Welcome, I'm Steve Forbes. It's a pleasure to introduce this week's guest, Whitney Tilson, founder of T2 Partners. Tilson has long invested in financial and credit card companies, and he'll give us the contrarian view on this troubled sector. But first--the Obama administration wants to enhance the regulatory powers of the Federal Reserve. That's a mistake. The Fed has all the power it needs to help the American consumer and the global economy. The Fed needs to stop buying government debt and start focusing on what matters.
Cash in the banking system is not the problem, so the Fed buying Treasuries won't solve anything. The Fed should be aggressively buying mortgage-backed securities, packages of credit card loans, car loans and other kinds of credit, as it promised to do last year. The Fed's balance sheet has shrunk since December, indicating an appallingly timid a response in the face of the crisis. The Fed doesn't have to balloon its balance sheet when it purchases these consumer credit packages, but it does have to pump hundreds of millions of dollars into the system to get credit flowing again.
In terms of regulation, it is a bit ironic they're still going to put new powers in the Federal Reserve--an agency that didn't exercise proper oversight over the banking system and whose lousy monetary policy in 2003 and 2004 made the bubble possible. The Fed doesn't need new powers, it needs to clean up the mess it created.
In a moment, my conversation with Whitney Tilson.
Steve Forbes: Whitney, thank you very much for joining us. You foresaw the housing bust, but not the absolute carnage that followed it. First, why the bust, and then, why the carnage?
Whitney Tilson: There were so many reasons--you could point to 20 reasons. And it turned into a partisan finger-pointing game to some extent today about why this happened. But my study of the history of financial markets is that booms and busts are almost inevitable. Human beings inevitably pile into whatever's hot, and then, particularly when there's a lot of money at stake and there were billions if not trillions of dollars at stake in this housing bubble, and a whole lot of people, lured by a whole lot of money, behaved very, very recklessly, ranging from individual homeowners all the way up to the highest levels of Wall Street. And the greatest bubble in history formed. Not just the U.S. housing market, but really the entire debt world all across the world, not just the United States. Virtually every debt market was infected by this bubble.
And it crashed. And we knew it was going to be bad. We manifested that in the funds we manage by being short a lot of financial and real estate stocks. Unfortunately, we didn't really realize how much leverage had built up and how bad it would get.
And when it collapsed, there was no place to hide. Certainly on the long side, everything got clobbered. And we paid the price for that, but escaped with our skin intact anyway because we stayed out of the financial and real estate sector and had some short positions there.
Forbes: Last year we saw a lot of bargains out there, and some of them became even more bargain-y. What stocks did you like back then, and what do you see now?
Tilson: Yeah, well we have always liked Berkshire Hathaway ( BRK - news - people ) as one of the anchors of our portfolio. We thought if there was one--
Forbes: Given the ratio of cash to the stock price. Still looks pretty good.
Tilson: Yes, well, we actually add up the cash, the bonds and the stocks it owns together and view that as investments per share. And then in addition to that, we value the operating businesses. Roughly 75 operating businesses, the largest of which are insurance, number one, and utilities, number two. And then a whole bunch from Justin Boots to Acme Bricks and dozens and dozens of other companies.
The cash and investments per share, depending on where the stock prices are, is somewhere in the $75,000 per share range. The stock these days is around $90,000. You're getting all of the operating businesses for about $15,000 per a share. And we think normalized earnings for those operating businesses are about $5,000 per share.
Today you can buy one of the strongest balance sheets in the world, run by one of the greatest investors of all time for three times the pretax earnings of the operating businesses. And we think that's pretty attractive, and that's been our favorite stock for a while.
Forbes: Now at the end of last year, early this year, you saw a lot of bargains out there. And one of the things you made a point about, "This is not about earnings, this is all about balance sheets." Can you elaborate on that?
Tilson: Well, as things got really bad last year, we made a couple of decisions. One is that we had almost no ability to predict what the earnings of any company would be in 2009. Because we thought the economy was going to be very bad, but very difficult to predict how bad. We were looking at, like all good value investors, first and foremost, preservation of capital. How do we protect our downside before we start thinking about how much money we can make on the upside?
And so we were looking for companies that we could buy at or near cash. Where we thought we had balance-sheet protection. Only secondarily did we think about, "OK, what's the earnings power of this business?" Maybe in a normalized environment, but that might be three or five years out. Berkshire Hathaway was a classic example. The stock got down to about $70,000 per share. At that point, you were paying less than cash and got all the operating businesses for free. And that's a dream come true. Every once in a decade you get an opportunity like that with a company of the quality of Berkshire (BRK.A, Financial)(BRK.B, Financial).
But there were a lot of other lower-quality businesses. But something like Echo Star, which was run by Charlie Ergen, sort of a hodgepodge of assets, but it was trading at cash. A tiny little specialty retailer called Delia*s (DLIA), which was trading at a 40% discount to cash at the bottom.
So, little things like that. That was one area that we focused on. And the other area is we made a deliberate decision to go into the most unpopular areas. We were looking for business with too much debt, cyclical businesses, the kind of stuff we thought other investors would be selling at any price. We thought that's where the bargains would be.
And in some cases, we got in way too early. But many of those stocks have doubled, tripled or more off their March lows. That's certainly helped us out 'cause we had the conviction to stay in those stocks even after we'd taken some big losses initially. They've all, or a lot of them, have rallied back.
AIG's Future
Forbes: Once upon a time, you liked AIG ( AIG - news - people ). What do you see happening to that now?
Tilson: Well, many years ago we owned AIG (AIG, Financial) briefly after the initial scandal and Greenberg was forced out and so forth. The stock got down to the 50-dollar-and-change range. And we owned it until it got back up to $70 or so. Then fast-forward a couple years. As the stock went down, we avoided it, even though it looked tempting and a lot of value guys were jumping in because there was so much of a black box element to it. The AIG financial products division, that eventually sunk the business; as outsiders, we couldn't figure it out. And it turns out the insiders couldn't figure it out, either. So, we stayed away. And then very near the end we actually shorted it from $20 to $2 on the way down, when it became clear to us that this part of their business was going to sink them.
Link to remainder of interview transcript: http://www.forbes.com/2009/07/02/tilson-capital-one-intelligent-investing-tarp.html
Cash in the banking system is not the problem, so the Fed buying Treasuries won't solve anything. The Fed should be aggressively buying mortgage-backed securities, packages of credit card loans, car loans and other kinds of credit, as it promised to do last year. The Fed's balance sheet has shrunk since December, indicating an appallingly timid a response in the face of the crisis. The Fed doesn't have to balloon its balance sheet when it purchases these consumer credit packages, but it does have to pump hundreds of millions of dollars into the system to get credit flowing again.
In terms of regulation, it is a bit ironic they're still going to put new powers in the Federal Reserve--an agency that didn't exercise proper oversight over the banking system and whose lousy monetary policy in 2003 and 2004 made the bubble possible. The Fed doesn't need new powers, it needs to clean up the mess it created.
In a moment, my conversation with Whitney Tilson.
Steve Forbes: Whitney, thank you very much for joining us. You foresaw the housing bust, but not the absolute carnage that followed it. First, why the bust, and then, why the carnage?
Whitney Tilson: There were so many reasons--you could point to 20 reasons. And it turned into a partisan finger-pointing game to some extent today about why this happened. But my study of the history of financial markets is that booms and busts are almost inevitable. Human beings inevitably pile into whatever's hot, and then, particularly when there's a lot of money at stake and there were billions if not trillions of dollars at stake in this housing bubble, and a whole lot of people, lured by a whole lot of money, behaved very, very recklessly, ranging from individual homeowners all the way up to the highest levels of Wall Street. And the greatest bubble in history formed. Not just the U.S. housing market, but really the entire debt world all across the world, not just the United States. Virtually every debt market was infected by this bubble.
And it crashed. And we knew it was going to be bad. We manifested that in the funds we manage by being short a lot of financial and real estate stocks. Unfortunately, we didn't really realize how much leverage had built up and how bad it would get.
And when it collapsed, there was no place to hide. Certainly on the long side, everything got clobbered. And we paid the price for that, but escaped with our skin intact anyway because we stayed out of the financial and real estate sector and had some short positions there.
Forbes: Last year we saw a lot of bargains out there, and some of them became even more bargain-y. What stocks did you like back then, and what do you see now?
Tilson: Yeah, well we have always liked Berkshire Hathaway ( BRK - news - people ) as one of the anchors of our portfolio. We thought if there was one--
Forbes: Given the ratio of cash to the stock price. Still looks pretty good.
Tilson: Yes, well, we actually add up the cash, the bonds and the stocks it owns together and view that as investments per share. And then in addition to that, we value the operating businesses. Roughly 75 operating businesses, the largest of which are insurance, number one, and utilities, number two. And then a whole bunch from Justin Boots to Acme Bricks and dozens and dozens of other companies.
The cash and investments per share, depending on where the stock prices are, is somewhere in the $75,000 per share range. The stock these days is around $90,000. You're getting all of the operating businesses for about $15,000 per a share. And we think normalized earnings for those operating businesses are about $5,000 per share.
Today you can buy one of the strongest balance sheets in the world, run by one of the greatest investors of all time for three times the pretax earnings of the operating businesses. And we think that's pretty attractive, and that's been our favorite stock for a while.
Forbes: Now at the end of last year, early this year, you saw a lot of bargains out there. And one of the things you made a point about, "This is not about earnings, this is all about balance sheets." Can you elaborate on that?
Tilson: Well, as things got really bad last year, we made a couple of decisions. One is that we had almost no ability to predict what the earnings of any company would be in 2009. Because we thought the economy was going to be very bad, but very difficult to predict how bad. We were looking at, like all good value investors, first and foremost, preservation of capital. How do we protect our downside before we start thinking about how much money we can make on the upside?
And so we were looking for companies that we could buy at or near cash. Where we thought we had balance-sheet protection. Only secondarily did we think about, "OK, what's the earnings power of this business?" Maybe in a normalized environment, but that might be three or five years out. Berkshire Hathaway was a classic example. The stock got down to about $70,000 per share. At that point, you were paying less than cash and got all the operating businesses for free. And that's a dream come true. Every once in a decade you get an opportunity like that with a company of the quality of Berkshire (BRK.A, Financial)(BRK.B, Financial).
But there were a lot of other lower-quality businesses. But something like Echo Star, which was run by Charlie Ergen, sort of a hodgepodge of assets, but it was trading at cash. A tiny little specialty retailer called Delia*s (DLIA), which was trading at a 40% discount to cash at the bottom.
So, little things like that. That was one area that we focused on. And the other area is we made a deliberate decision to go into the most unpopular areas. We were looking for business with too much debt, cyclical businesses, the kind of stuff we thought other investors would be selling at any price. We thought that's where the bargains would be.
And in some cases, we got in way too early. But many of those stocks have doubled, tripled or more off their March lows. That's certainly helped us out 'cause we had the conviction to stay in those stocks even after we'd taken some big losses initially. They've all, or a lot of them, have rallied back.
AIG's Future
Forbes: Once upon a time, you liked AIG ( AIG - news - people ). What do you see happening to that now?
Tilson: Well, many years ago we owned AIG (AIG, Financial) briefly after the initial scandal and Greenberg was forced out and so forth. The stock got down to the 50-dollar-and-change range. And we owned it until it got back up to $70 or so. Then fast-forward a couple years. As the stock went down, we avoided it, even though it looked tempting and a lot of value guys were jumping in because there was so much of a black box element to it. The AIG financial products division, that eventually sunk the business; as outsiders, we couldn't figure it out. And it turns out the insiders couldn't figure it out, either. So, we stayed away. And then very near the end we actually shorted it from $20 to $2 on the way down, when it became clear to us that this part of their business was going to sink them.
Link to remainder of interview transcript: http://www.forbes.com/2009/07/02/tilson-capital-one-intelligent-investing-tarp.html
