Happy Thanksgiving
November 27, 2008, 11:25
Filed under: Uncategorized

Happy Thanksgiving to the 20 or so people that check my blog out every day:)



Coup d’état
November 27, 2008, 11:25
Filed under: Politics | Tags: , ,

I’m praying for a Coup d’état in Nicaragua. 

The country was doing “alright” in the 1970s.   The country was ruled by a corrupt dictator, but he was at least consistent and this allowed the nation to develop.  The country had one sky scraper.  Then came the Sandinistas.  This group opposed the status quo. Many people, from the elite down to the maids, supported change and the Sandinistas were able to come to power under the leadership of Daniel Ortega.

The US was still uneasy with the USSR and threw a whole lot of money towards taking Ortega down.  Embargo, the Iran Contra Affair, etc.  The country erased decades of progress and slid into poverty, civil war, and unrest. 

Enough, said the people, we want change.  Ortega never thought he’d lose, so he allowed an open election and had the surprise of his life when Violeta Chamorro took the presidency.  A democratic change of government after a decade of war is impressive—there was hope for the country.

Chamorro tried to bring the country together, which means that the Sandinistas were allowed to co-exist under the new status quo.  Another election happened and Arnoldo Aleman came to power.  His corruption left Nicaragua stuck in the mud.  The following president, Enrique Bolanos, fought against the corruption and managed to put Aleman in jail.  Again, there was hope that Nicaragua would leave the corruption behind and start prosper despite two decades of lost growth.

Unfortunately, that didn’t happen. Greed. Hubris. Distrust.  There was a major split in the non-sandinista party.  Daniel Ortega harnessed the people’s discontent with the corruption of the prevoius elections and won the race for president.

Everything has gone down hill since then.  He is in the palm of Chavez and just stole the mayoral electionf of Managua.  The international community is withdrawing its foreign investments. Once again, the country has stagnated.

Damn it. It makes me so mad.  The withdrawal of foreign investment will impact every corner of the nation, and hopefully motivate a coup against Ortega.  Who knows who will replace him, but at this point anything will be a better alternative.

Why do I care:  I’ve spent several summers in Nicaragua and it is an amazing country, with amazing people and unparalleled natural beauty.  I see value in that country, I see potential….and it’s gut wrenching to see the nation’s leaders throw the country’s potential into the trash.

Black Clouds
November 26, 2008, 11:25
Filed under: MBA | Tags:

Seem to follow me…  I’m down.  I still have no clue what I want to do this summer or after I graduate from my MBA.  My resume just got a shiteous review. Everyone else is meeting with potential employers over Thanksgiving break, except me.  I am at least 2 weeks behind in every class.  And, I’m in a volatile relationship that has me feeling manic depressive (i.e. either really good or really bad, nets out even). I’m at home for the break but I feel like I’m always in a bad mood.



I recognize I’m being over-dramatic but I feel like venting so DEAL WITH IT.

History Repeats Itself

1989 was like 2007—markets were going up and up, people were buying stocks like crazy and it was easy to think that something fundemental about the world had changed.  The growth was here for good.  My hero, Warren Buffet, thought otherwise.  Please read his 1989 letter to Berkshire Hathaway’s equity holders and look out for the parts in bold (particularly relevant).
To the Shareholders of Berkshire Hathaway Inc.:

     Our gain in net worth during 1989 was $1.515 billion, or
44.4%. Over the last 25 years (that is, since present management
took over) our per-share book value has grown from $19.46 to
$4,296.01, or at a rate of 23.8% compounded annually.

     What counts, however, is intrinsic value – the figure
indicating what all of our constituent businesses are rationally
worth. With perfect foresight, this number can be calculated by
taking all future cash flows of a business – in and out – and
discounting them at prevailing interest rates. So valued, all
businesses, from manufacturers of buggy whips to operators of
cellular phones, become economic equals.

     Back when Berkshire’s book value was $19.46, intrinsic
value was somewhat less because the book value was entirely tied
up in a textile business not worth the figure at which it was
carried. Now most of our businesses are worth far more than their
carrying values. This agreeable evolution from a discount to a
premium means that Berkshire’s intrinsic business value has
compounded at a rate that somewhat exceeds our 23.8% annual
growth in book value.

     The rear-view mirror is one thing; the windshield is
another. A large portion of our book value is represented by
equity securities that, with minor exceptions, are carried on our
balance sheet at current market values. At yearend these
securities were valued at higher prices, relative to their own
intrinsic business values, than has been the case in the past.
One reason is the buoyant 1989 stock market. More important, the
virtues of these businesses have been widely recognized. Whereas
once their stock prices were inappropriately low, they are not

     We will keep most of our major holdings, regardless of how
they are priced relative to intrinsic business value. This ’til-
death-do-us-part attitude, combined with the full prices these
holdings command, means that they cannot be expected to push up
Berkshire’s value in the future as sharply as in the past. In
other words, our performance to date has benefited from a double-
dip: (1) the exceptional gains in intrinsic value that our
portfolio companies have achieved; (2) the additional bonus we
realized as the market appropriately “corrected” the prices of
these companies, raising their valuations in relation to those of
the average business. We will continue to benefit from good gains
in business value that we feel confident our portfolio companies
will make. But our “catch-up” rewards have been realized, which
means we’ll have to settle for a single-dip in the future.

     We face another obstacle: In a finite world, high growth
rates must self-destruct. If the base from which the growth is
taking place is tiny, this law may not operate for a time. But
when the base balloons, the party ends: A high growth rate
eventually forges its own anchor.

     Carl Sagan has entertainingly described this phenomenon,
musing about the destiny of bacteria that reproduce by dividing
into two every 15 minutes. Says Sagan: “That means four doublings
an hour, and 96 doublings a day. Although a bacterium weighs only
about a trillionth of a gram, its descendants, after a day of
wild asexual abandon, will collectively weigh as much as a
mountain…in two days, more than the sun – and before very long,
everything in the universe will be made of bacteria.” Not to
worry, says Sagan:  Some obstacle always impedes this kind of
exponential growth. “The bugs run out of food, or they poison
each other, or they are shy about reproducing in public.” 

     Even on bad days, Charlie Munger (Berkshire’s Vice Chairman
and my partner) and I do not think of Berkshire as a bacterium.
Nor, to our unending sorrow, have we found a way to double its
net worth every 15 minutes. Furthermore, we are not the least bit
shy about reproducing – financially – in public. Nevertheless,
Sagan’s observations apply. From Berkshire’s present base of $4.9
billion in net worth, we will find it much more difficult to
average 15% annual growth in book value than we did to average
23.8% from the $22 million we began with.

     But as happens in Wall Street all too often, what the wise
do in the beginning, fools do in the end. In the last few years
zero-coupon bonds (and their functional equivalent, pay-in-kind
bonds, which distribute additional PIK bonds semi-annually as
interest instead of paying cash) have been issued in enormous
quantities by ever-junkier credits. To these issuers, zero (or
PIK) bonds offer one overwhelming advantage:  It is impossible to
default on a promise to pay nothing. Indeed, if LDC governments
had issued no debt in the 1970’s other than long-term zero-coupon
obligations, they would now have a spotless record as debtors.

     This principle at work – that you need not default for a
long time if you solemnly promise to pay nothing for a long time
– has not been lost on promoters and investment bankers seeking
to finance ever-shakier deals. But its acceptance by lenders took
a while: When the leveraged buy-out craze began some years back,
purchasers could borrow only on a reasonably sound basis, in
which conservatively-estimated free cash flow – that is,
operating earnings plus depreciation and amortization less
normalized capital expenditures – was adequate to cover both
interest and modest reductions in debt.

     Later, as the adrenalin of deal-makers surged, businesses
began to be purchased at prices so high that all free cash flow
necessarily had to be allocated to the payment of interest. That
left nothing for the paydown of debt. In effect, a Scarlett
O’Hara “I’ll think about it tomorrow” position in respect to
principal payments was taken by borrowers and accepted by a new
breed of lender, the buyer of original-issue junk bonds. Debt now
became something to be refinanced rather than repaid. The change
brings to mind a New Yorker cartoon in which the grateful
borrower rises to shake the hand of the bank’s lending officer
and gushes: “I don’t know how I’ll ever repay you.”

     Soon borrowers found even the new, lax standards intolerably
binding. To induce lenders to finance even sillier transactions,
they introduced an abomination, EBDIT – Earnings Before
Depreciation, Interest and Taxes – as the test of a company’s
ability to pay interest. Using this sawed-off yardstick, the
borrower ignored depreciation as an expense on the theory that it
did not require a current cash outlay.

     Such an attitude is clearly delusional. At 95% of American
businesses, capital expenditures that over time roughly
approximate depreciation are a necessity and are every bit as
real an expense as labor or utility costs. Even a high school
dropout knows that to finance a car he must have income that
covers not only interest and operating expenses, but also
realistically-calculated depreciation. He would be laughed out of
the bank if he started talking about EBDIT.

     Capital outlays at a business can be skipped, of course, in
any given month, just as a human can skip a day or even a week of
eating. But if the skipping becomes routine and is not made up,
the body weakens and eventually dies. Furthermore, a start-and-
stop feeding policy will over time produce a less healthy
organism, human or corporate, than that produced by a steady
diet. As businessmen, Charlie and I relish having competitors who
are unable to fund capital expenditures.

     You might think that waving away a major expense such as
depreciation in an attempt to make a terrible deal look like a
good one hits the limits of Wall Street’s ingenuity. If so, you
haven’t been paying attention during the past few years.
Promoters needed to find a way to justify even pricier
acquisitions. Otherwise, they risked – heaven forbid! – losing
deals to other promoters with more “imagination.”

     So, stepping through the Looking Glass, promoters and their
investment bankers proclaimed that EBDIT should now be measured
against cash interest only, which meant that interest accruing on
zero-coupon or PIK bonds could be ignored when the financial
feasibility of a transaction was being assessed. This approach
not only relegated depreciation expense to the let’s-ignore-it
corner, but gave similar treatment to what was usually a
significant portion of interest expense. To their shame, many
professional investment managers went along with this nonsense,
though they usually were careful to do so only with clients’
money, not their own. (Calling these managers “professionals” is
actually too kind; they should be designated “promotees.”)

     Under this new standard, a business earning, say, $100
million pre-tax and having debt on which $90 million of interest
must be paid currently, might use a zero-coupon or PIK issue to
incur another $60 million of annual interest that would accrue
and compound but not come due for some years. The rate on these
issues would typically be very high, which means that the
situation in year 2 might be $90 million cash interest plus $69
million accrued interest, and so on as the compounding proceeds.
Such high-rate reborrowing schemes, which a few years ago were
appropriately confined to the waterfront,  soon became models of
modern finance at virtually all major investment banking houses.

     When they make these offerings, investment bankers display
their humorous side: They dispense income and balance sheet
projections extending five or more years into the future for
companies they barely had heard of a few months earlier. If you
are shown such schedules, I suggest that you join in the fun: 
Ask the investment banker for the one-year budgets that his own
firm prepared as the last few years began and then compare these
with what actually happened.

     Some time ago Ken Galbraith, in his witty and insightful
The Great Crash, coined a new economic term: “the bezzle,”
defined as the current amount of undiscovered embezzlement. This
financial creature has a magical quality: The embezzlers are richer
by the amount of the bezzle, while the embezzlees do not yet feel

     Professor Galbraith astutely pointed out that this sum
should be added to the National Wealth so that we might know the
Psychic National Wealth. Logically, a society that wanted to feel
enormously prosperous would both encourage its citizens to
embezzle and try not to detect the crime. By this means, “wealth”
would balloon though not an erg of productive work had been done.

     The satirical nonsense of the bezzle is dwarfed by the real-
world nonsense of the zero-coupon bond. With zeros, one party to
a contract can experience “income” without his opposite
experiencing the pain of expenditure. In our illustration, a
company capable of earning only $100 million dollars annually –
and therefore capable of paying only that much in interest –
magically creates “earnings” for bondholders of $150 million. As
long as major investors willingly don their Peter Pan wings and
repeatedly say “I believe,” there is no limit to how much
“income” can be created by the zero-coupon bond.

     Wall Street welcomed this invention with the enthusiasm
less-enlightened folk might reserve for the wheel or the plow.
Here, finally, was an instrument that would let the Street make
deals at prices no longer limited by actual earning power. The
result, obviously, would be more transactions: Silly prices will
always attract sellers. And, as Jesse Unruh might have put it,
transactions are the mother’s milk of finance.

     The zero-coupon or PIK bond possesses one additional
attraction for the promoter and investment banker, which is that
the time elapsing between folly and failure can be stretched out.
This is no small benefit. If the period before all costs must be
faced is long, promoters can create a string of foolish deals –
and take in lots of fees – before any chickens come home to roost
from their earlier ventures.

     But in the end, alchemy, whether it is metallurgical or
financial, fails. A base business can not be transformed into a
golden business by tricks of accounting or capital structure. The
man claiming to be a financial alchemist may become rich. But
gullible investors rather than business achievements will usually
be the source of his wealth.

     Whatever their weaknesses, we should add, many zero-coupon
and PIK bonds will not default. We have in fact owned some and
may buy more if their market becomes sufficiently distressed.
(We’ve not, however, even considered buying a new issue from a
weak credit.) No financial instrument is evil per se; it’s just
that some variations have far more potential for mischief than

     The blue ribbon for mischief-making should go to the zero-
coupon issuer unable to make its interest payments on a current
basis. Our advice: Whenever an investment banker starts talking
about EBDIT – or whenever someone creates a capital structure
that does not allow all interest, both payable and accrued, to be
comfortably met out of current cash flow net of ample capital
– zip up your wallet. Turn the tables by suggesting
that the promoter and his high-priced entourage accept zero-
coupon fees, deferring their take until the zero-coupon bonds
have been paid in full. See then how much enthusiasm for the deal

     Our comments about investment bankers may seem harsh. But
Charlie and I – in our hopelessly old-fashioned way – believe
that they should perform a gatekeeping role, guarding investors
against the promoter’s propensity to indulge in excess.
Promoters, after all, have throughout time exercised the same
judgment and restraint in accepting money that alcoholics have
exercised in accepting liquor. At a minimum, therefore, the
banker’s conduct should rise to that of a responsible bartender
who, when necessary, refuses the profit from the next drink to
avoid sending a drunk out on the highway. In recent years,
unfortunately, many leading investment firms have found bartender
morality to be an intolerably restrictive standard. Lately, those
who have traveled the high road in Wall Street have not
encountered heavy traffic.

     One distressing footnote: The cost of the zero-coupon folly
will not be borne solely by the direct participants. Certain
savings and loan associations were heavy buyers of such bonds,
using cash that came from FSLIC-insured deposits. Straining to
show splendid earnings, these buyers recorded – but did not
receive – ultra-high interest income on these issues. Many of
these  associations are now in  major trouble. Had their loans to
shaky credits worked, the owners of the associations would have
pocketed the profits. In the many cases in which the loans will
fail, the taxpayer will pick up the bill. To paraphrase Jackie
Mason, at these associations it was the managers who should have
been wearing the ski masks.


My most surprising discovery: the overwhelming importance in
business of an unseen force that we might call “the institutional
imperative.” In business school, I was given no hint of the
imperative’s existence and I did not intuitively understand it
when I entered the business world. I thought then that decent,
intelligent, and experienced managers would automatically make
rational business decisions. But I learned over time that isn’t
so. Instead, rationality frequently wilts when the institutional
imperative comes into play.

     For example: (1) As if governed by Newton’s First Law of
Motion, an institution will resist any change in its current
direction; (2) Just as work expands to fill available time,
corporate projects or acquisitions will materialize to soak up
available funds; (3) Any business craving of the leader, however
foolish, will be quickly supported by detailed rate-of-return and
strategic studies prepared by his troops; and (4) The behavior of
peer companies, whether they are expanding, acquiring, setting
executive compensation or whatever, will be mindlessly imitated.

     Institutional dynamics, not venality or stupidity, set
businesses on these courses, which are too often misguided. After
making some expensive mistakes because I ignored the power of the
imperative, I have tried to organize and manage Berkshire in ways
that minimize its influence. Furthermore, Charlie and I have
attempted to concentrate our investments in companies that appear
alert to the problem.

What’s Next

Credit card bail out—I’m looking at Citi’s 3Q financials and their credit card divisions have experienced year-over-year losses of over 50% in every region.  The North American credit card division experienced a 68% rise in credit losses.  Most of the losses happened in the Q3, which means that this party just got started. HOLY MOLY.

That is a tremendous increase in losses. The good news—this represents “only” $4.2 billion in losses which is manageable when you compare that figure to Citi’s mortgage losses (ahem: $55 billion in the first three quarters of 2008 with another $28.5 billion in nonperforming loans whose losses have not been recorded yet.)

The rate of losses is scary, but I guess the severity of the losses is mitigated by the fact that people carry much less debt on their credit cards than they do on their mortgages.  This is the difference between defaulting on a $15,000 credit card balance and a $450,000 mortgage.

Perspective matters….but bad news is bad news, and I wish the bad news was over with.

Why TARP (the bailout) Makes Sense

The DOW lost approximately 50% of it’s value this year. The index represents the overall value of US companies, but we must all agree that it is preposterous to think that companies have physically lost 50% of their value in just a few months. 

Are they selling 50% less goods? NO!!  Are they selling stuff at 50% discounts?  NO!!! Did half of these companies buildings burn down? NO!!!! Did all of these companies own subprime mortgages that fell in value? NO (only financial institutions)!!!!!!!

The market HAS NOT lost 50% of it’s value. Period.  Prices are down because people are making fear-driven investment decisions.  Retirees, hedge funds, and all other types of investments have sold their investments because they’re scared the markets will fall even more.  Selling drives prices down, freaks more people out, drives more selling which lowers prices…’s a cycle but what you have to remember is that companies HAVE NOT lost that much tangible value.

The same applies to the failing mortgage portfolios held by banks.  Yes, more people started defaulting on their mortgage loans and this increases the banks’ credit losses.  Yes, the houses collateralizing the securities have also dropped in value which means the securities themselves lost value.  However, not EVERY homeowner is in default and just because a house costs less than it did yesterday DOES NOT mean that it is worth $0.

This fact is why the TARP (bailout) is brilliant.  The mortgage assets that the US government is purchasing with the TARP fund (i.e. Another $20 billion went to Citi today) are undervalued.  The “Freak-Out Market” effect has driven prices down below their real values. The problem is that no one knows where to peg the real values.  The only way to find out the price is… wait.  The only institution on earth with the strength and patience to wait…is the US government.

Once things calm down and the true price of these assets is revealed, the US will be able to offload the assets and sell them to people willing to pay a fair price in return for the now measurable risk embedded in the assets. 


Information is power, but it takes time to get the information.  TARP is the best vehicle to get us the time and information we so desperately need.

How To Survive a Recession—For Small Businesses

(Skip to bottom of page to see steps a small business owner can take to survive this recession)

It’s not only the banks that are facing tough times recently. Businesses of all sizes find it increasingly difficult to access credit or sell as much quantity as they used to. They are being squeezed on three fronts:  Costs, Prices, Quantities sold.  There’s a nifty equation in finance that helps explain why businesses of all sizes are having  a hard time staying afloat:  Profitability = (Price-Cost) x Quantity Sold

Business owners have seen their margins shrink.  Some companies have had to lower their prices.  Others face higher costs given their difficulties accessing credit; meaning, companies need more cash on hands so cash tied up paying regular expenses (i.e. rent, Internet, etc) “costs” them more since that cash must also cover operating costs that credit used to cover. To make things worse, consumer spending has decreased so the overall quantity of goods sold has fallen dramatically these last few months. 

Lower margins x less quantity sold = a lot less profitability.

What to do?  Here are some suggestions:

  1. Lower fixed expenses, NOW.  Companies need to start conserving their cash in order to make sure that they have enough liquidity to cover the costs of their transactions. In order to save cash you have to lower your fixed expenses.
    • Re-negotiate the lease on your office space.  Look around, see if you can find cheaper office space somewhere and when you find an alternative tell your landlord that you are willing to walk out unless he/she lowers the rent.  This is a great site for finding cheap rental space near you.
    • Or better, move your office into your home.  It’s uncomfortable.  Working from home dissolves the barrier between life and work. However, you will save a significant amount of cash if you do this. 
    • Try using SKYPE (free) instead of paying long distance on you land line, especially for international calls. 
    • Put a temporary pause on all unnecessary employee benefits.  All hands on decks my friends.
    • If you absolutely have to, layoff unnecessary staff or reduce the number of hours they must work.  This is a last resort.
  2. Decrease variable costs.  I’m obsessed with access to credit, which is what most companies use to finance operations (i.e. purchase of raw supplies) while they wait for customers to pay their bills in full.  Here are some suggestions:
    • It’s going to be harder and harder to get lines of credit from the Citi’s, WaMu’s, etc of the world.  These banks were overexposed to mortgage securities and now they do not have the cash they used to throw into lines of credit, credit cards, etc. 
    • However, these banks have significantly less exposure to mortgages so their cash cofers are relatively safe:  Local banks, Regional banks, New banks.   Reach out to these institutions and see if you can’t secure some sort of credit line to hold you over in case things get worse (i.e. Another bank falls through, your corporate credit gets cancelled, etc). 
    • This is how you can find your local bank.  You can also try searching for banks on the FDIC site—it’s excellent. I recommend it. Search for banks that were founded 2007 or later because they are less likely to have subprime exposure.  Also, filter banks that specialize in commercial banking.
    • Encourage your customers to pay cash up front, reducing your need for credit or credit interest.
  3. If you can’t raise prices, then do everything you can to raise sales volumes by implementing bulk-sales discounts.  As long as their is even a penny of margin in there, it’s worth selling more quantity.

These suggestions are not great, but they’re the low-hung fruit that most companies can grab to save cash.  I am open to suggestions and will include them in this post should you leave them in my comment box.