Friday, March 27, 2009

Other People's Words And My Reaction: Part 1 of Many

Failure’s hard but success is far more dangerous. If you’re successful at the wrong thing, the mix of praise and money and opportunity can lock you in forever. – Po Bronson

Success and failure are judgments of results. I don't think it is possible to encourage or discourage either. Process can be encouraged or discouraged. Different people have different interpretations of results though, and there are varying degrees of measurement costs associated with those interpretations.

I viewed this quote in the context of my recent thoughts about external versus internal feedback. So if someone pays me $1 million to do a job that's a piece of feedback that says I'm a success. Or if someone I care about is proud of me
because I have "a good job" that is clear feedback. But those are arbitrary measurements of success and I might be miserable inside.

Things like salary, job title, employed vs. unemployed, married vs. single, academic degrees, awards won, etc. are all very easy to measure. That does not mean they are valuable or accurate measurements, however.

An individual can get caught up in these easy measurements and ignore more important ones, and the problem comes when easy measures of success are followed and the more meaningful ones get ignored.

It is also difficult to place more weight on one's own judgement than other people's, even though one's own judgement is almost certainly more meaningful. This is because a person is fully aware of his own doubts but others appear certain when they give opinions. For example, if I ask you if I should take a CEO position at AIG or the store manager job at a local coffee shop, you'll give me some answer and sound sure of the answer, but in reality you probably put almost no thought into it and in any case its a judgement based on your values and your perception of what is best for me. I'll feel uncertain of the right decision but to you it was a no-brainer so I take the AIG job and before you know it I'm getting yelled at by idiot Congressmen.

Thoughts on Warren Buffet's Op-Ed

Buffett is an interesting character. There is a lot to learn from him; beyond that it would be folly to emulate him. I lost a lot of respect for him in late 2008 for two reasons: First, I think that op-ed was irresponsible. No one else on earth lives in his world. His advice is perfect for him, probably, but he can afford to lose a few billion. In fact, this man's marginal utility of money is zero.

For a typical American his advice was horrible, even without today's hindsight. (I submitted a piece to the P-I in response; they, of course, declined to publish it). Though he didn't explicitly tell people to buy U.S. stocks, the fact that he is publishing his own actions in the Times makes it a recommendation. There are people, like my Dad, who see him as an icon, and assume he must be right. Most of that audience is unaware of the work that goes into separating value from refuse. They still believe that the stock market only goes up. His piece reinforces the (unfortunately) widely held belief that the market must go back up to its recent highs.

Furthermore, if one wants to evaluate Buffett as a model, one must understand his position. I don't. Why does this guy invest? He doesn't consume anywhere close to his earnings. He doesn't give it to family and friends. He doesn't control his charitable projects. If wealth is accumulated saving and saving is future consumption, this man should have no incentive to increase wealth. That is not the case for those who read the article.

Buffett's most famous quotation is repeated here: Be fearful when others are greedy, and be greedy when others are fearful. This is bad advice, and I don't believe he follows it. Fear and greed are pathogens. They do not balance each other; each reinforces the ills of the other. The key is to keep one's head when fear and greed surround, see value where other's don't - if it is there.

It is certainly true that there is value to be found in the U.S. stock market. Finding it is another matter. If one buys an index as a proxy, he will buy into many failing enterprises. Last March I predict that 20% of the DJIA would be gone by the end of 2010. I don't mean a 20% decline in valuation; I mean 6 of the 30 companies will cease to exist. AIG is now dead, we are just waiting for the funeral. GM, Citigroup, and Bank of America have no chance for survival. Their names might live on, but neither their business model nor their equity will.

There will be great opportunity to pick through battered stocks; I don't believe that opportunity has come. The battering will continue. Right now, buyers are only guessing. Some of those guesses will be large winners, others will lose everything.

In 20 years we will read an article in Fortune explaining that if you bought XYZ Enterprises in 2011 you'd have made a return of 100,000 percent. But for every XYZ there are 249 Pets.coms out there and most people have no clue how to tell one from the others.

For people like you and I to find it worthwhile to devote scarce resources to investing we have to beat the averages. That means taking chances. I believe that, more often than not, taking a chance should mean holding back on buying something of value because it might be cheaper later. If we believe in our own abilities, then future opportunities will offset missed opportunity.

More egregious though, in my opinion, was Buffett's rent-seeking behavior. He bought his stake in Goldman Sachs not because he saw a good business but because he saw an opportunity to take advantage of government action. He made that
clear to his investors. Then he lobbied the government on his own behalf. I think he may have been an Obama campaign advisor.

Like my dad, the American people and their elected officials do not understand Buffett's position. They see his success as an indvidual investor as cause to grant him authority on how to manage the macroeconomy. So his "suggestions" hold weight and they influence policy.

There was one great paragraph in his op-ed, but most people would not even read that far let alone remember it. Here it is:

"Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash

The 1999 article, by contrast, is fantastic, with some great insights that few understand. I've gone on long enough though so I won't comment on that.

Why Is The Response So Bad?

I think it is possible that some people just are so conditioned to think a
certain way. They may not actually be trying to screw people for their own

Bernanke, for example, is stuck inside the world of his economic models. He may
just be unable to think about more complex, or simply different problems.

It could be true of Paulson as well, though I place a relatively high
probability on Paulson being pure evil. He has been an investment banker for so
long, he may be unable to see the bigger picture.

It really comes down to a lack of creativity. They see the system as it was and
they believe that the essential components of that system need to be preserved.
But a better system may have different essential components.

Our nation's collective consciousness is concentrating all of its energy on the
non-existent past and the imagined future (which are both completely
irrelevant), and ignoring the reality of the current situation, which is nowhere
near as bad as advertised.

This is why the banking system needs a right-brained economist like me.

As Homer Simpson said when his ARM reset, "When you gave me that money you said
I wouldn’t have to repay it ‘til the future. This isn’t the future; it’s the
lousy stinking now."

Recessions Aint So Complicated

The best, simple explanation for the current recession is that interest rates have been, and are, excessively low. The best single policy to get out of it isto RAISE them.

This comes as a response to an interesting statement made by David Rosenberg of Merrill Lynch, brought to my attention by a friend:

"We do not aim to be critical, and we do not claim to be public policy experts by any stretch, but the reality is that the economy is in dire need of a major positive exogenous shock. Whether that means the Fed starting to buy Treasuries to pull down market rates even lower, the public sector establishing land banks to establish a floor under residential real estate prices, or the White House instructing Congress to dole out a $1 trillion zero percent long-term loan to the beleaguered state and local governments who are being forced to cut back services and raise taxes at the worst possible time, or all of the above, we will leave open for debate. What is not open for debate is the state of the economy, and we can no longer just label this a recession after the latest
string of shockingly negative employment reports. The government has to declare war right now ... against this modern-day depression."