The Wisdom of Einhorn
At the Fall 2009 Value Investing Congress, David Einhorn delivered this insightful speech. Here are a few pieces of his wisdom:
On the Too Big to Fail Doctrine and Lehman
The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to makesure that no institution is too big or inter-connected to fail. The test ought to be that noinstitution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test.
The lesson of Lehman should not be that the government should have prevented its
failure. The lesson of Lehman should be that Lehman should not have existed at a scale that
allowed it to jeopardize the financial system. And the same logic applies to AIG, Fannie,
Freddie, Bear Stearns, Citigroup and a couple dozen others.
On Government Accounting
When the government calculates its debt and deficit it does so on a cash basis. This
means that deficit accounting does not take into account the cost of future promises until the
money goes out the door. According to shadowstats.com, if the federal government counted
the cost of its future promises, the 2008 deficit was over $5 trillion and total obligations are
over $60 trillion. And that was before the crisis.
On Moody’s and Sovereign Risk
My firm recently met with a Moody’s sovereign risk team covering twenty countries
in Asia and the Middle East. They have only four professionals covering the entire region.
Moody’s does not have a long-term quantitative model that incorporates changes in the
population, incomes, expected tax rates, and so forth. They use a short-term outlook – only
12-18 months – to analyze data to assess countries’ abilities to finance themselves. Moody’s
makes five-year medium-term qualitative assessments for each country, but does not appear to
do any long-term quantitative or critical work.Their main role, again, appears to be to tell everyone that things are fine, until a real
crisis emerges at which point they will pile-on credit downgrades at the least opportune
moment, making a difficult situation even more difficult for the authorities to manage.
I can just envision a future Congressional Hearing so elected officials can blame the
rating agencies for blowing it, as the rating agencies respond by blaming Congress.