Sunday, May 23, 2010

Marty Whitman, Letter from the Chairman q210

It is difficult to function as a value investor unless the value analyst has a firm grasp of economic reality. It is equally difficult to promulgate intelligent financial regulations unless the sponsors of the regulation have a firm grasp of economic reality. Neither the general public, nor legislators and Obama administration officials, seem to have much of a grasp of economic reality, at least when it comes to dealing with troubled financial institutions.

I recently finished reading the book, Freefall by Joseph E. Stiglitz, an eminent economist. It certainly seems obvious from reading Stiglitz’s prose that economists, whether left wing or right wing, have little conception in certain important areas of what is really involved in rehabilitating troubled companies, or what are the uses and limitations of financial accounting.

In this letter, I discuss eight areas of financial misunderstanding:
  1. Rehabilitation of troubled entities can be accomplished via three approaches, either alone or in concert: recapitalizations; monetization or liquification of certain assets, (i.e., liquidations); and capital infusions.
  2. “Too Big to Fail” is a phony concept.
  3. In the aggregate, debt is never repaid. It is refinanced and expanded by those borrowing entities which remain credit-worthy.
  4. The private sector and government are in partnership whether they like it or not. The private sector is part of the problem and part of the solution. Government is part of the problem and part of the solution.
  5. Wall Street professionals and corporate executives are all in the business of creating moral hazards. Eliminate moral hazards and you eliminate entrepreneurship, creativity, and much of superior management performance.
  6. Taxpayer bailouts are a phony concept, stretching beyond creditability the concept of substantive consolidation. If the government provided financing at a loss to private sector entities, then it is the government providing bail-out funds, not taxpayers, which can be deemed to be the equivalent of common stockholders of the U.S. government.
  7. A revolution in corporate reorganizations and liquidations may have occurred in 2009 when General Motors, Chrysler, and CIT reorganized speedily and relatively cheaply through controlled Chapter 11 reorganizations. No longer do large, important companies necessarily have to be reorganized in uncontrolled Chapter 11s where administrative expenses can run into the hundreds of millions to billions of dollars. Also, most uncertainties about what a reorganization might entail can be resolved before a filing takes place rather than at some indeterminate time in the future.
  8. Strict regulation is essential if most financial institutions are to function well.
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