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Eddie Lampert Tells Sears Stockholders to read Hayek

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March 01, 2009 – Comments (0)

The full SEC filing can be found here.  Below are some excerpts:

The two most important books that any student of current events should be reading in this environment are both by Friedrich Hayek, the esteemed Austrian economist. Based on events he witnessed beginning in the early part of the 20th century, Hayek wrote The Road to Serfdom as a warning to England and the United States against the damaging impact of socialist policies and The Fatal Conceit as a warning against heavy intervention in markets and society at large. Despite the almost universal belief today that more, but better, regulation is needed and that the role of the state needs to be not just temporarily larger, but permanently larger, Hayek’s writings and logic should give everybody pause as to the consequences of these actions.

As a country, we need to rebuild confidence and trust and to understand what happened. Whether by business or by government, the misdiagnosis of situations leads to poor prescriptions for rehabilitation and recovery. When the misdiagnosis is done at the federal government level and involves large parts of a national economy, the consequences can be swift and significant.

 

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Benjamin Graham said, as Warren Buffett paraphrased, that “in the short run, the market is a voting machine. In the long run, it’s a weighing machine.” Despite this caution, much of our financial system now rests on the shoulders of a “voting machine” rather than a “weighing machine.” Don’t be fooled by the term “mark-to-market.” Mark-to-market is a regulatory convention and not a free market convention. As regulated entities, most financial institutions are required to account for their assets by regulatory convention. Similarly, all publicly traded companies are required to conform to GAAP (Generally Accepted Accounting Principles). This helps for comparability and it helps to assure investors that they can rely on the financial statements of publicly traded companies.

What has happened is that we have gone from a system which stressed objectivity and verifiability to a system in which the market price of an asset, under conditions of economic stress and financial dislocation, must be derived using a significant amount of judgment. But this is not where it stops. Once you accept the mark-to-market convention, you begin the debate of what is the correct market price. Different people and different firms end up pricing the same asset differently. This has been true for a long time in the derivatives markets, but it also is now true in markets in which asset prices are less liquid. This allows critics and commentators to charge that financial institutions are not marking their assets properly (regardless of whether the critics have any specific evidence or not). The incessant drumbeat of these charges leads to a loss of confidence among investors as well as concerns from regulators and rating agencies who are fearful of being accused of being lax in overseeing these institutions. The accounting profession, as well, is put into a position of being second-guessed for the financial statements they prepare and certify, so they too become “conservative.” So much time and money ends up spent ensuring that the financial statements are immune from criticism that it can become much more of a distraction than a useful tool for investors and managers.

 

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Investors in regulated industries rely on the fact that regulators will not behave in an arbitrary fashion and, if they do, that there are due process remedies that their managements and boards can pursue. Investors in financial institutions who experienced what can happen when funding was compromised earlier in the year in the case of Bear Stearns, now experienced what can happen when a regulator unilaterally decides that the rules of the game are not sufficient or appropriate. Both Fannie Mae and Freddie Mac had capital in excess of the required levels under regulatory guidelines and accounting rules in effect, with Fannie Mae’s capital being significantly in excess of the required levels. However, if one were to use some other standard (and many were being suggested and recommended for quite a while), one could make the case that neither company had the capital desired by their critics, some of whom were not investors, while others had an academic or political interest in the housing and mortgage area that was adverse to the GSEs. 

 

David in Qatar

 

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