Third Avenue Shareholder Letter Q3 2011

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Third Avenue Shareholder Letter Q3 2011The 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
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 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. corporate and securities law is reliable and
• The U.S. has the world’s best university system.
• The U.S. has the world’s most efficient distribution
• 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,

Third Avenue 3Q 2011 Shareholder Letter

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