Street Capitalist: Event Driven Value Investments

Click the image to see full-size:

I just added text to the graphic already provided by the awesome people at ProPublica. It’s really quite amazing to see not only the size of how these have grown from the past almost-40 years but also the recency of most of these bailouts.

source: ProPublica

What a difference just under a year makes. If you remember, back in December of 2007 Andrew Bary at Barron’s felt that Berkshire Hathaway (NYSE:BRK.A) was overvalued as it traded around $144,000 per share. Bary cited that Berkshire would face difficulties in finding appropriate investment situations for its cash horde and that there were other undervalued securities in the market:

As noted, Berkshire looks pricey relative to many financial companies. Take AIG, the world’s largest property and casualty insurer. Depressed by its exposure to subprime mortgages, AIG has seen its shares fall 21% this year, to 57. It’s now valued at eight times projected 2008 profits. AIG has two-thirds of Berkshire’s market value and 50% more earnings. It may be a better bet than Berkshire in coming years, as could Wells Fargo, American Express and Allstate.

One alternative to Berkshire is Loews (LTR), the conglomerate run by the Tisch family that also combines insurance and investments. Loews has had a great record in recent years and now trades at 47, 12 times projected 2007 profits and a discount to its net asset value of about $62 a share. Loews is sitting on $3 billion in excess cash. It’s easier for the Tisches to move the needle than Buffett because Loews has 1/10th of Berkshire’s market value.

Buffett’s investment genius is undeniable, but his talents seem well reflected in Berkshire’s rich price. Looking out a few years, Berkshire stock probably will be higher. But our bet is that financial companies like AIG, and even the S&P 500, will do even better, especially if Buffett’s glorious tenure ends. And, remember, Buffett didn’t build the Berkshire powerhouse by paying much more for acquisitions than they were worth. That’s a lesson worth pondering by anyone considering buying his stock.

Sorry, Warren, Your Stock’s Too Pricey (Barron’s)

Out of curiosity, I decided to check Bary’s suggestions versus Berkshire’s performance over the same period:

With the exception of Wells Fargo (NYSE:WFC), Berkshire Hathaway has steadily outperformed the rest of the picks offered by Barron’s back in December.

Today though, Barron’s is actually recommending that you invest in Berkshire Hathaway:

THE FINANCIAL CRISIS HAS GOTTEN SO BAD, some investors are even questioning Berkshire Hathaway ‘s strength. But the worries seem overblown…

Barron’s took heat from Berkshire boosters with our bearish cover story on Berkshire last December, when the stock traded around $144,000. Berkshire has been hurt by declining profits in the auto-insurance and reinsurance markets, both of which might be bottoming. But now is probably a good time to buy. Looking out to 2009, Berkshire’s earnings could get a lift from improving conditions in the insurance market, and from some new high-yielding investments, including $8 billion of 10% preferred stock of Goldman Sachs (GS) and General Electric (GE).

If the stock market rallies in 2009, Berkshire probably will see record profits. Its operating profits this year could be about $5,400 per Class A share, excluding losses on equity and junk-bond derivatives that may cause a fourth-quarter loss. One big investor says earnings could hit $7,000 a share by 2010, a modest 13 times the current stock price.

Historically, Berkshire’s stock price is linked to its book value. We estimate that Berkshire’s book value now is around $66,000 a share, down $11,000, or 14%, since Sept. 30. Our calculation factors in Berkshire’s recent statement that its book value fell about $9 billion, or $6,000 a share, in October, on market declines. November has been about as bad for stocks, with the S&P off 17%.

True, Buffett does have less financial firepower to make investments because Berkshire’s cash probably has been halved, to about $15 billion, since Sept. 30 — in part because of its investments in GE, Goldman and Wrigley. It’ll be interesting to see if the 78-year-old Buffett is willing to issue equity or debt for a major deal, should he want to make one in the coming months.

Berkshire now trades below 1.4 times estimated book value, versus an average of around 1.5 in the past decade — and current book is depressed. If the stock market rallies 25% in the next year, the stock could hit $110,000, or 1.4 times potential year-end ’09 book value of $80,000 a share.

Finally, Berkshire Looks Undervalued (Barron’s)

Bary makes a pretty good case for investing in Berkshire right now. It seems to have taken them a while to acknowledge the benefit of investing in Berkshire and its “Fort Knox”-like balance sheet, but they’ve finally come around. It makes you wonder though — did they willingly ignore the balance sheets of those other companies that they recommended back in December? Almost all of them have been absolutely obliterated by the credit crisis and represented a highly speculative investment at the time as the credit crisis took hold of the markets.

I think that in times of crisis, that’s one thing to keep in mind. Any investment you make has to be compared to the universe of opportunities around you. At the time, Berkshire may have been overvalued, but with that cash horde, AAA rating, and lack of sub-prime/CDS exposure it represented a much safer proposition than most other financials.

Now, it appears as if even the great universal bank Citigroup (NYSE:C) has become yet another casualty of our financial crisis:

The federal government agreed Sunday to take unprecedented steps to stabilize Citigroup Inc. by moving to guarantee close to $300 billion in troubled assets weighing on the bank’s books, according to people familiar with details of the plan.

Treasury has agreed to inject an additional $20 billion in capital into Citigroup under terms of the deal hashed out between the bank, the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corp. Treasury officials will charge a higher interest rate for the capital injection — 8% for the first few years — than it has charged to dozens of other banks now borrowing money under the government’s the $700 billion rescue package approved by Congress last month.

In addition to the capital, Citigroup will have an extremely unusual arrangement in which the government agrees to backstop a roughly $300 billion pool of its assets, containing mortgage-backed securities among other things. Citigroup must absorb the first $37 billion to $40 billion in losses from these assets. If losses extend beyond that level, Treasury will absorb the next $5 billion in losses, followed by the FDIC taking on the next $10 billion in losses. Any losses on these assets beyond that level would be taken by the Fed.

Citigroup would also agree to work to modify — if possible — troubled mortgages held in the $300 billion pool, using standards created by the FDIC after the collapse of IndyMac Bank.

U.S. Agrees to Citigroup Bailout (WSJ)

With the bank trading at a market cap of $20 billion a capital injection of an additional $20 billion would cut the current stock price in half, if I’m reading the terms correctly. The story seems to still be developing, I’ll post more as more details emerge. On the contrary, today’s trading shows us that the $300 billion guarantee is yielding a surge in confidence for Citi, sending their stock price up 56%.

While most market participants are attacking Warren Buffett’s reputation, one really interesting bit of news came out. Fairfax Financial Holdings (NYSE:FFH) would be investing alongside Warren Buffett by purchasing $500 million in convertible senior notes, issued by USG Corp (NYSE:USG). Now, many of you might remember that Fairfax is run by Prem Watsa, one of the great yet underrated and under-recognized investors today. About 75% of my portfolio is concentrated in my Fairfax position, so you already know that I think highly of Watsa and his company.

This USG deal is quite interesting though. In most cases, Berkshire Hathaway (NYSE:BRK.A) does deals like this by itself. In the past, I know that they’ve partnered with Leucadia National Corp. (NYSE:LUK) but it’s really quite rare. At the very least we can probably agree that Buffett thinks positively about Fairfax, since he’s allowing them to invest alongside Berkshire.

From the Globe and Mail:

Toronto-based insurer Fairfax Financial Holdings Ltd. has teamed up with Berkshire Hathaway Inc. to invest in a U.S. building products company, creating a partnership between the chief executive officer of Fairfax and his investing hero.

“It is our first co-investment with Berkshire,” Fairfax spokesman Paul Rivett said. “We are extremely pleased to be investing in a leading industrial firm with one of the world’s great investors.”

Fairfax CEO Prem Watsa is a devotee of Berkshire CEO Warren Buffett, and is often referred to as the Canadian version of the legendary investor, someone he has openly sought to imitate…

As for their joint investment, USG Corp. will sell $300-million of convertible senior notes to Berkshire, and a further $100-million to Fairfax.

Watsa teams up with his investing hero (Globe and Mail)

As you can see, things haven’t been so good for USG’s stock price. They’ve been hit hard by the downturn in the housing market, but once things turn, USG will be poised for strong performance. The company has sort of a monopolistic position with their sheetrock products which gives the company a pretty sustainable moat. In addition, after their bankruptcy in 2001, the company was able to shed a lot of terrible liabilities which helps bolster their long term prospects.

This, combined with the fact that Fairfax has recently removed their equity hedges makes me think that Watsa is gradually finding some good opportunities for investing our capital. That’s going to be good news for any other shareholders in Fairfax, especially when they factor in the gains that we’ve made from the financial crisis.

One of the stories I’ve been following for a while is the sale of AIG’s International Lease Finance Group (ILFG). This is a best in class company, run by a very able entrepreneur with a true passion for the business. At the time, I said that whoever bought this company would be in for a real gem, something akin to one of the many businesses acquired by Warren Buffett’s Berkshire Hathaway in the past.

While I mentioned that this would be a great catch for Berkshire, it’s likely that the unit will fetch a price that’s just too high for Buffett to pay. Yesterday, Bloomberg reported that a deal for the unit will close early next year:

“We’re in the process of selling ILFC to a group of investors including management that will take back the company from AIG,” Steven Udvar-Hazy, the unit’s founder and chief executive officer, said yesteray at an aviation conference in Cancun, Mexico. He suggested the unit had a value of about $10 billion and didn’t identify the investors.

“Early next year, we will consummate the closing,” he said in a subsequent interview. “One thing is to reach a deal. It’s another to close the deal.”

The pending sale is “extremely good news” for both AIG and ILFC, Richard Aboulafia, an analyst with aviation consulting firm Teal Group in Fairfax, Virginia, said in an interview.

For ILFC, “no matter how sound the fundamentals of their business were, they were being dragged down by AIG’s negatives,” Aboulafia said. “For AIG, it’s good news because they need the money.”

Aboulafia said Udvar-Hazy has track record of making a profit in aviation and that he’s probably the industry’s most powerful executive as a key customer for jets. “He created this, he can run it,” Aboulafia said.

ILFC, which Udvar-Hazy founded in 1973 and took public 10 years later, will have revenue this year of about $5 billion. Net income for the first nine months was $913 million, up 39 percent from the same period last year, he said.

AIG to Sell ILFC to Management Group Next Year, Udvar-Hazy Says (Bloomberg)

What’s interesting about this is the fact that deal making has changed over the course of the financial crisis. Initially, the the US government took a much less active role in these types of interventions, they would back financing and have a bigger player consumer the smaller at fire sale prices.

Now though, with the US taking sometimes 80% of control in some of these financial entities, fire sale prices and quick deals work against tax payer interests. It’s really going to create a new dynamic for deals, we’re going to be in for longer go-shop periods in order to make sure that meaningful returns are made on government investments. This is probably why we haven’t seen a deal for ILFC already and why the price is going to be too high for value-sensitive groups like Berkshire.

These are tough times for anyone who’s an investor. I thought that some of you might enjoy Rudyard Kipling’s poem “If”. It’s a favorite of many great investors.

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you
But make allowance for their doubting too,
If you can wait and not be tired by waiting,
Or being lied about, don’t deal in lies,
Or being hated, don’t give way to hating,
And yet don’t look too good, nor talk too wise:
If you can dream–and not make dreams your master,
If you can think–and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you’ve spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build ‘em up with worn-out tools:

If you can make one heap of all your winnings
And risk it all on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: “Hold on!”

If you can talk with crowds and keep your virtue,
Or walk with kings–nor lose the common touch,
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much,
If you can fill the unforgiving minute
With sixty seconds’ worth of distance run,
Yours is the Earth and everything that’s in it,
And–which is more–you’ll be a Man, my son!

-Rudyard Kipling

On the hedge fund industry

ROSE: What’s happening, in your judgment, to this industry?

ACKMAN: The answer is it depends on what you benchmark the industry against. You know, the markets are obviously having a difficult year, and also something extraordinary happened to hedge funds. Hedge funds generally go long and they go short. And hedge funds woke up on a Friday in September. All of a sudden it was illegal to be short. That caused hedge funds to lose enormous amounts of money, as they were surprised that something that was perfectly legal for many years became illegal.

ROSE: This is so important. I’m going to have you do the definitions, even though we talk about this all the time, here on this program and other places. Tell us what a hedge fund is and going long and going short.

ACKMAN: A hedge fund is really an investment partnership. The difference between a hedge fund and a mutual fund is that the manager is compensated largely on performance. A manager typically gets 20 percent of the profits. A manager typically has a very large investment alongside his investors. I would say that’s the principle difference.

ROSE: And he gets two percent fee, two in twenty?

ACKMAN: One to two. It’s a good business.

ROSE: Yes. It’s a good business because you got it going both ends. You’re going to make your money, and if it goes up you get 20 percent of it. If it goes down –

ACKMAN: You’re out of business at a certain point. So you won’t get that two percent for long.

ROSE: Right. So it was a huge thing for how many years?

ACKMAN: The hedge fund business or short selling?

ROSE: Hedge fund.

ACKMAN: Hedge funds really started — Ben Graham, going back to Warren Buffett’s mentor, He was a hedge fund manager in effect. He went long and occasionally he went short. But it didn’t become a real industry where there are thousands of participants until five, six, seven years ago.

ROSE: And going long and going short means?

ACKMAN: Going long and going short — going long is making an investment. You buy a stock on the exchange. Going short is borrowing a stock, selling it on the hope you can buy it back on a lower price.

ROSE: You were a very good short seller.

ACKMAN: Occasionally we got it right.

ROSE: You were a very good short seller.

ACKMAN: Not always. It’s a difficult business.

ROSE: When the government shut it down for a while, it was terrible for people in the hedge fund business.

ACKMAN: It was more that the rules of the game were changed mid- stream. I think if the government had said, look, we’re going to phase out short selling over a period of time, it wouldn’t have been disastrous for an industry. But if you have investors who commit to their partners to stay balanced, they don’t want to be more than a certain amount long versus the amount that they’re short. You lose the ability to insure yourself. Short selling is really a form of protecting yourself from the market going down. By taking away that very important tool, managers got imbalanced. They were actually forced to sell their long positions.

We’re not large short sellers shorting stocks. Most of our short selling we do through derivatives, another topic. But something called a credit-default swap is a way to be short.

On the credit crisis

ROSE: What did you see and when did you see it, to paraphrase Howard Baker’s famous question of the Nixon administration people? What did the president know and when did he know it?

ACKMAN: I was princely a long investor for the first ten years of my investment career. In 2002, I came across a company called Farmer Mac, which is a GSE, not that different from Fannie and Freddie, but that operates in the agricultural credit market. It was recommended to me as a long investment, something I should buy. The more I looked, the more I concluded that this was a good short. And without going into too many details, I bought a credit default swap and it turned into a profitable bet.

I then looked at Fannie and Freddie. Actually in 2002, I made short bets through credit default swap market on Fannie and Freddie, but ultimately gave up because I thought of them as too big to fail. But as part of that research, I was looking for other companies that had Triple-A ratings, where perhaps they didn’t deserve their rating. I came across a company called MBIA, which is a bond insurer. It’s a company that started out in a very low-risk business, guaranteeing California bonds, for example. And over time what you see with financial institutions is that as markets become more competitive, they’re forced to take on more risk to make their share holders happy.

The bond insurers were started out as almost cooperatives. They weren’t for profit in a conventional sense. But in the early ’90s, most of them went public. They had demands from their share holders and management was compensated with option. They started to look for other avenues of profit. They had a Triple-A rating from the rating agencies.

So Wall Street got ahold of them, and said, look, you guarantee California bonds. You guarantee hospital bonds. Why not grantee corporate risk? Why not guarantee mortgages? Over time, they started to enter a market they knew less well. They’re very leveraged companies. What struck me when I first opened the annual report of one of these companies is they had a Triple-A company, yet over 100 to one in leverage. That just didn’t compute.

ROSE: Unbelievable, doesn’t compute. We think of 30 and 40 to one as high.

ACKMAN: Yes. But the world up until recently was a world that believed, you know, the financial markets were –

ROSE: What does that mean, the world believed.

ACKMAN: Where investors would buy a bond based on its rating. They’d buy a CDO. They’d buy a complex security. It was too difficult for them to analyze. They outsourced the analysis to three companies, the rating agencies.

On ratings agencies

ROSE: One person after another has come to this table and just cast huge criticism at the ratings agencies.

ACKMAN: Yes.

ROSE: It’s all deserved?

ACKMAN: It’s deserved.

ROSE: How did it come to that?

ACKMAN: You know, I think the rating agencies perform what amounts to almost a regulating function. Determining the credit worthiness of a bond is something that the SEC uses to determine the capital adequacy of an investment bank. So they got an almost sovereign like-status, but they were for profit entities. That for profit nature of what is a quasi- regulatory body caused them I think to push for production. And, you know, the incentives of trying to meet next quarter’s earnings can cause someone to — in a competitive marketplace perhaps to sign off on a rating that wasn’t deserved.

There was a lot of rating shopping. An investment bank would walk into Moody’s and say, look, here is a risk. We’re looking for a Triple-A rating. It would be analyzed by Moody’s and they’d say, OK, it’s Triple-A. The investment bank would say, what, if I throw this in, is it still Triple-A? They would say, looks Triple-A to us. What if I threw in a few more bad mortgages, is it still Triple A? At some point Moody’s would say, it’s no longer Triple-A. They’d say OK. Then they’d walk across the street to S&P. They’d take a look at it, and if they said yes, they’d get paid a 600,000 dollar fee. Yes, it’s Triple-A. If they said no, they wouldn’t make any money.

ROSE: That raises a big question about what’s going to happen to rating agencies.

ACKMAN: I think they’ve become a lot less relevant.

ROSE: People have to do their own credit analysis.

ACKMAN: You can’t outsource credit analysis. The problem with the rating agencies is that these monikers, the good house-keeping seal of approval of a Triple-A rating has lost its value. That was exported around the world. So it’s almost like regulators around the world deferred to the rating agencies, and that caused securities that probably should not have been sold to spread around the world. And the crisis that we’re in now is largely because people took their — if you think about the Internet bubble, when people lost a lot of money, it wasn’t as bad –

ROSE: There were no earnings.

ACKMAN: The Internet bubble, people were taking not their savings they needed to make mortgage payments, they took their highest-risk assets. They knew they were taking a risk when they were buying floose.

ROSE: They were betting on the comp, so to speak.

ACKMAN: But people who invested in Triple-A obligation, these CDOs and asset-backed securities, took their lowest risk money. It was the money that banks didn’t have to hold capital against. It was the retiree who said I want to make sure I have enough in my retirement. The result is people have lost confidence, because they took their safest, most important nest egg funds. They put it in stuff that’s supposed to be risk-free, and it turned out to be far from risk-free.

On hedge fund redemptions

ROSE: Couple things. One, how much redemption is going on with hedge funds?

ACKMAN: A lot.

ROSE: Explain what that means?

ACKMAN: Hedge funds are not — the capital isn’t permanent. It’s a little more permanent than a mutual fund. You could call up Fidelity and tomorrow you can liquidate your entire account. The hedge fund, you have to give notice. It depends on the fund. Some funds have five-year lockups. Some have two-year lockups. Some have 90-day lockups. As investors have lost — as hedge funds have lost money — this year, perhaps, you’re right. The average hedge fund might be down 20 or 25 percent. Investors are concerned. They’re looking for sources of liquidity. And they put in a redemption notice to hedge funds.

What that means is the manager has less money. He has to sell what he owns.

ROSE: In order to pay back the persons.

ACKMAN: Which puts pressure on the market, which puts pressure on funds, which causes more redemptions.

ROSE: Do you know a lot of people that are experiencing terrible margin calls.

ACKMAN: No, I actually don’t hang around with people who use a lot of leverage.

ROSE: Really?

ACKMAN: Really. There has been too much leverage in the system.

Is it time to invest?

ROSE: This is a time of opportunity for people with money, is it not?

ACKMAN: Absolutely. It’s the single best time in my career that I’ve seen to invest.

ROSE: To invest. There’s more value out there than you could ever imagine.

ACKMAN: The spread between price and value is the widest in many years, 30 or more years.

ROSE: Prices are way below value.

ACKMAN: Yes. Not every case.

ROSE: Why do I hear so many stories — I am a babe in the water — about people sitting on cash, cash, cash, cash. They’re just sitting on it. You’re saying there are tons of great investments to be made and there is a greater spread between value and price than there’s ever been. And yet they’re sitting on cash.

ACKMAN: Yes. A couple reason, one, if you don’t know how much money your investors are going to ask you for, you have to put aside money to take a conservative point of view. Very few people have permanent capital. Mr. Buffet is about the most fully invested we’ve ever see him. He spent 50 billion in the last few months. I mean, it’s hard to keep track. He can do that because his capital is permanent. Most investors in the marketplace, mutual funds, hedge funds, managed account managers –

ROSE: His capital comes from money that comes into –

ACKMAN: Every day.

ROSE: From businesses he owns.

ACKMAN: That’s right. And that’s unusual. So in a marketplace where your capital isn’t permanent, people have to be on the defensive.

On Government bailouts

ACKMAN: I’ll say the Federal Reserve and the secretary of the Treasury. I focus on the TARP. The 700 billion dollars, that authorization from Congress, I think so far has been spent well. Two hundred fifty billion dollars going into some of the best banks in the country so they’ve got more capital to lend, so that there is more confidence in your counter-parties is a very important first step. So I like that.

Second thing is the government taking steps to cause the rate at which companies borrow to decline. So the Libor rate, versus the interest rates that the Fed funds rate has — that spread has narrowed, which means that the cost of funding for businesses has come down. That’s a positive. So I think we’ve taken some positive steps.

I do have some concern about, you know, what you read about in the newspaper, in terms of other things they’re thinking about.

ROSE: Like?

ACKMAN: I’m concerned about G.M. Why am I concerned?

ROSE: G.M., the car company?

ACKMAN: There are reasons to be concerned, but this is a very important company for the country. It competes in a global marketplace. It’s been hamstrung for years because it has too much debt and it has contracts that are uneconomic.

ROSE: It’s in the health care business.

ACKMAN: That’s right. The way to solve that problem is not to lend more money to G.M. That just creates another Fannie or Freddie problem. The way to solve that problem is to use the reorganization system of the country. I don’t think –

ROSE: So reorganize G.M. for me.

ACKMAN: What should happen is they should do a prepackaged bankruptcy. The equity holders have been largely wiped out already.

ROSE: Because the stock is selling at two dollars or something?

ACKMAN: It’s a four or five dollar stock today. It’s maybe a couple billion dollar market cap. The debt trades at 30 cents on the dollar.

ROSE: You can buy all of general motors for two billion dollars.

ACKMAN: And you’re over-paying.

ROSE: You’re over-paying.

ACKMAN: You’re over-paying.

ROSE: That’s why nobody has bought it.

ACKMAN: What you need to do is reduce the amount of debt at General Motors to a level that the company can support, and the debt holders, in exchange for giving up their debt claim, will end up owning the business. What you want is a General Motors that can compete. You don’t want to lend tax payer money to an insolvent company so they can pay interest to the people who lent them money five years ago. That’s not a solution to the problem.

I’d rather the government’s money be used to retrain employees for other jobs, for infrastructure. You know, the welders at General Motors are going to be — can help on the infrastructure of the country. That’s a much better use of tax-payer money than lending money to an insolvent company. So we can’t be afraid — the bankruptcy word scares people. It’s simply a system. I have no economic interest either way in General Motors. But I guess for the good of the country I have an interest in General Motors. I’d like to see General Motors have a capital structure.

ROSE: Should it merge with Chrysler?

ACKMAN: If that would make the company more efficient, it should. It’s just like Fannie and Freddie. You have two companies that effectively perform the same function. My guess is there’s significant –

ROSE: What about Ford?

ACKMAN: If it makes sense, I think we should design –

ROSE: One great American auto company.

ACKMAN: We should design an auto company that can compete on a global scale.

ROSE: So you buy into the recapitalization program when you think the auto companies ought to be reorganized.

ACKMAN: There’s a viable business at General Motors, but it needs a different –

ROSE: It seems like what you’re basically saying is that the federal government is making a mistake.

ACKMAN: Yes.

ROSE: And Congress is making a mistake, if, in fact, they think that just pouring money into AIG or into General Motors will solve the problem.

ACKMAN: AIG is a little different from the other two, but you have to start with — once you’re done with the tax- payer putting in — if you look at the bank bailout, it was done very well because the government didn’t go invest. It put preferred stock in only solvent institutions. Right? They’re not — they’re letting — 17, 18 banks have failed. They’re letting them fail, because there is no hope of rescue.

ROSE: Should Lehman Brothers have been allowed to fail?

ACKMAN: It’s a complicated question. I would say my regret with Lehman Brothers is if you — once Bear Stearns was saved, the message on Wall Street was we’re going to let shareholders die, but we’re going to protect counter-parties. As a result, when Lehman failed and the counter- parties lost 90 cents on the dollar, more money was lost, in my opinion, than should have been lost. If the government had said, look, we saved Bear because we didn’t have time to figure it out — it was over the weekend. They had plenty of time to know that Lehman had issues and they should have let the market know, this is the last — we’re not going to save every counter-party.

ROSE: My impression is Lehman went around looking for buyers and, in fact, there was a South Korean buyer that might have been in place for a while, et cetera, et cetera.

ACKMAN: Apparently Buffett made a proposal that was rejected. I think Lehman could have been saved, but I think the management loved their institutions too much to take money on terms they thought was unfair. And ultimately it cost the institution.

ROSE: They didn’t realize that the failure to take that deal would be the consequence they found.

ACKMAN: Also, investment banks were never 30 to 40 to one levered institutions until more recently.

The future of investment banks
ROSE: Where are we with investment banks today? I’ve had one guest after another, Ace Greenberg, among others, saying investment banks, as we have known them, are gone forever.

ACKMAN: I think that’s right, as we have known them recently. I think we’re going back to the old model.

ROSE: In terms of Morgan Stanley and Goldman Sachs.

ACKMAN: I think there are some very profitable investment banks in the old model. Lazard is a very profitable investment bank.

ROSE: It’s like a boutique, though.

ACKMAN: It doesn’t take enormous — it’s not a 40 to one. People pick on hedge funds for being levered. Many Wall Street firms became hedge funds.

ROSE: What was the leverage at Goldman Sachs.

ACKMAN: High, 30 plus. When your competitor is levered 30 to one, you have to do the same.

ROSE: Paul Volker has questioned this program, the model of big investment banks that have hedge funds under the umbrella. Big investment banks should or shouldn’t have hedge funds?

ACKMAN: Actually, in my view, investment banks became hedge funds.

ROSE: That’s what some have said to me. Some have said to me that private equity firms are the new investment banks.

ACKMAN: Yes. Yes and no. I think there are some issues there, too. Too much leverage. I think that, you know, we went through a period of time where the consumer, the investment bank, the business got attracted to very low-cost money.

ROSE: There is a problem right there. It was too much easy money, in part.

ACKMAN: That’s right.

ROSE: That got to be such a distance between the person who was making the loan and the person who was asking for the loan.

ACKMAN: Exactly right.

ROSE: Credit risk got way out of whack.

ACKMAN: Correct. Fueled again by the rating agencies.

When will the housing market turn around?

ROSE: And the housing market will turn around when?

ACKMAN: OK, I’ll try to be optimistic because I’m an optimist. Come the turn of the year, we have a new president; we have much lower interest rates than we’ve had for a long period of time; housing prices have come down a lot; it’s the spring; you’ve been wanting to buy a home for years. You’ve saved money. You’ve been a good citizen. You’ve not borrowed too much on your credit cards. A house that used to cost 600,000 dollars is now available for 280,000 dollars. Fannie and Freddie are in business.

ROSE: And money is at one percent.

ACKMAN: Money is cheap.

ROSE: What is money at?

ACKMAN: The answer is it’s less so much the cost of money. There is money for a good credit consumer that puts down a 20 percent down payment. The problem –

ROSE: That’s right.

ACKMAN: It’s really in the corporate world. What’s causing the economy to weaken is that companies are not concerned they’re not going to be able refinance their debts they have coming due.

ROSE: Because banks aren’t lending money.

ACKMAN: That’s right.

ROSE: Banks don’t lend money, they can’t pay their debts. They can’t pay their debts, they can’t make their products. They can’t make their products, they can’t pay their employers. They can’t pay their employees, they’re out of business.

ACKMAN: That’s right. We need to fix that problem. We’re on our way. We’re not there yet.

ROSE: Have we turned the corner though?

ACKMAN: I think we have certainly turned the corner.

The new presidential administration

ROSE: So you’re optimistic because we’ve turned the corner?

ACKMAN: I’m optimistic we’ve turned the corner. I’m optimistic about the new administration.

ROSE: Why are you optimistic about the new administration other than it brings optimism to the country?

ACKMAN: First of all, that’s important. A lot of what’s going on is driven by mood. Confidence plays an enormous role.

ROSE: Trust and confidence?

ACKMAN: Not just the consumer level but at the business level. If an executive feels like he can grow his company, he will spend money. So I think having a leader that can inspire the people, having a leader that can stand up and say, “the only thing you have to fear is fear itself,” it reminds me of a — the U.S. is a turn around now. We invest in turn arounds. They can be difficult, but we’ve got a lot of wonderful assets here.

We have a country that people want to live in. The U.S. government is incredibly solvent. People get concerned about an extra trillion or two of debt. That’s a very big number, but you have to remember that the government owns 35 percent of every corporation because they have taxing power. The government owns 40 percent of every wealthy individual’s earning power. That’s a big off-balance sheet asset.

We’ve got a solvent government. We borrow in our own currency, and the new CEO of America is not going to be afraid to make big decisions, because he doesn’t have to live with any legacies.

(Edit: Transcript is here)

I managed to catch Bill Ackman’s interview on Charlie Rose last night. Ackman manages Pershing Square Capital Management, a $6 billion dollar hedge fund. The interview really did not cover too much new ground, he mostly discussed his perspectives on the credit crisis; ranging from the Fannie Mae and Freddie Mac bailout to the current TARP program. I’ll be sure to post a link to the video and have more of the transcript later. For now, here’s an interesting bit on General Motors (NYSE:GM), Ford (NYSE:F), and the possibility of a Detroit automaker bailout:

Charlie Rose: Where are we today?
Bill Ackman: We made progress. The TARP ($700B) has been spent well so far. $250B to banks was an important first step. 2nd, the Gov taking steps to make cost of spending go down is a positive. We have some concern about other things they’re thinking about.

Charlie Rose: Like?
Bill Ackman: I’m concerned about GM. This is a very important company. It has too much debt, uneconomic contracts. The way to solve this problem is to use the bankruptcy reorganization process for the company. Do a pre-packaged bankruptcy. The equity holders have been largely wiped out. Debt trades at $0.30 on the dollar. Equity guys are overpaying right now. Reduce the amount of debt to a level that the company can support. Debt holders will own the business. You want them to compete. Not so that they can borrow taxpayer money and pay interest to people who they owe money to from 5 years ago. We can’t be afraid of bankruptcy. I have no economic interest except for the good of the country.