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The Stingy News Quarterly (Q3/2007)

New @ StingyInvestor

The Income 100
"A year ago we helped you target Canada's best income trusts in our second All-Canadian Trust Guide. We ranked the largest trusts in Canada and assigned each a letter grade depending upon how its financial numbers stacked up. Despite the carnage in the trust sector as a result of new tax rules introduced in late 2006, our picks hit the bulls-eye. Our top-flight trusts - those rated either A or B - gained an average of 11.7% over the past year. That continues a streak of strong performance. Since we started ranking trusts in 2005, our top trusts have gained a total of 44.9%."

No assembly required
"Many of us would love to become landlords - if it just weren't for those darn tenants. Every prospective landlord hears stories about deadbeat tenants who skip town without paying the rent. And even if you have good tenants, the life of a property entrepreneur isn't easy. Nothing takes the shine off a potential investment faster than the thought of fielding complaints at two in the morning about clogged toilets or devoting part of your weekend to fixing the broken-down washing machine at your rental property. Fortunately, there is an easier way to become the next Donald Trump. Rather than buying rental units directly, why not invest in property through Real Estate Investment Trusts?"

The Best of Stingy Links

Stingy Links: Accounting

Wells Fargo gorges on mark-to-make-believe gains
"The board last September approved a new, three-level hierarchy for measuring 'fair values' of assets and liabilities, under a pronouncement called FASB Statement No. 157, which Wells Fargo adopted in January. Level 1 means the values come from quoted prices in active markets. The balance-sheet changes then pass through the income statement each quarter as gains or losses. Call this mark-to- market. Level 2 values are measured using 'observable inputs,' such as recent transaction prices for similar items, where market quotes aren't available. Call this mark-to-model. Then there's Level 3. Under Statement 157, this means fair value is measured using 'unobservable inputs.' While companies can't actually see the changes in the fair values of their assets and liabilities, they're allowed to book them through earnings anyway, based on their own subjective assumptions. Call this mark-to-make-believe."

Debugging Wall Street's funky math
"In the first half of the year, most Wall Street firms awarded themselves large profits from assets that are rarely traded and difficult to price, according to numbers contained in the brokerages' recent financial statements. But, with markets seizing up since the end of June, those assets could be even harder to value, potentially prompting investors and regulators to question Wall Street's earnings."

A book-keeping error
"New research suggests that the increasing reach of fair-value accounting might be a mixed blessing. A paper by Guillaume Plantin of the London Business School, Haresh Sapra of the University of Chicago and Hyun Song Shin of Princeton University concludes that fair-value accounting could sometimes generate fluctuations in asset values that distort the very price information that it puts such store by."

Stingy Links: Behaviour

Was Harry Potter inevitable?
"The study's setup allowed for a very explicit test of social influence. The independent group, unswayed by the opinion of others, provided a reasonable indicator of song quality. If social influence is unimportant, you would expect the song rankings - and downloads - to be similar in all nine worlds. On the other hand, if social influence is important, small differences in the initial download pattern in the social worlds would lead to very different rankings. Cumulative advantage triumphs intrinsic quality. What did the study show? Well, song quality did play a role. A top-five song in the independent world had about a 50 percent chance of finishing in the top five for a social influence world. And the worst songs rarely topped the charts. Beyond that, the scientists found social influence played a huge part in success and failure. In the eight social worlds, the songs downloaded early in the experiment affected the songs downloaded later. Since the patterns of download were different in each social world, so were the outcomes. One song, "Lockdown" by 52metro, illustrates the point. The tune was ranked 26 in quality in the independent world, effectively average. Yet it was the number 1 song in one of the social influence worlds, and number 40 in another. Social influence catapulted an average song to hit status in one world and delegated it to the cellar in another."

Persistence of myths
"The federal Centers for Disease Control and Prevention recently issued a flier to combat myths about the flu vaccine. It recited various commonly held views and labeled them either "true" or "false." Among those identified as false were statements such as "The side effects are worse than the flu" and "Only older people need flu vaccine." When University of Michigan social psychologist Norbert Schwarz had volunteers read the CDC flier, however, he found that within 30 minutes, older people misremembered 28 percent of the false statements as true. Three days later, they remembered 40 percent of the myths as factual. Younger people did better at first, but three days later they made as many errors as older people did after 30 minutes. Most troubling was that people of all ages now felt that the source of their false beliefs was the respected CDC."

Money isn't everything
"Psychologists have known for a long time that economists are wrong. Most economists - at least, those of the classical persuasion - believe that any financial gain, however small, is worth having. But psychologists know this is not true. They know because of the ultimatum game, the outcome of which is often the rejection of free money."

Stingy Links: Bonds

Profiting from mortality
"Death bonds may be the most macabre investment scheme ever devised by Wall Street"

Stingy Links: Buffett

Warren Buffett MBA Talk
See Warren's address to MBA students on You Tube in 10 parts.

Tend to overanalyse stocks?
"Contrast this with the investment process of Warren Buffett and his partner, Charlie Munger. Their record is astounding, yet they have no analysts on staff to crank out spreadsheets or discounted cash flow valuations. I'm not even sure these two guys know how to use Microsoft Excel to model financial projections (probably not). How can two people out-research a staff of 100 highly-trained CFAs using the latest and greatest computer technology? The answer is that Buffett and Munger are able to filter out the noise better than just about anyone else."

Making money the Warren Buffett way
"When an investor amasses $52 billion over half a century, humble stock pickers take note. When he's Warren Buffett, the homespun "Oracle of Omaha," it not only pays to heed his thinking, but it's fun."

Warren Buffett: "I don't care" if the Fed cuts rates
"I represent a different view, maybe, than your other viewers. I don't think it makes any difference whatsoever to an investor in stocks what they do today. I don't care, I wouldn't care whether they raise the rate in terms of what I would do in stocks. If I knew exactly what they were going to do, I would not change a buy or a sell order that I have in." [Perhaps one of the silliest Buffett interviews I've seen. Who did they think they were interviewing?]

A world of winners, Warren's way
"We have been running this screen for more than 12 years. Since its inception on Feb. 13, 1995, through July 31, 2007, the screen has had an annualized return of 15.69% vs. 9.28% for the Standard & Poor's 500-stock index. Year-to-date through July 31, 2007, the Buffett screen stocks outperformed the market, returning 7.69% vs. the 2.61% gain for the S&P 500 (all results are price appreciation only)."

How Buffett bounces back
"Thousands have studied the success of Warren Buffett, the chairman and CEO of Berkshire Hathaway (BRKA). And for good reason: The value of Berkshire stock increased 361,156% from 1964 to 2006. But the country's most famous investor has made some infamous mistakes, too. Buffett's blunders offer their own lessons to investors trying to emulate the "Sage of Omaha.""

Stingy Links: Crime

Crooks with deep pockets
"Berger's case is one example of how difficult it can be for authorities to track down white-collar fugitives. They have advantages that more typical criminals lack, including ties to foreign countries, advanced degrees, and barrels of money that can help secure safe havens. Berger, now 35, was born in London and grew up in Salzburg, Austria. He managed hundreds of millions of dollars out of Park Avenue offices in New York before authorities charged him with misleading investors about his stockpicking prowess. Even as he reported stellar returns to his backers, Berger was hemorrhaging more than $400 million by betting against Internet stocks in the late 1990s. Using his connections and his persuasiveness, Berger was able to avoid legal authorities for years."

Stealing from the dead
"In March 2006, the Tennessee board that regulates cemeteries got a five-page complaint, in neatly penned cursive longhand, from Geraldine Story, an elderly Memphis woman. Story's husband Ralph had died on January 22. In preparation for that day, he and she had each, more than thirty years earlier, purchased prepaid funeral services from the Forest Hill Funeral Home in Memphis, to make sure that each's burial expenses would not be a burden to the other or to their families. Six hours before her husband's wake, however, Story learned that the casket would not look anything like the bronze one promised in the contract. Instead, it would be made of brown painted wood, with "a single latch on the lid that resembled a cheap tool box," as she wrote. If she wanted an upgrade, the least expensive alternative would run $3,995.00. She bought that one, of course, but after the funeral she followed up and was eventually told by a candid funeral home staffer that the funds set aside to fulfill her contract had been "skimmed off the top several times," and now the home was stuck with more than 13,000 "pre-need" contracts just like hers with no way to pay them. "He said they had to operate the way they are doing," she wrote, "or go out of business in two months and we don't want that, do we?" The then-unraveling scam that victimized Ms. Story turned out to be worse than that, even. The same folks who looted Forest Hills, according to Michigan authorities, were also looting trust funds from 28 cemeteries in that state (including the final resting places of Rosa Parks and Henry Ford)."

Scam alert
"Pratkanis says these telemarketers gain victims' trust by calling often, boosting their self-esteem and by bad-mouthing their children and other watchdogs. He offers some tips for countering a relative's allegiance to scammers and protecting against repeated rip-offs."

New credit card scam
"The caller asks you to look for seven numbers on the back of your card. He reads you the first four, which are part of your card number, and asks for the last three - the security numbers that verify you are the possessor of the card. When you give the security numbers, he says, "That is correct. I just needed to verify the card has not been lost or stolen and you still have it." The scam is effective because you say very little. The caller already has your credit card number, your address and the issuer's name and gives you all the information - except for the one piece he wants."

Stingy Links: Debt

Confessions of a credit-card pusher
"Politicians and college administrators are growing increasingly concerned about the damage that credit-card debt is causing students, and they're trying to crack down on some of the card companies' practices. They're limiting marketing on some campuses and trying to restrict the size of credit lines extended to students. Earlier this year, the state legislatures in Texas, Oklahoma, and New York moved to clamp down on credit-card marketing to college students"

Stingy Links: Dividends

Dividend deluxe
"Brace yourself for this because it's powerful stuff. If you buy the shares of a dividend grower today, in a decade you could be enjoying a tax-efficient flow of income with a double-digit yield. Bonds and guaranteed investment certificates offered double-digit yields back in the early 1990s, but it's hard to see that happening again any time soon. Income trusts commonly offered double-digit yields at one time, but mainly the weaker names do today. Anyway, few trusts offer the same level of blue-chip quality as the best dividend growers."

Stingy Links: Dorfman

Robot stock portfolio rides high again
"Our picks by the data machine for 2007 each had a market value of more than $500 million, more than a penny of profit per share in the latest four quarters reported, more shareholder equity than debt and the lowest share price on the market relative to recent earnings."

Stingy Links: Dreman

Dreman interview
"I guess the key word is yet. I think we'll have some really major opportunities in the stock market. But I think there will be -- we'd like to see a little more unwinding. Actually, the stock market is fundamentally very strong."

Stingy Links: Fun

Hedge-fund guy atones for his subprime bond sins
"Dear investor, we'd like to take this opportunity to update you on the recent performance of our hedge fund, Short-Term Capital Mismanagement LLP. As you know, market selection for the entire fund is guided by a proprietary investing tool we like to call "a dartboard." Once the asset classes are decided, individual security selections are generated by digitizing our unique hexagonal cuboid models. Unfortunately, it transpires that our hexagonal cuboids are not as unique as we thought. Hundreds of other hedge funds possess identical dice. The technical term for this is a "crowded trade." You may also see it referred to as "climbing on a bandwagon already headed for the wall.""

Stingy Links: Funds

Scale effects in mutual fund performance
"Our study examines the role of trading costs as a source of diseconomies of scale for mutual funds. We estimate annual trading costs for a large sample of equity funds and find that they are comparable in magnitude to the expense ratio; that they have higher cross-sectional variation that is related to fund trade size; and that they have an increasingly detrimental impact on performance as the fund's relative trade size increases. Moreover, relative trade size subsumes fund size in regressions of fund returns, which suggests that trading costs are the primary source of diseconomies of scale for funds."

Stingy Links: Government

Dead men farming
"Here's a fact that supporters of the Farm Bill might want to consider as the legislation is deliberated on the House floor this week: Between 1999 and 2005, the U.S Department of Agriculture paid $1.1 billion in farm payments to nearly 173,000 people who weren't alive. Nothing illegal--just Washington business as usual. Under certain conditions, estates can receive farm payments for up to two years after a recipient's death. But according to a study released Tuesday by the Government Accountability Office, 40% of the deceased who received payments from 1999 to 2005 had been dead for at least three years. In one instance, someone who died in 1995 got $400,000."

The escape of the enablers
"Wall Street loves to talk about letting financial markets weed out the weak. But when the Street itself gets in trouble, it sticks out its little tin cup, asking for help. And gets it. The subprime-mortgage-market meltdown is a classic example of the way small fry get devoured, but the whales of Wall Street get rescued. Here's the deal: People with crummy credit who took out mortgages are being allowed to fail in record numbers. The mortgage companies that made those loans are being allowed to fail. The Street itself? It's bailout city. Even before the Fed made a symbolic half-point cut in the discount rate, it and other central banks from Switzerland to Singapore were trying to rescue the Street by injecting hundreds of billions of dollars into the financial markets and announcing they will put up more, if needed."

The OSC fraud squad
"Wow. Stop the presses. Suspected scam artists are being asked to take a two-week summer holiday. Meanwhile, the organizations in question are still lining up potential suckers."

Stingy Links: Graham

What most don't know about P/E ratios
"Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the past 10 years, the P/E ratio has been hovering around 27 recently. That's higher than it has been at any other point during the past 130 years, except for the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off."

Stingy Links: Gross

Tough love on Wall Street
"The past few weeks have exposed a giant crack in modern financial architecture, created by youthful wizards and endorsed for its diversity by central bankers present and past. While the newborn derivatives may hedge individual institutional and sector risk, they cannot eliminate the Waldos. In fact, the inherent leverage that accompanies derivative creation may foster systemic risk when information is unavailable or delayed in its release. Nothing within the current marketplace allows for the hedging of liquidity risk, and that is the problem at the moment. Only the central banks can solve this puzzle, with their own liquidity infusions and perhaps a series of rate cuts. The markets stand by with apprehension."

Stingy Links: Health

How the brain busts the budget
"Sure, persistent money troubles can cause the blues -- but sometimes it's the other way around. Many common disorders can lead to financial woes."

Attack of the mutant rice
"America's rice farmers didn't want to grow a genetically engineered crop. Their customers in Europe did not want to buy it. So how did it end up in our food?"

Stingy Links: Law

Wage wars
"In overtime cases, Depression-era laws aimed at factories and textile mills are being applied in a 21st century economy, raising fundamental questions about the rules of the modern workplace. As the country has shifted from manufacturing to services, for example, which employees deserve the protections these laws offer? Generally, workers with jobs that require independent judgment have not been entitled to overtime pay. But with businesses embracing efficiency and quality-control initiatives, more and more tasks, even in offices, are becoming standardized, tightly choreographed routines. That's just one of several factors blurring the traditional blue-collar/white-collar divide. Then there's technology: In an always-on, telecommuting world, when does the workday begin and end? The ambiguity now surrounding these questions is tripping up companies and enriching lawyers like Thierman."

Viscusi interview
"So, for instance, in the case of Superfund cleanups of hazardous wastes, the people who benefit from the cleanups are not paying the costs directly and thus demand the most stringent standards possible. The result is that the median cost per cancer case averted is about $7 billion. It's off the charts because you are using the responsible parties' money to clean up the site. In contrast, if you look at the amount of money people are willing to pay for houses that are not exposed to hazardous waste risks, you don't observe that kind of large trade-off at all."

Justices end 96-year-old ban on price floors
"Striking down an antitrust rule nearly a century old, the Supreme Court ruled today that it is no longer automatically unlawful for manufacturers and distributors to agree on setting minimum retail prices. The decision will give producers significantly more leeway, though not unlimited power, to dictate retail prices and to restrict the flexibility of discounters."

Stingy Links: Management

Outdoing the Swiss Army knife
"Long before holstered cellphones appeared on handymen's belts, another gadget won their hearts and hips: the Leatherman Pocket Survival Tool. Within three months of its first listing in a mail-order catalog, the multifunctional gizmo became essential for thousands of hikers, hunters, and knife enthusiasts. Since then, Leatherman tools have blasted into space with NASA astronauts, severed umbilical cords on newborns, and extracted shrapnel from American troops in Iraq. As founder Tim Leatherman tells it, the idea behind his company grew out of a routine car breakdown. He and his wife spent most of 1975 touring Europe and Asia in a used Fiat. Its hoses leaked and the wiring failed constantly, and Leatherman's generic pocketknife lacked the means to fix them. Inspiration struck: Why not add pliers to a pocketknife? By the time the couple returned to the U.S., Leatherman had sketched out a design. A few weeks later he was using his brother-in-law's machining tools to construct the first prototype."

A virtuous cycle
"In 18th- and early 19th-century Britain a sizable chunk of the nation's economy was run by members of the religious sect known as the Quakers. Quakers owned more than half of the country's ironworks. They were key players in banking (both Barclays and Lloyds were Quaker institutions). They dominated consumer businesses like chocolate and biscuits. And they were instrumental in facilitating the transatlantic trade between Britain and America. Initially their success was built around the benefits Quakers got from trading with one another. Because they dissented from the Church of England, members of the sect were barred from the professions and as a result gravitated toward business. When Quakers went looking for credit or for trade, then, they found it easy to partner with fellow believers. Their common faith facilitated trust, allowing a Quaker tradesman in London to ship goods across the ocean and be certain that he would be paid when they arrived in Philadelphia. Quaker prosperity did not go unnoticed by the outside world. They were well known already for their personal emphasis on absolute honesty, and as businessmen they were famously rigorous and careful in their recordkeeping. They also introduced innovations like fixed prices, which stressed transparency over sharp dealing. All of this clean living, as it were, paid off. Soon, people outside the sect began to seek out Quakers as trading partners, suppliers and sellers. And as Quaker prosperity grew, people drew a connection between that prosperity and the sect's reputation for reliability and trustworthiness. In the long run, observant businessmen came to see, being trustworthy was more lucrative than being Machiavellian. Honesty was the best policy."

Stingy Links: Markets

In nature's casino
"From Miami to San Francisco, the nation's priciest real estate now faced beaches and straddled fault lines; its most vibrant cities occupied its most hazardous land. If, after World War II, you had set out to redistribute wealth to maximize the sums that might be lost to nature, you couldn't have done much better than Americans had done. And virtually no one - not even the weather bookies - fully understood the true odds."

How bad debt infected the world
"Cathy Busby has never met Mick Mayor. The 47-year-old hospital administrator from Colorado had no idea that when she fell behind with the mortgage payments on her three-bedroom home in the suburbs of Denver, it would stop Barclays extending the overdraft limit on Mayor's business four months later. But this is the true story of the global credit crunch. What seemed initially to be a problem in the US housing market is now forcing up the cost of borrowing in Britain, having swept from Denver to Darlington."

Too clever by 50 basis points
"The past few weeks have shown that financiers did not fully understand what they were trading. The boom in derivatives was one of those moments when financial engineering raced ahead of back offices and risk-management departments, leaving them struggling to value or account for their holdings. Pierre Pourquery, of Boston Consulting Group, says it is not uncommon for investors to break their exotic purchases into smaller pieces in order to feed them into their risk-management systems. This brings new risks, particularly that the parts will behave differently from the whole under stress. Steven Schwarcz, a professor at Duke University and writer on securitisation, has come across contracts which are so convoluted that it would be impractical for investors to try to understand them: they would have to spend more money hiring experts to deconstruct them than they could ever hope to earn in extra returns."

Bear bonanza
"Earlier this year Prem Watsa, the gunslinging chief of Fairfax Financial, had $341 million riding on a hunch that dozens of brokers, banks and insurers could struggle paying their debts. Watsa has a history of making a killing on bearish bets. He sold half the company's stock holdings before the 1987 crash and bought puts against the S&P 500 before the index fell in 2000. But as summer began, his latest wager had produced nothing but losses. Then the credit markets seized up, and investors began clamoring for the Toronto insurer's collection of credit default swaps, basically insurance against bond defaults. Prices climbed. By the end of July Fairfax's swaps were worth $537 million, up 170% in a month."

Crisis counsel
"In one way, I'm sympathetic to the institutional reluctance to face the music. I'd give a lot to mark my weight to "model" rather than to "market.""

Another pounding
"The current fear is not so much that the housing market could drive America into recession, although that could still happen. The worry is more that credit conditions may get tighter. The spread paid by higher-risk European firms has increased by almost a percentage point since mid-June. Investors are shying away from some loans being offered to finance leveraged buy-outs. A slowdown in such private equity-driven bids would hit the stockmarket."

Bear Stearns' collateral damage
"The implosion of a hedge fund often sheds some unwanted attention on the wealthy investors who chose to sink money into the venture. That's certainly the case with an 11-month-old Bear Stearns hedge fund that bet heavily on risky bonds backed by subprime mortgages and is teetering on the verge of collapse"

Fed bends rules to help two big banks
"The regulations in question effectively limit a bank's funding exposure to an affiliate to 10% of the bank's capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, "that represents about 30% of Citibank's total regulatory capital, which is no small exemption," says Charlie Peabody, banks analyst at Portales Partners. The Fed says that it made the exemption in the public interest, because it allows Citibank to get liquidity to the brokerage in "the most rapid and cost-effective manner possible." So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle."

'Uptick' rule change an opportunity
"The old SEC rule said that short selling could only be done at a price higher than the last traded price. It was instituted to eliminate the "bear raids" of the roaring 1920s, when well-financed stock operators would come out with wave after wave of short selling at ever lower prices. This spiralling price fall would give the raiders the chance to buy back their shorted shares from panicked sellers, and go home richer at the expense of the uninformed masses. The "sell on uptick" rule eliminated such bear raids, with some exceptions. One was in commodities, where you can short at any price, and another was for some brokers, in some cases. The last one is important because it helped cause the 1987 crash, through "portfolio insurance," which gave investors dyspepsia and a buying opportunity, same as it might in the near future."

Stingy Links: Miller

What's luck got to do with it?
"Somebody once asked Bill Ruane [the late manager of the legendary Sequoia Fund], and I happened to be in the audience that day, "How do you learn about investing?" And Bill said, "Well, if you read Ben Graham's Security Analysis and The Intelligent Investor you'll be well versed in it. And then if you read Warren Buffett's shareholder letters and understand them too, you'll know everything there is to know about investing. And you will become a successful investor." And I think Bill was right, but it takes a lot of time to do that. Puggy Pearson made it a little pithier when he said, his line was, "There ain't only three things to gambling. Knowing the 60/40 end of a proposition, money management, and knowing yourself.""

Bill Miller Q2 Letter
"Owning housing stocks in the midst of the worst housing market in at least 15 years, and one where the problems may linger until 2009, may prompt a reaction similar to that one client had when we bought a company in the midst of a scandal: don.t you read the papers? At LMCM we actually try to buy low and sell high, and you don't buy low when everything is great and the headlines reflect it. Usually, but not always, when you read about some industry or company having the worst time since some period of years, or even decades ago, you will find that buying that industry or company when it was going through those difficulties proved quite profitable if your time horizon wasn.t measured in days or months. The headlines today are all about this being the worst housing market since the early 1990.s. Had you bought housing stocks during that previous period of duress, you would have made many times your money and handily outperformed the market over the subsequent decade."

Stingy Links: Montier

Index investing isn't passive
"Just for the record, Bogleheads are die-hard devotees of index investing. Occassionally someone will mistake my criticisms of much of the active management industry for support of the Bogleheads' position. However, this isn't the case. In fact I reject pretty much all the foundations that index investing is built upon (see Chapter 35 of Behavioural Investing). The only exception is that the Bogleheads are quite right to point out the importance of minimising costs."

The folly of forecasting
"One of the papers that didn't make it into the Behavioural Investing book (but with hindsight perhaps should have been added in) was on the performance of economists in forecasting recession. In it I pointed that economists are simply hopeless when it comes to forecasting recessions (I could have stopped that sentance before the word recessions). Their track record is truly appalling. The chart below shows that in recent history (1980 onwards) the consensus of economists has not managed to forecast either of the recessions that have occurred."

Stingy Links: Munger

Charlie Munger's 2007 commencement address
"Safest way to get what you want is to deserve what you want. Deliver to the world what you would buy if you were on the other end. There is huge pleasure in life to be obtained from getting deserved trust. And the way to get it is to deliver what you would want to buy if the circumstances were reversed."

2007 Wesco notes
"Railroads - now that's an example of changing our minds. Warren and I have hated railroads our entire life. They're capital-intensive, heavily unionized, with some make-work rules, heavily regulated, and long competed with a comparative disadvantage vs. the trucking industry, which has a very efficient method of propulsion (diesel engines) and uses free public roads. Railroads have long been a terrible business and have been lousy for investors. We did finally change our minds and invested. We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time. There's a German saying: Man is too soon old and too late smart. We were too late smart. We finally realized that railroads now have a huge competitive advantage, with double stacked railcars, guided by computers, moving more and more production from China, etc. They have a big advantage over truckers in huge classes of business."

Stingy Links: Real Estate

Housing woes hit high end
"The jumbos are probably a bigger impediment than fear. The term refers to home loans in excess of $417,000. By rule, they cannot be guaranteed by the government-sponsored mortgage finance companies Fannie Mae and Freddie Mac. Of late, if Fannie or Freddie aren't vouching for your loan, there's trouble. As with most mortgages, jumbos are typically bundled together by lenders and then resold to investors (often mutual or pension funds) as mortgage-backed securities. The problem: The rising number of defaults on subprime mortgages -- particularly among borrowers who took out interest-only or other exotic loans -- has laid bare the, um, less than diligent practices of many lenders. That has spooked investors and dried up the secondary market for mortgages -- even those of sterling quality -- that aren't guaranteed by Fannie or Freddie. Unable to resell their jumbo mortgages on Wall Street, lenders are now making far fewer mega-loans, and those they are making charge much more onerous interest."

Don't buy that house
"The dream of owning your own home is as American as apple pie--and (supposedly) better for you. Over and over, we are told that homeownership will make you happier, healthier and wealthier. Heck, it's even supposed to make you a better citizen. Of course, there are times when, depending on your age, your savings and your income, buying a home can be a smart decision and an excellent way to build wealth. But is buying a home really such a universally good idea?"

Why rent? To get richer
"Shares return 7% a year after inflation because that's how fast companies tend to increase their profits. Houses have their own version of profits: rents. Tenant-occupied houses generate actual rents, while owner-occupied houses generate ones that are implied but no less real: the rents their owners don't have to pay each year. House prices and rents have been closely linked throughout history, with both increasing at the rate of inflation, or about 3% a year since 1900. A house, after all, is an ordinary good. It can't think up ways to drive profits like a company's managers can. Absent artificial boosts to demand, house prices will increase over long periods at the rate of inflation, for a real return of zero."

Florida foreclosure future shock
"A tidal wave of foreclosures may be heading toward Florida, if you judge by the number of homeowners looking to get rid of their homes as fast as they can. Duane LeGate, president of House Buyer Network, arranges quick sales for home owners in distress. He claims he can predict where markets will go bad by looking at the traffic on his Web site. "We can tell you what's going to happen nine months from now," he said. His most endangered market right now is Orange County, Florida, home of Disney World."

Stingy Links: Shiller

A psychology lesson from the markets
"Many people feel that they have discovered their true inner genius as investors and have relished the new self-expression and excitement. Investors across the world have been thinking that they are winners - not recognizing that much of their success is only a result of a boom. Declines in asset prices endanger this very self-esteem. That is why it is so hard to turn around investor attitudes once a downward psychology sets in. The Fed and other central banks do not have lithium or Prozac in their bag of remedies, and so cannot control it."

Stingy Links: Taxes

The naked truth about tax shelters
"There's no shortage of promoters in Canada today who are happy to provide tax opinions on their strategies, written by reputable legal and accounting firms, and may even provide other evidence supporting the tax deductions or credits being claimed. The problem? Those opinions and that evidence is not worth the paper it's written on if the strategy should have been registered as a tax shelter with Canada Revenue but wasn't. If you're considering a tax strategy that's being marketed by a promoter, it's just as important to ask for a legal opinion on whether the strategy is defined to be a tax shelter (if no TSIN has been applied for) as it is to read the tax opinion on the strategy itself."

When to pull trigger on a loss
"It makes most sense to sell to trigger a capital loss when at least one of the following is true: (1) you don't want to own the investment any more, or (2) you have capital gains in the current or a prior year that you'll be able to apply the losses against. Otherwise, think twice before selling."

It's intent that counts in loss claims
"My four-year-old son Michael set up a lemonade stand at the end of our driveway and made $2.75 (selling lemonade to my wife Carolyn and me ). Excitedly, he asked: "Dad, can we go to the store to buy some candy?" "Wait a minute," I replied. "You earned $2.75, but the lemonade cost $1.75, and the plastic cups cost $2. By my calculations that means you actually lost $1. And to make matters worse, when you claim that loss on your tax return, Canada Revenue might say you weren't carrying on a commercial activity, and deny the loss." Michael looked at me with a blank stare."

The perils of joint ownership
"What you should avoid, however, is giving the last laugh to someone who, against your intentions, inherits some of your assets when you're gone. If you're not careful, joint ownership can cause this problem. Let me share three stories to help explain."

Company cars: Perk or penalty?
"Whether it makes sense to drive a vehicle provided by your employer or to provide your own vehicle for use in your work comes down to a number-crunching exercise. Your best bet is to have an accountant do the math for you, but there are some general guidelines that apply."

Income transfers can backfire
"The only thing that might hurt more than paying double the cost is being double-taxed. Subsection 56(4) of Canadian tax law can cause this problem if you're not careful."

Stingy Links: Thrift

How rich friends make you feel poor
"Trying to live as if you have more money than you do may be one of the biggest causes of financial distress in America today, and nobody wants to talk about it."

What's up with all those tip jars?
"Am I alone in taking pointed notice of all the tip jars that have blossomed on business countertops? From delis to pizzerias, Chinese takeout joints to barbershops, the word has spread like wildfire: If you put out a tip jar, people will fill it. Well, maybe they will, but I have yet to be shamed (if this is the right word) into casting my coin into the tip jar fountain. Perhaps it is the scientist in me, but I try to reason the situation out like this: I call in my order to the Chinese restaurant. I drive there to pick it up. I pay the menu price. Why on earth would I pay more than they are asking for their product? Doing so strikes me as positively un-American. Tipping used to be confined to service-oriented occupations: waitresses, taxi drivers, doormen. Now it has spread to businesses where I seem to be doing most of the work."

How to earn $1 million by not watching TV
"A recent study found that it would take $1 million for someone to be willing to give up TV for the rest of their lives. Guess what? If you decided to give up TV and invested the money you saved, you would get that $1 million -- and probably a lot more."

Stingy Links: Value Investing

Absence of fear
"There have been several studies as to how inflated housing prices had become prior to the present correction. According to the work done by Gary Shilling's firm, home prices would have to correct between 22% and 28% to return to the equivalent of the median asking rent or to the trend line of the CPI. Prior to 1996, both of these measures approximated the rate of increase in home prices. According to Robert Shiller of Yale University, his real quality-adjusted existing house price index would have to correct nearly 45% to bring it back into alignment. My initial reaction to this estimate was one of disbelief and that it appears excessive; however, home prices would appear to have a considerable way to fall, given the high level of total homes available for sale. With nearly 4.5 million homes for sale in 2007, this compares to an average of approximately 2.5 million homes since 1990 or an excess of approximately 2 million homes. Since 1965, the median dollar volume of single-family homes sales as a percentage of nominal GDP has averaged 8.4% versus 16.3% at the 2005 peak, according to Northern Trust Global Economic Research."

The value of Fundamental Indexing
"Proponents of market benchmarks weighted by such factors as dividends, earnings or sales claim that an investment management revolution is afoot. But is the concept really new - or is it just a cleverly repackaged version of the discipline known as value investing?"

The evolution of the idea of 'value investing'
"Benjamin Graham and David L. Dodd's Security Analysis, first published in 1934, brought structure and logic to the field, creating an intellectual framework for sound investment. In an area where much looks foolish shortly after publication, Graham's principles have proved reliable for over sixty-five years."

In the risk-reward game, Hartco worth holding
"A general rule of investing is the higher the potential rate of return, the greater the degree of risk. One way that this relationship expresses itself is when people chase yield. We did exactly that with our purchase of Hartco Corp. at prices from $3.02 to $3.46 over the past year or so."

The bargain basement isn't empty
"Jeremy J. Siegel, a professor of finance at the Wharton School of the University of Pennsylvania and an adviser to WisdomTree Asset Management, is also a believer. He said that value stocks "have been bid up a bit more than they have in the past," but that "it is not a time to abandon value and go for growth. In the long run, value stocks have done better.""

Why disciplined value investing is so difficult
"Ask yourself a simple question, Jean-Marie Eveillard says. "If Warren Buffett is the second-richest man in the world, why aren't there more professional value investors?"

Prem Watsa Intelligent Investing Lecture
"The topic of Mr. Watsa's keynote speech was Ben Graham and Bubbles."

Frugally Yours,
Norman Rothery
ISSN 1499-2787

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