Monthly Archive for January, 2009

Page 3 of 3

Different Thoughts and Different Actions

Posted on January 5, 2009, 12:41 pm. Closed

I have a retirement account with TIAA-CREF and a personal brokerage account with Tradeking. Back in late 2007 and early 2008, after seeing the market react to bad news, the Fed cutting rates, and reading as much as I could, I was conflicted on how I should manage both accounts. The retirement account was nearly 100% in stocks just like the personal account.

Unable to decide one way or the other, I chose to leave my personal account alone and make some serious allocation changes with my retirement account. In March 2008, I shifted the allocation away from stocks and into the money market, fixed income, and TIAA’s guaranteed. Then in mid-December I changed my allocation yet again and now I am 70% in stocks, 15% money market, and 15% guaranteed. With this allocation shifting, my retirement account only suffered a 6.9% loss for 2008. Quite good considering everything that happened.

Unfortunately, I did not do this with my personal account. It suffered losses similar to everyone else.

Looking back, I want to try to understand why I did two different things. I should not have treated my personal account any differently from my retirement account. I had worked hard to accumulate the money that I deposited into both accounts, but I still treated my personal account almost as if it was money I had won with a lottery ticket. Also, acting in such a way seems to be indecisive. Or maybe I was just hedging my bets?

As I’ve been studying value investing and value investors, nearly all have said that efforts to predict the future are wasted. The same goes for trying to time the market. The same goes for trying to understand macro events. But timing the market and taking into consideration macro events are exactly what I did when I made a drastic reallocation of my retirement account.

I’ll definitely have to do some more reflection on this.

Enron’s Flaws Mirrored in Home Loan and Financial Industry

Posted on January 4, 2009, 1:18 pm. Closed

A few weeks ago I purchased The Smartest Guys in the Room, a book about the rise and fall of Enron. I found the book in the bargain bin for $10, which was about roughly 65% off list price—a great example of what one should do as a value investor: look for great things selling at great bargains!

As I began to read, a lot of things stand out in just the first 80 pages, mostly the business practices that the home loan and financial industries mirrored in the past five years that eventually brought about this current crisis.

For example, the compensation structure of Enron’s international division and the home loan industry are quite similar in that both were fatally flawed and both structures eventually helped lead each to their downfall. Enron International made money by building power plants and energy-related infrastructure to developing nations. However, the fatal flaw was the compenstation structure:

Developers got bonuses on a project-by-project basis. The developers would calculate the present value of all the expected future cash flow from a project…. When the project reached finanancial close—that is, when the banks lent money but before a single pipe was laid or foundation poured—they were paid. No wonder the developers were so eager to move on to the next deal; they had no financial incentive to follow through on the one they’d just completed…. The more deals Enron International did, and the bigger they were, the richer the developers got. The system encouraged international executives to gamble without risk.

Just like the compensation structure of Enron’s international division encouraged volume regardless of quality, so did the compensation structure of the mortgage and home loan industry. This structure also helped bring about the downfall of many lenders, banks, and financial institutions. Whether you’re in the energy infrastructure business, insurance underwriting, or home loan business, a compensation structure that values volume over quality seems to eventually lead to financial hardship or ruin over the long term.