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We underestimated Countrywide’s vulnerability to liquidity risk

December 12, 2007 | About:

A message from Wally Weitz to shareholders: "Our Funds are having a very poor year in both relative and absolute terms. We under-estimated Countrywide’s vulnerability to liquidity risk and we were early in assuming that the effects of the housing market collapse were priced into various high quality consumer stocks."

We discussed our portfolios at some length in our last quarterly letter and will do so again when we write the next quarterly report.

In the meantime, we have received calls and emails from shareholders asking how we are dealing with the current market and what our outlook is. Without going into specific transactions, we thought it might be helpful to make a few general comments:

We are continually re-assessing each company’s prospects and financial strength, and we have made some portfolio changes that we believe reduce our exposure to future credit problems while maintaining considerable upside potential. We believe we are being realistic and willing to adjust to an evolving environment;

While few financial company stocks have escaped unscathed (Berkshire Hathaway, our largest holding, being a notable exception), we believe that the market has over-reacted to the potential credit exposure of many good companies;

Many stocks’ prices already appear to discount a recession that may or may not occur. We believe our companies are priced at discounts to their intrinsic values whether or not their earnings and cash flows are depressed for a few quarters by a weak economy.

We have seen markets like this before—e.g. 1974, 1982, 1987, 1990, 1994, 1998, and 2002—when it was hard to imagine how stocks could ever go up again. In various combinations, Iraq and other geopolitical uncertainties, oil and other commodity prices, speculative excesses in securities markets, and credit problems periodically shake the economy and scare investors. The size and pervasiveness of the credit and liquidity issues today seem more daunting than ever, but this kind of environment has always presented great opportunities for investors. We have no idea when the panic will subside, but stocks have a way of bottoming long before all the uncertainties are removed. In the meantime, our companies are making lots of money and investing it wisely.

Read the complete letter

Rating: 3.5/5 (13 votes)


Kfh227 - 9 years ago    Report SPAM
I love transparency. And I agree in that some very good financial stocks are being dragged under water with the dead fish. Now is the time to be a shark.
Brady56 - 9 years ago    Report SPAM
I love Wallace's comments. He is one of the main reasons for me to hold on to my financial holdings, which I believe none will go bankrupt and revive soon or later.

Fk - 9 years ago    Report SPAM
I'm really interested to hear his explanation on Countrywide. He indicated in that letter that he felt many stocks tend to bottom out long before the crisis is over (without naming specific holdings). Are countrywide's problems fully known at this point, or do we still have more carnage to follow, with new waves of adjustable subprime mortgages getting reset, people defaulting, etc.? What do you guys think? Most 'experts' seem to believe it will take at least another 6-12 months for the full extent of damage to be known.

Owning BRKB seems to be bailing out the portfolios of many of the gurus here in gurufocus like Pabrai, Weitz. Imagine what their returns would be without it.

Valuemodel - 9 years ago    Report SPAM
The foreclosure situation is fluid: we don't know where house prices will settle, who will foreclose, what the foreclosure rate will be, the degree to which bank assets will be impaired. Someon posted an excellent presentation here a couple of weeks ago indicating that the largest volume of ARM resets occurs in 2008.

Any of us could have written the letter referenced above, because the underlying logic is simple: housing is cyclical and it will work out eventually. It will, but what if it doesn't bottom in 2008, and it turns out to be 2009 or 2010? If there were more meat to that argument stating the maximum estimated damage to the balance sheet, need for funding, etc., then I would be interested. Instead, I'm going to wait to see the pictures in newspapers of houseowners with their furniture on their lawns, evicted from their houses, because then I know we will all feel like ****. This last is not my idea, I heard it on the I. Box, but it sounds like it could happen.

I am actually considering finding some way to hedge the value of my house going down, maybe SRS (ultra-short real estate) or maybe another instrument more geared to what is going on in my neighborhood. I've already experienced a drop in housing values (New York in the late 1980s) prior to this, and it actually became a realized loss because I was transferred overseas. Major bummer, and I don't want to go through this again. Has anyone here considered hedging their homes?
Buffetteer17 premium member - 9 years ago
I don't see much point in hedging my home, because I intend to own a home for the next 20+ years. I doubt that the housing downturn will last that long, whatever the market seems to think. Even if I should move, selling the current home and buying another is a wash. I have sufficient cash and credit that getting a new mortgage is not an issue (I could pay cash and rent the old place while I wait to sell it).

I'm not against hedging in general. I do hedge my stock portfolio, because I have a big margin loan and most of my retirement money in it. I want to make the probability that the portfolio value drops below a minimum threshold for comfortable retirement is very low, even though the hedge costs me a couple of percent return. If I had a lot more money, I wouldn't hedge.

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