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Marty Whitman's Third Avenue Management First Quarter 2014 Letter

March 26, 2014 | About:
Holly LaFon

Holly LaFon

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Dear Fellow Shareholders: Much emphasis is placed on general "debt levels" in the belief that the amounts borrowed by u.S. Federal, State and Local governments are excessive. Indeed, 74% of recent poll 1 respondents stated that a high priority ought to be given to debt reduction by governments.

It is obvious that this almost universal emphasis on general debt levels is misplaced. rather the emphasis should be on the credit-worthiness of borrowers, specifically what are the borrower's abilities to access capital markets, if needed.

There are two things about borrowing that any rational analyst ought to keep in mind. First, while individual debt instruments mature, aggregate debt for most borrowers almost never gets repaid from the borrower's perspective. rather, for most borrowing entities, debt is refinanced and expanded as the borrower becomes increasingly credit-worthy. Second, if a borrower is not credit-worthy and can't be made credit worthy, then sooner or later that borrower has to reorganize or liquidate. reorganization can encompass capital infusions, major asset sales or a recapitalization designed to reduce or extend cash service that the borrower has to pay out for interest, principal retirements and premiums.

Credit-worthiness is a function of four factors for feasible borrowing entities – whether corporate or governmental:

• Debt level;

• Terms of the Debt;

• How productive are the use of Proceeds received from the borrowings; and

• How liquid is the borrower.

There seems to be a common belief that a government's use of proceeds is always non-productive. Insofar as this is true, it seems to be valid to concentrate attention on the debt level because large debt levels coupled with a lack of productive use of proceeds means that the government entity will not be, or remain, credit-worthy. However, there seems to be no evidence that all government expenditures are non-productive. Indeed, in at least three historic areas, the federal government's use of borrowed moneys was unbelievably productive, probably returning to society and the country benefits with a present value hundreds of times greater than the amounts spent. These three areas which come to mind are as follows:

1) The Homestead Act of 1862 which enabled and accelerated the rapid settlement of the U.S. West.

2) The Serviceman's readjustment Act of 1944 (the GI Bill of rights) which resulted in the u.S. obtaining a highly educated population and the world's best university system.

3) research and Development expenditures by the U.S. military after World War II which gave the U.S. and the world, among other things, the Internet and a highly efficient aviation industry.

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