The latest from Marty Whitman:
Dear Fellow Shareholders: Based, as always, upon a bottom-up, value oriented, approach to analysis, my view of what is happening in the U.S. economy seems to be quite different from the views held by politicians and academics. Third Avenue shareholders, hopefully, might gain insight from understanding my views about the economy and various economic entities, particularly with regard to the U.S. economy, the global economy and, most important to Third Avenue Management, the companies that must contend with both. Central to economic debate and discussion throughout 2011 has been the question of the solvency of the United States government. Declaring the U.S. bankrupt is now in fashion and has been used to justify investment decisions and to sell investment strategies and products. The belief that the U.S. government is insolvent, or is on the path to insolvency, is not a motivating factor behind Third Avenue’s decision to invest considerable assets in the equities of companies based outside of the U.S. Still, the question of U.S. solvency is worth considering. The true test of solvency is the creditworthiness of the economic entity, not the amount of debt that it owes. The amount of debt is important, but it is only one element in determining creditworthiness. In fact, creditworthiness is a function of three factors:
• Amount of debt • Terms of debt • Productivity in the use of proceeds arising out of the borrowings The third factor – productivity or growth – seems by far the most important of the three functions for the U.S. government (as is the case for most of the common stocks in the various Third Avenue portfolios). Historically, certain U.S. government uses of proceeds have been unbelievably productive, such as the Homestead Act of 1862 and the Servicemen’s Readjustment Act of 1944 (the “G.I. Bill of Rights”). While it is relatively easy to measure the productivity of use of proceeds on the corporate level – profits and/or growth in net asset values – it tends to be much harder to measure productivity where the expenditures are made by a government not motivated primarily by seeking profits. Take military expenditures, for example. In my opinion, from an economic point of view, few things seem more wasteful than the country’s involvement in Iraq and Afghanistan. On the other hand, it is doubtful that there have been more productive expenditures during the past 25 years than Military Research and Development. Among myriad of other things, it was the military that gave us the Internet. Given my prejudices though, I would think that enormous longterm benefits would accrue to the nation from expanded expenditures on education, infrastructure, and research and development. The proposal for a Balanced Budget Amendment to the U.S. Constitution, thus, seems to be a bad idea. The government should be allowed to raise debt to finance productive activities. A productive economy, not a debtfree government, should be the ultimate goal. While individual debt instruments mature, debt in the aggregate is almost never repaid. Debt is, instead, refinanced and expanded by entities which remain creditworthy. This is certainly true for the common stocks in each of the Third Avenue portfolios. While each issuer had a strong financial
position, almost every common stock issuer represented in the Third Avenue portfolios have so increased in size and profitability over the years that they now enjoy enhanced debt issuing capacity. The same ought to be made true for the U.S. government and its various debt issuing agencies. The U.S. government did run budget surpluses in the mid to late 1990s, as a direct result of decades of debt-financed, productive spending. Much of the credit for that performance seems attributable to the dot-com bubble, made possible by the widespread adoption of the Internet and the vast electrical and telecommunications infrastructure of the U.S. Various newly minted billionaires paid huge amounts of capital gain taxes and the tax base was broadened, as a new industry created demand for highly-skilled, and mostly well-paid, workers. Much of the growth in high tech during that time seems to have been triggered, in part, by the Initial Public Offering (“IPO”) Boom and, in part, by defense cutbacks, which compelled smart engineers and nerds to get involved in attractive start-ups, rather than taking jobs with Lockheed Martin and General Dynamics. The speculative excesses of the 1990s seem to have contributed much permanent good to the economy with the development of extremely able, extremely productive, high-tech industries. All of this occurred while causing huge harm to passive market participants who speculated in dot coms and did not sell their investments in time. Value investors, who remained focused on fundamentals, seem to have not suffered all that much from the bursting of the dot-com bubble.
Damage has been done to the U.S. government’s true credit rating by the failure to reach an early agreement on increasing the debt limit, regardless which rating agencies maintain its AAA rating. Creditors are just too efficient not to take account of the fact that the government’s willingness (not ability) to service its obligations is now suspect. Here lies the issue for those who have had their faith shaken in the “full faith and credit” of the U.S. government. Theatrics like we saw during the debt ceiling debate make the government look frivolous, wasteful and inefficient in the eyes of its creditors and in the eyes of many of its citizens. With a long background in distress investing, it is impossible for me to hold the view that the federal government is inefficient and Corporate America is the paragon of efficiency. It seems to me, that large institutions screw up rather consistently – whether governmental or corporate. The recent experiences of U.S. corporations and financial institutions demonstrate this. See the residential mortgage debacle after 2007 and still ongoing. See the insolvencies of General Motors, Chrysler and so many auto suppliers. See the loss of the U.S. manufacturing base (shoes, TVs, autos, computer components, textiles, shipbuilding, etc.) to East Asia. The federal government has problems; but, who would deny that the federal government is less corrupt, and probably attracts more high-quality employees, than most state or local governments? In my view, the relationship between the federal government and corporations has to be viewed as a partnership – whether one likes it or not. Events of the last 10 years
seem to indicate that relatively strict regulations of
financial institutions are necessary. The ultra-strict
regulations of investment companies, while quite
onerous, have proven to be a boon for mutual funds. Over
the years, investors have flocked to mutual funds because
they know they will get a fair shake from them.
Management fees and overall expenses are limited,
diversification is a must, affiliated transactions are limited,
borrowings are almost non-existent, and the payout of
income and capital gain is required.
As far as I can tell, there is no evidence that higher personal
income tax rates for the wealthy retard economic growth
and employment. Many countries which level high taxes
on individuals seem very prosperous, like Sweden and
Canada. Indeed, it may be true, at least partially, that
higher tax rates encourage many people to work harder in
order to achieve the same take home income after taxes
that they had when tax rates were lower. I’m an oddball
when it comes to personal income taxes. My university and
graduate school education was paid for by the G.I. Bill of
Rights. The U.S. is also a great place to live in and raise a
family. No matter how high my personal tax rates become,
I’ll always owe the U.S. government more than it owes me.
Of course, we can make things better.
While caution has to be used in creating more tax
loopholes, the use of the tax mechanism can foster actions
that could be highly productive the for the U.S. economy.
Areas where tax break incentives might be particularly
productive include the following:
• Allow trafficking in tax loss carry-forwards by
eliminating the changes that were part of the 1986 Tax
• Provide tax incentives in the education field.
• Provide tax incentives for housing.
• Provide additional tax incentives for infrastructure.
• Provide additional tax