrputcy candidate.
T-2's math is very pro and can be a bit overwhelming in this book for the non-CPA but it is clearly stated and does become clearer on a second or third more careful reading. The reader is walked, hand in hand through the often intentionally muddy fields of accounting and corporate balance sheets. As Tilson & Tongue write, non in the least hyperbolically, "Wells Fargo is currently in a race for its life, trying to earn its way out. If big (loan) losses materialize quickly but profits are weaker than we expect, WFC will be in big trouble."
REITS (real estate investment trusts) are in even worse shape than banks, yet this isn't mentioned much in T-2's book but it brings up the question regarding both banks and REITS: can vital, much needed industrys fail in aggregate? US airlines and auto makers suggest it's quite plausible and what that means for the country is pretty much open for endless discussion but I doubt it can be good.
They also offer an in-depth look at Berkshire Hathaway, which they describe as "an unusual company and possibly the most talked-about yet least understood business in the world." Tilson has long understood Buffett's giant free cash generation machine and its proprietary advantages, penning his classic "The Last Bull on Berkshire" a decade ago when he & Alice Schroeder, then an analyst, were the only people in the mainstream press to get Berkshire. He and Tongue still do, and as they advise the reader, betting against Warren Buffett & Charlie Munger has never been a good idea.
They also advise buying beaten-down, super solid blue chips such as Wal-Mart, Exxon, Mc Donalds and Altria. There's a good section on shorting (T-2 say "most people should avoid it, to which I add an "amen.)
In conclusion, they offer a fine selection of worthwhile web sites and an exhaustive reading list well worth persuing.