This week, David Einhorn has been all over the news. We covered the news, but thought some of his old speeches/ideas before he was super famous would be of interest to readers. We found some material from 2007/08. If you have anything earlier we would LOVE to see it send us a tip. Here is the first one, a speech Einhorn made in October, 2007. We will be posting more. sign up for our free newsletter to ensure you do not miss any.
Helbrunn Center for Graham & Dodd Investing
17th Annual Graham & Dodd Breakfast
David Einhorn’s Prepared Remarks
October 19, 2007
What strikes me the most about the recent credit market crisis is how fast the world is trying to go back to business as usual. In my view, the crisis wasn’t an accident. We didn’t get unlucky. The crisis came because there have been a lot of bad practices and a lot of bad ideas. Securitization is a mediocre idea. Re-securitization of already securitized assets into a CDO is a bad idea. Re-securitization of CDOs into CDO-squared is a really bad idea. So is funding a pool of long-term illiquid assets with very short-term funding in the so called asset backed commercial paper market. And as I will get to in a moment, it is a horrendous idea to delegate most of the responsibility for assessing credit risk to a group of credit rating agencies, paid for by the issuers rather than the buyers of bonds.
This crisis came for exactly the right reason. There is a big flaw in the structure of our credit markets. The bad structure induced lenders to take imprudent risks and make imprudent loans, which, of course led to losses. What is unique about this crisis compared to others is that the losses are in illiquid, opaque structures scattered around the world. Why should anyone be surprised? We got what we deserved.
Last Saturday’s Wall Street Journal reported that the big fear that the US Treasury department is working to avoid is, “the danger that dozens of huge bank-affiliated funds will be forced to unload billions of dollars in mortgage-backed securities and other assets, driving down their prices in a fire sale. That could force big write-offs by banks, brokerages and hedge funds that own similar investments and would have to mark them down to the new, lower market prices.” So the fear is that the new prices are actually disclosed. This is the “don’t ask-don’t tell” method of security valuation.
In my view, the credit issues aren’t just about subprime. Subprime is what the media says. Subprime is what parts of our financial establishment say. Subprime is about them – those people and the people who made foolish loans to them. The word “Subprime” is pejorative. Subprime is not about us, for we are not subprime. How convenient to be able to pass the blame.
There has been much talk from politicians and pundits about predatory lending – that is making loans at high rates to people who couldn’t reasonably be expected to pay them back. They are right, that is a bad practice, but that is not what’s shaking the markets. At issue today is that lenders of all sorts have lent too much money and did not demand enough interest to compensate them for the risks they took. There has been a colossal undercharging for credit across the board.
I believe the poor lending standards and the low cost of credit in subprime extend through-out the credit markets into all areas of residential real estate, commercial real estate, and the corporate lending markets.
Let’s start with the U.S. housing market. In addition to under-priced subprime loans, we have home equity loans to prime borrowers. We now see that when house prices fall – and they are falling – from a creditor’s perspective, a second lien is not much better than a credit card receivable, though the interest received is much less. Structures backed by Alt-A loans with no documentation are performing just as poorly as subprime structures, due to the lower amount of over collateralization embedded in those deals.