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 Act. • Provide tax incentives in the education field. • Provide tax incentives for housing. • Provide additional tax incentives for infrastructure. • Provide additional tax incentives to encourage Research and Development.
Beyond tinkering with the tax code, I will make two broader suggestions, without much regard for how feasible they are in the current political climate, that I believe would help to solve the current crises in housing and municipal finance: Encourage massive immigration to the U.S. Take advantage of the fact that so many upper income and/or highly educated people want to move to the U.S. and, maybe, become citizens. A few million of such people moving to California, Nevada and Florida would go a long way toward solving the housing crisis. To do this, the U.S. might use the Canadian point system tailored to American needs. Immigrants could get points to come to the U.S. based on: their willingness to buy houses, their level of higher education, if they have amassed wealth and/or have the ability to create jobs. Partner with private industry to shore up the credit worthiness of municipal borrowers. The U.S. government and its agencies are the only AAAs left standing, according to two of the three principal ratings agencies. The U.S. government should use its AAA rating to cure certain debt problems and also make a profit. In partnership with the private sector, municipal debt should be made AAA initially, being credit insured by the private sector whose insurance policies would be reinsured by the USA or agencies thereof. The private sector is necessary to do the appropriate due diligence, set premium prices, and possibly aid in the marketing of insured municipal credits. A majority of the common stocks in the Third Avenue portfolios now consist of common stocks issued by nonU.S. companies,
either Canadian or offshore. There is some
concentration in the Far East, especially in Hong Kong blue chips with large presences in mainland China. I am pleased with this concentration. However, like most value investors, I worry a lot about the investment risks taken and what could go wrong with our approach. Frankly, if prices were close to equal, and growth prospects were close to equal, I would much prefer to invest in the U.S. than elsewhere. Prices and growth prospects seem far from equal though.
Even so, it is important to understand why the U.S. is such a good place for long-term investment. • Fund managements, except Third Avenue International Value Fund, understand the U.S. culture better than other cultures. • The U.S. is a diversified, continental economy. • There seems to be a relative lack of corruption in the U.S. • U.S. corporate and securities law is reliable and comprehensive. • The U.S. has the world’s best university system. • The U.S. has the world’s most efficient distribution system. • The U.S. workforce is highly productive.
• U.S. corporate managements mostly seem highly able and motivated compared to their foreign counterparts. • U.S. securities markets are well developed. • Most U.S. companies seem well financed, at least those which are candidates for investment by the various Third Avenue equity funds. • In the U.S., there is a relative absence of violence in the streets and also relative political stability. I will write you again when the fiscal 2011 Annual Report is published after the fiscal year closes on October 31, 2011. Third Avenue 3Q 2011 Shareholder Letter
George Soros And The Human Uncertainty Principle
The division between academic economics and the way traders look at the market is deep. The efficient market hypothesis assumes that markets and valuations are always pushing towards an equilibrium, and evidence to the contrary gets pushed aside as fluctuations or statistical deviations. But the dot com bubble, the