Highly recommended reading: http://www.leggmason.com/individualinvestors/documents/insights/D6485-MillerShareholder.pdf
I would highlight two passages. Firstly his apology.
Guys like Bill Miller are true legends. He acknowledges his mistakes made. Unlike some other delusional investment advisers/fund managers.
- The Current Crisis
The current crisis is in its second year, and it is only in the past 30 days that effective policies to deal with it are finally being implemented. The policy response prior to this can only be described as disastrous, culminating in the decision to let Lehman Brothers go bankrupt, a decision widely and, we believe, correctly seen to have been a mistake of historic proportions. This decision created a whole new crisis in the global credit markets, which, combined with the existing housing-related crisis, brought the financial system to the point of collapse.
I think the Treasury, up until very recently, must have been operating under the motto of Boris Johnson, mayor of London, who said, “My friends, as I have discovered myself, there are no disasters, only opportunities. And, indeed, opportunities for fresh disasters.”
That of course, applies to us as well. General Douglas MacArthur has famously remarked that every military disaster can be summed up in two words: “Too late.”
That certainly applies to this crisis and to our response to it. The authorities and we were too late to recognize the scope and seriousness of the unfolding crisis, and too late to take the appropriate action. When Federal Reserve Board Chairman Ben Bernanke and others repeatedly said the crisis was contained, we thought that the probabilities were that it was—they had far more information and far more resources than anyone in the private sector to make that judgment. We were both wrong.
This is not the venue for a complete analysis of policy failures, nor is it my desire to blame policymakers for their errors. I have made enough mistakes in this market of my own, chief among them was recognizing how disastrous the policies being followed were, yet not taking maximum defensive measures, believing that the policies would be reversed or at least followed by sensible ones before things got completely out of control. In this market, our long-term orientation and optimism about the future have not served us well.
I believe the present phase of the crisis was initiated by the politically popular but, in my judgment, economically disastrous decision to nationalize Fannie Mae and Freddie Mac (the GSEs)1 on September 7. The best analysis of this, in my view, has been done by famed economist Anatole Kaletsky of GaveKal Research, whose two papers, “The Unintended Consequences of Mr. Paulson” and “The Financial Doomsday Machine” are required reading, in my opinion. Some of the more historically minded of you may recognize the title of the first as harking back to John Maynard Keynes’s 1925 work, “The Economic Consequences of Mr. Churchill.”
The stock market had been recovering from its July 15 low, with the S&P 500 Index rising nearly 100 points by the end of August. Even the GSE’s stocks had been rising. Then the seizure happened, and a bit over a week later Lehman went bankrupt, Merrill was sold to Bank of America, and AIG was “rescued,” again nearly wiping out shareholders. The day after the GSEs were seized, AIG stock was $24. Eight days later it opened at $1.85.
The GSE nationalization created what Karl Marx would have called a “contradiction” in the capitalist system. The contradiction was that the government repeatedly said financial institutions needed more capital, and that it wanted private capital to solve the problem. But the government also indicated that if it needed to provide additional assistance in the future, then shareholders who had provided capital should be completely or mostly wiped out. Private capital will not be forthcoming if it believes it is the policy of the government to wipe it out should intervention later be necessary. Still, prior to the seizure, there had been enough private capital around to put large amounts of money into Merrill Lynch, AIG and Lehman. But when the government preemptively seized the GSEs, not because they needed capital and could not get it (Fannie Mae had $14 billion in excess capital, and Freddie Mac several billion above regulatory requirements), but because the government believed they would run out in the future, then shareholders of every other institution that needed or was perceived to need capital did the only rational thing they could do — sell, in case the government decided to preemptively wipe them out as well.
This made it effectively impossible for any institution, except those who manifestly did not need it, to raise capital. John Thain at Merrill recognized this immediately and salvaged something for Merrill shareholders. The bankruptcy of Lehman, though, ushered in a whole new stage of the crisis.
Heretofore, when financial institutions failed or were seized, their creditors suffered no losses. Bear Stearns creditors were protected, as were those of the GSEs. Lehman, though it was twice the size of Bear Stearns, was allowed to go bankrupt. Creditors who had investment-grade paper on Friday had worthless paper on Monday, leading the oldest money market fund, the Reserve Fund, to “break the buck,” and precipitating a complete freezing up of all short-term credit markets as no one knew whose paper could be trusted.
As I noted earlier, this now seems to be recognized by many as a monumental policy error. (I think it is still widely held that the GSE seizure was good policy, though. If so, it is awfully difficult to account for the financial collapse of all those institutions so close on the heels of what was supposed to be a confidence-building policy decision.) This is not the place for further discussion of the aftermath of Lehman. The question for investors is, where are we now and what of the present policy?...
Lastly, the following passage is probably what most investors seek and want to read about.
- The Current Investment Environment
What should one make of an investment environment where the major indices are down 40% to 50% or more, credit markets are completely disrupted, housing prices are falling for the first time in 70 years, bond spreads are at record highs, consumer confidence has plunged, and fear is palpable? If you have been hoarding cash waiting for the collapse, you feel vindicated, maybe even gleeful. If, like many of us, you have been carefully acquiring assets, building up capital, investing for the long term, trying to ignore market fluctuations, you feel sick, maybe even disillusioned, at the scale of the losses to date.
There is little dispute among knowledgeable investors that U.S. (and global) equities are extraordinarily attractive on a wide variety of measures based on historical standards. The worry is they may go a lot lower before they eventually recover, as the current crisis unfolds and as the economy undoubtedly gets worse. This worry is legitimate. After all, to most of us, stocks seemed quite cheap at the end of September, and now they are a whole lot cheaper. So what to do? The data indicate there is now a mountain of cash on the sidelines, enough in money market funds to buy about half the market capitalization of the S&P 500.
One of the most important bullish signs has been little remarked upon. The monetary base, which consists of cash in circulation or in banks, had been decelerating during the entire time the Fed had supposedly been injecting liquidity into the system since last August. Thus, the amount of what economist Milton Friedman called high-powered money to stimulate the economy was decelerating, and so was the economy as the crisis continued. Now, though, the base is exploding as the Fed has finally turned up the liquidity pump. Since just after the GSE seizure, the Fed began expanding the monetary base, so far by over $300 billion, an unprecedented increase. It takes a while for all that liquidity to find its way into the system, but find it, it should, and the transmission mechanism is typically through capital markets first. As it does so, the odds are very good credit spreads will begin to decline sharply and equity prices rise.
It is an old cliché that they don’t ring a bell at the tops and bottoms of markets, but it is not entirely true. Occasionally someone climbs up in the belfry and does just that, as a public service, but knowing that few are likely to heed the bell. That someone is Warren Buffett, and the reason he is one of the richest men in the world is that he understands asset values and human behavior as it relates to those values better than anyone. In 1974, which prior to now was the worst bear market since the 1930s and the best buying opportunity since then, he recognized that the values were compelling and advised that the time was right to start investing. In 1999, he warned that prices were very high and future rates of return likely to be far below normal. Sure enough, the trailing 10-year return on stocks is now negative, something seen only a few times in history, and an event that has historically heralded strong returns over the next 10 years. Mr. Buffett has returned to the belfry to ring the bell again, with his October 17 New York Times piece saying to buy American stocks, that the values are once again exceptional. His partner, Charlie Munger, has also recently remarked that we are setting the stage for a 10- or 15-year bull market. Once again, few are paying heed.
We are.
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