1-2 Knockout

Well, now that Cox solved that problem...

Cox made his "no short selling" announcement at 12:51 (according to Bloomberg).  Expecting the end of the worst, investors bid up shares 9%, only to realize that maybe it wasn't the naked shorts 'who dun it'.

Thanks, Comrade Paulson

Over at Naked Capitalism, Yves Smith laments over William Butler's "characteristically colorful" piece "Time for comrade Paulson to pull the plug on the Fannie and Freddie charade".  Yves regrets Mr. Butler beating him to the punch over the backdoor socialism movement underway here in America.  It is a topic i have opined on numerous times, but never with the clarity of thought Mr. Butler or Mr. Smith provide.

"But Buiter's beef isn't the operation of the GSEs but the philosophy behind them, the hydra-headed and not fully visible ways the US has socialized real estate (did you know about the Farm Credit Banks, for instance?). He provided a good summary of the history and dramatis personae."

Read both editorials.  They are incredible.

Enjoy your weekend and take a shot (or down a fifth) of Jack for me while you ponder the impending downfall of the American financial system--you've got a front row seat.

(hat tip - ep)

 

Setting the Record Straight: Taxpayers Are NOT Funding JPM's Buyout of Bear Stearns

Since news of its imminent collapse and the actions of the Federal Reserve to prevent it, much of the criticism heaped upon JP Morgan’s takeout of Bear Stearns has revolved around whether it amounts to a taxpayer-funded bailout of Wall Street. Countless media reports would have their readers believe that this is indeed the case, but I have yet to read a single compelling explanation of how exactly this is the case. It does not take much effort to stoke the populist fire by quoting anonymous sources or citing vague ‘reports’ supporting this conclusion. To date, not a single account I have read attacks the crux of the matter, which is to explain the mechanisms, or under what circumstances taxpayer funds were, or could be used to fund the transaction.

I’ve scoured information on the Federal Reserve’s website and spoken with respected authorities on the subject, none of which suggest that taxpayers are footing the bill for the transaction. The likelihood that taxpayer funds will every be used at all is slim-to-none. One source I spoke with, a respected Finance Professor (of Markets & Banking, among other subjects) went so far as to say that he doesn’t expect either JPM or the Fed to take any significant loss as a result of the Bear deal when all is said-and-done.

Before anyone jumps down my neck, let me elaborate.

Two weeks ago the Fed released its quarterly update of the collateral pledged against its loan to JPM was marked down to $28.9 Bn from ~$30 bn when the loan was first made. Maturities on the assets pledged extend out 10-20 years or more, according to what I’ve seen, although the Fed is relatively mum on the exact composition of the portfolio.

To illustrate what would happen in an extreme case, lets consider a semi-arbitrary situation in which the default rate on the pledged assets is 100% (which is very unlikely, baring global financial catastrophe or something on that scale), with zero recovery on any assets, spread out evenly over 15 years. In this example, these are not simply mark-to-market accounting losses (how they’ll actually show), but economic losses, just to illustrate the point. In this example, the Fed will have to absorb ~$2bn per year over that 15 year period, a figure which may seem extreme, but as I’ll explain, is relatively insignificant in the grand scheme of things.

In “Purposes & Functions of the Federal Reserve”, pp. 11, it states:

The income of the Federal Reserve System is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. Other major sources of income are the interest on foreign currency investments held by the System; interest on loans to depository institutions; and fees received for services provided to deposi­tory institutions, such as check clearing, funds transfers, and automated clearinghouse operations.

“Ok, BFD, so what?” you say. Relax my young padawan, for the truth shall set you free:

After it pays its expenses, the Federal Reserve turns the rest of its earn­ings over to the U.S. Treasury. About 95 percent of the Reserve Banks’ net earnings have been paid into the Treasury since the Federal Reserve System began operations in 1914. (Income and expenses of the Federal Reserve Banks from 1914 to the present are included in the Annual Report of the Board of Governors.) In 2003, the Federal Reserve paid approxi­mately $22 billion to the Treasury.

In 2007 this number was $38.7bn, up from $29.1bn in 2006 (pp. 360 of the report). Even if we take the low number from 2003, the $2bn annual loss from the above extreme example would only represent less than a 10% hit to the funds contributed to the Treasury by the Fed.

For those who still don’t get it, let me explain. While the Fed is funded and overseen by Congress, it is “private within the Government;” it is effectively a self-funded entity operating as a “private” organization within Government. The loan extended by the Fed to JPM (via Maiden Lane, LLC) was a direct extension of credit from the Fed’s balance sheet, not from an appropriate of taxpayer monies, which so far as I can tell, would have required specific Congressional action.

When this information is taken in its entirety the only possible “hit” to taxpayers would be a budgetary shortfall resulting from poor budgetary planning (e.g. if the budget was based on receiving X dollars from the Fed, only to actually receive X minus whatever “loss” the Fed absorbed from collateral losses in the Bear collateral). Even in this situation, taxpayers still are not actually funding any part of the transaction, only the foregone funds – which were never a certainty to begin with – of the difference between the estimated Fed contribution and its actual contribution in a given year.

May I be missing something (or potentially many things)? Absolutely. But all research I’ve done suggests that one thing is certain (or at least as certain as anything can be these days): Taxpayers are NOT funding the purchase (“bailout,” whatever) of Bear Stearns.  Until, or unless someone can provide clear, factual support that this is not the case, journalists, pundits, and even those of us on The Street need to resist the urge to propagate the unsubstantiated claims of those who cannot or will not back up such claims.

Gas Prices Are WAY Worse Than We Thought

Receiving little, if any coverage in the media are the horrific effects high gas prices are having on the country club set.  In hindsight, this shouldn't come as a surprise, considering that the average vehicle in any country club parking lot probably gets somewhere around 10 miles per gallon. 

Anyway, things are so bad that Callaway, maker of such legendary products as the Big Bertha driver,  has resorted to offering customers free gas cards when they purchase a new sledgehammer driver. 

I'm sorry folks, its one thing when drab automaker du jour, Chrysler, offers gas cards when people buy their cars (or whatever they sell these days), but golf clubs?  Callaway?  I mean, does Congress know HOW BAD IT REALLY IS, or, do THEY HAVE NO IDEA??????

Taken at Sports Authority, 6/19/2008

(Mis)Adventures in Myopia

We're all supposed to 'know' that investors are myopic, that they tend to focus on the present and very-near future while ignoring the long-term.  While this may be a convenient assumption in modern finance, it behooves the prudent investor to look beyond the 'now', so-to-speak, beyond the hype, to find attractive long-term investment success.  Unfortunately, this approach seems to be about as popular as Nick Hogan at a MADD conference.  The sheer amount of evidence is staggering, but I'll keep it light and let Bloomberg do the work:

Retail sales in the U.S. rose twice as much as forecast in May as Americans snapped up electronics, clothes and furniture, evidence that they aren't hoarding their tax-rebate checks or using them just to pay for gasoline.

``It's just amazing -- the American consumer's resilience in the face of everything negative,'' Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, said in an interview with Bloomberg Television.

Yes!  Long live consumer whoredom!  Maybe we can spend our way out of this 'recession' after all, no?  Hell, the S&P Retail Index is off its year lows (although well-below its highs), and, as Bloomberg points out, retail sales were up TWICE as much as expected!!!  The rest of the article above takes this tone, that the worst of our problems are already behind us.  But, lest we prematurely jump to any conclusions, the very last paragraph reminds us of that which so many seem to be overlooking:

The bulk of the tax rebates will probably be spent from July through September, giving third-quarter growth a lift, before the economy decelerates again in the last three months of the year, the Bloomberg poll also showed.

Oh.  So they're saying that, Aeropostale isn't going to keep increasing same-store sales 20% every quarter? That people are going to have to decide between filling the tank in their Escalade or buying a new XBox?  HOGWASH!  I bet next you're going to try to tell me that defaults on auto and other consumer loans are on the rise, ha!  Rubbish!

And so, sarcasm aside, despite what by all measures is an inevitable storm of difficulties for the economy - especially the consumer discretionary sector - the S&P is already up almost 10% from the lows reached only 3 short months ago.  It seems daily, the so-called pundits, experts, and talking heads in the media are trying to convince us that the worst is already behind us, that the economy is strong.  It is certainly possible that we may be further along towards absorbing the negative affects of the subprime mortgage fiasco, but we've only begun to scratch the surface of the secondary and tertiary effects of a slowing, or receeding economy.  Trading in November, 2008 CBOE Volatility Index (VIX) options strongly support this thesis, as there is massive open interest all the way up to $37.50, implying that some market participants are seriously hedging their bets (or betting outright) should things tank over the next 2 quarters.

It seems, especially in the retail and discretionary sectors, that results have been heavily influenced by the receipt of tax refunds and "stimulus" checks.  While most of the relevent data has yet to come out, early indications suggest that consumers were spending more of their "free" money at the malls, instead of paying off their ever-increasing debt load.

Higher commodity and energy prices, ever-increasing consumer (and government) indebtedness, and a generally downward turning business cycle do not bode well for the state of the U.S. (nay, Global) economy in the itermediate-term.  Unfortunately, it seems that our human nature (or the nature of crowds), the predisposition towards unbridled optimism - even in the face of mounting evidence to the contrary - has been, and will continue to overpower logic and reason. 

Only time will tell, but as I write this and overlook the menacing clouds hovering over the East River, I can't help but think of the storm cloud of consequences from our irresponsible and short-sighted decision-making, threatening the economic well-being of the entire Country as a whole.  Hopefully I'm just letting my predisposition towards cynicism get the best of me, but until I see substantial evidence that my worst fears are only that, I'll be cautiously taking the other side of your long America trades. 

Disclosure: Anal_yst is short Aeropostale, but really long America (at least in heart, but less in portfolio, or something).  Anal_yst is not a creative writer (clearly).

They always say...

You can't get higher returns without taking on more risk...but what about not getting any return regardless of your level of risk? 

Ok, so that's a bit extreme, but here's an interesting chart I made the other day.  It seems that over the past ten years an extremely risk averse (100% LB Agg) portfolio yielded the nearly the same returns as a risk seeking all-equity portfolio (MSCI EAFE).  In other words, incremental risk wasn't rewarded with incremental returns as MPT suggests (see the 28 year efficient frontier in blue for a "normal" version).

This seems trivial, and probably uninteresting to anyone outside of portfolio management, but I think this explains a lot about the past decade's financial foibles, and how we got into our current financial "crisis".

Really I'm just whetting your appetite for a future post.

Said Nextel, "Let Them Eat Cake"

Over at tech uber-blog Engadget, there is an interesting story that Sprint/Nextel waived early-termination fees (the other ETF) for Government employees/agencies.  This is especially interesting, since Chris Cox, chairman of the FCC is trying to push the mobile carriers to come to some sort of agreement to chill out with the ridiculous ETFs.

Thats all well-and-good, and I'm sure theres some yet-to-be-explored angle there, but I'm more interested in the discussion that followed in the comments section on Engadget.  As could be expected, many decried the CRAZY early termination fees as usurious extortion by the carriers.  Some tried (and failed) to kind-of explain, but even the most 1/2 hearted attempts fell on deaf ears.  I also tried (and failed) to lend some reason to the debate, but the kind folks at Engadget refuse to recognize my logon/password, even though I copied it directly off the automated confirm sent to my email when I first signed up.  Alas, I shall not be ignored!

I put together a quick & dirty (spreadsheet ) to illustrate a simple example of the cell phone retail business model, but to summarize, it goes something like this: 

• Step 1. Subsidize cost of phone (i.e. sell as loss-leader)
• Step 2. Amortize the loss/make $$ by locking customers into long-term contracts.
  • Step 2.5. Charge mucho dinero to customers for walking away from said contracts.

Now, some people have a hard time with these fees, which can be as much as $250 (if not more).  My first reaction is generally somewhere along the lines of, "READ THE CONTRACT BEFORE YOU SIGN (idiot)."  Of course, we all know the average person's ability to read (nay, comprehend) contracts is not so good ("hey, who wants a no-doc, stated-income jumbo option arm mortgage?"), so this response is pretty much a waste of breath. 

In reality, people need to understand that they simply cannot have their cake (i.e. affordable handsets) and eat it too (no/low early termination fees). Thats just how the world works.  Deal with it.

In this example, I assumed a 2-year contract period, on which the carrier takes a loss (subsidy) of $200 on the handset at purchase, a contract costing $50 monthly, and an annual interest rate of 9% (semi-arbitrary).  The NPV to the carrier over the life of the contract is about $900.  However, if there we assume a hypothetical situation where there is no early-termination fee and the customer were to cancel after only 12 months, the NPV drops down to about $375, almost a 60% drop in profit.  To the layman, this may seem silly, as the company is still 'making a profit', but that only captures a small part of the picture, running a mobile communications company is an awfully expensive proposition.  Thus, the "profit" generated by long-term mobile contracts enables the company to conduct business, that is, it doesn't simply trickle down to the bottom line uninterrupted.

We'd be delusional, of course, to expect every Joe and Jane Doe understand the complex business model of a wireless carrier, and we'd be similarly delusional to expect the fervor surrounding early-termination fees to die down any time soon. 

Lets assume that the FCC and the carriers come to some sort of agreement limiting the ETFs, avoiding the possibility that Cox & Crew will bow to the anti-capitalist cries from the masses and mandate they be eliminated entirely.  How, then, will the carriers account for the increased uncertainty of future cash flows from service contracts?  One thing is certain:  The carriers are absolutely not going to roll over and play dead.  I'd imagine they'll play ball, so-to-speak, and give up some restrictions on early-termination, but where they're losing money (and the attendant certainty of that money) they'll make up for it elsewhere.  I'd expect they'll keep up with the practice of heavily subsidizing handsets as their main sales driver, and reducing ETFs should definitely increase sales, as people can upgrade their phones more often. 

Its important to keep in mind that not only are the carriers losing out on previously-certain future cash flows, but they'll also suffer a hit to their gross margins as higher handset sales directly increase their CoGS.  To offset this, I'd expect the carriers will increase the cost of service contracts to even-out the PV calculation, and changing the structure (i.e. tenor) of the service contracts they offer.  I think the most obvious solution is that there will be a shift towards 1-year contracts, reducing the likelihood that a customer will switch carriers or upgrade their phone before the contract expires. 

Of course, the trade off is that the shorter-duration contracts will most likely cost more per month than the traditional 2-year variety, but as I said, you can't have your cake, and eat it too.

Welcome to Economics 101, n00b

Every now and then I read something so obscenely dumb, I can't help but respond.  This was one of those times:

DJ Mark to Market: How Much Would You Pay For an iPhone?

By Jim Murphy
A DOW JONES NEWSWIRES COLUMN

...For those readers who don't remember it, the iPhone initially cost $599, but
Mr. Jobs is not concerned about a backlash from existing iPhone customers,
disappointed that they paid significantly more for their cell phones than
future users, the WSJ reported. "This is the way the technology markets work,"
he said.

This is not a revolutionary thought: People should be charged what something
is worth, not whatever the highest possible amount of money the provider of
that something can squeeze out of them.

Oh, duh!  Lets just sell a product for what its worth, my god its so obvious now!  Ok, enough sarcasm, but lets get serious folks, the above statement, and its normative language is in-itself ridiculous, but to make such a claim based upon some arbitrary, unexplicable ideal is at-best painfully ignorant.  I'd have less of a problem (but still one regardless) if the author had presaged the statement with some sort of disclaimer admitting his point doesn't exactly make much sense, or if he'd elaborated as to how one is to determine this mystical idea of "worth."  To be fair though, that statement is far from the most eggregious failure of financial understanding I've seen to-date, it just happened to catch my eye when it could stand to take no more; it was the proverbial straw that broke the camel's back. 

(1-2 chime in)

That being said, the pricing scheme Apple has embarked on makes perfect sense.  It is simply a well executed version of third-degree price discrimination.  By setting the price high for the early adopters (who he arguably didn't charge enough judging by the opportunity cost forgone those who lined up for hours on end to wait for the phones release proved...well maybe their opportunity cost just wasn't that high).  It is the same principal as using coupons to segregate segment customers by price elasticity.   Those who are willing to hunt for coupons are obviously more price sensitive than those who don't care to search through newspapers daily, thus they are charged less.  These are the same people who are now being charged less for second generation iPhones (the price sensitive group), while the inelastic purchasers (early adopters) were charged a price that was able to extract more of the consumers' surplus.

However, it remains to be seen what kind of demand destruction this quickly shifting price structure has.  This is obviously more a branding question with economic impacts than a straight economics question, but if people don't trust that their new iGadget will retain its value for longer than six month they may just not buy first generation products.   It is a careful balance to strike, but perhaps Jobs has it just right.

 

Either way, this was not a benevolent break by Steve Jobs. 

This is a perfect application of price discrimination...the good kind.

Kids: No Work For You (This week in Duh Special)

So, I was going to do a long winded post on this, but Paul Hickey at Bespoke Investment Group did a fine job in his Week in Review (subscription only).

A 10% increase in the unemployment rate is never a good thing, even if a breakdown of the report shows that maybe things weren’t quite so bad. Breaking out the unemployment rate by its various categories shows that workers aged 16 to 19 years old were the primary driver of the increase. The unemployment rate among this sector rose by 21.4% (from 15.4% up to 18.7%). Workers from other categories (married men and married women), where pay is usually higher rose by much more modest amounts.

So why have teenagers become so much less attractive to employers? While the slow economy bears some of the responsibility, another factor in this increase is the result of last year’s legislation to increase the minimum wage. While most employees are paid more than the Federal minimum, the group which has the highest percentage of employees making that wage is teenagers. As college and high school kids looked to get work this summer, employers were less willing to pay them 27% more. (Emphasis Mine).

In short, as the price of a good (in this case labor) increases, the demand for that good decreases.  While employers may be willing to hire students/kids at $4, they don't need them at $6.  So, who loses?  The very people who congress claims to "protect" with minimum wage laws.   

The Biggest BSD You've Never Heard Of

With the scrutiny that comes with big money, it is very rare that a big-time money manager can trounce the market year after year, and continue to evade said scrutiny.  There is one man though, that has for the most part achieved this goal, and even the few publications (e.g. FT) that have mentioned him or his firm have been unable, as far as I can tell, to garner any idea as to the size or performance of this manager's operation.  Since the early 80's, one man, and one firm have somehow, in this Internet age, managed to consistently make the market their bitch, all the while flying mostly under the radar of both the media and investor communities.

His name is Seth Klarman.

And he is, in fact, kind of a big deal.  According to my sources, his firm, the Boston-based Baupost Group currently manages roughly $26 billion, up from about $16 billion the prior year.  Those in-the-know will immediately question these figures, as that AUM would put them squarely in the top-10 largest hedge funds globally, per rankings data from Institutional Investor Alpha, and such a return (net, btw) of mid-to-high double digits on such a large base would surely put him amongst the highest-earning managers last year.   How then, does such a large, market-destroying fund (or fund manager) happen to stay off the radar of most journalists and market followers for so long?  How has he managed this seemingly impossible task, especially when he has even published a book, now out of print, which sells for well over $1,000 on Amazon.com? To that, well, I'm as stumped as the next guy, but I imagine when you're minting that kind of money, you can pretty much set terms with your investors, business partners, and the like.

More important than the issue of his anonymity though, is what he stands for, and how that has enabled him to crush the market for the past 25 years.  To this end, I submit exhibit A: speech given by the man himself at MIT back in October, 2007.  Just a warning, as its a bit on the long side, but definitely well worth reading in its entirety.  Seriously.  It is one of, if not THE most prescient, cogent, and frankly, intelligent things I've read in recent memory with regards to finance and investing.

Klarman may very well be the second coming of Benjamin Graham, the father of value investing.  True to form, he echoes the words of Warren Buffet, and is well on his way to achieving a track record that would make even the Oracle proud:

Right at the core, the mainstream has it backwards. Warren Buffett often quips that the
first rule of investing is to not lose money, and the second rule is to not forget the first rule. Yet few investors approach the world with such a strict standard of risk avoidance. For 25 years, my firm has strived to not lose money—successfully for 24 of those 25 years—and, by investing cautiously and not losing, ample returns have been generated. Had we strived to generate high returns, I am certain that we would have allowed excessive risk into the portfolio—and with risk comes losses...there is no assurance whatsoever that the incurrence of greater risk will actually result in the achievement of higher return. The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk.

His views, not just on investing, but on the macro-factors that have affected everyone from the biggest institutional managers to Joe and Jane Doe, are critical of the 'easy-money' policies that have, in large-part, fueled the economic growth of the past 1/2-century:

We live in an era of leverage not just on Wall Street but on Main Street. For two
generations, credit has become much more widely available and acceptable. In our
grandparent’s era, there were no credit cards, home equity or subprime loans, or CDOs. People paid cash for what they purchased, and worked hard to earn that cash. The sequencing of that mattered, too: first you worked hard, then you bought what you wanted. Even the federal government was expected—except in times of war—to run a balanced budget. But during our parents’ lifetimes and our own, credit has become increasingly available and standards increasingly lax, to the point where credit cards and checks backed by credit lines arrive unrequested in the mail, where your house can be used as an ATM, where people with dismal credit histories are eagerly sought after to provide them with loans, where investors flock to buy junk bonds and shaky companies seek to issue them, and where investment funds are offered the opportunity to enhance their return through structured products, derivatives and exotic financings, all of which embed high amounts of leverage.

The moral imperative of repaying the banker—your neighbor—who granted you the loan across his imposing desk has been replaced by the moral vacuum of anonymous lenders using credit scoring—who quickly resell your loan to someone you will never meet—and who are actually comfortable with the actuarially determined probability that you may default. Credit rating agencies have embraced the debt orgy with lax standards and naïve models, brewing conflicts of interest and accepting healthy fees to label toxic waste as investment grade.

Some of you may invariably and immediately label this as old-fogey "back in my day" rhetoric, but Klarman is no octogenarian (he's in the 50-ish range), nor is he a staunch conservative (based in Boston? me thinks not!).  Those theoreticians and quants amongst you will likely be part of this critical group, as his ideas present a direct affront to that worldview.  To you, my mathematically-inclined friends, Mr. Klarman responds (highlights are mine):

As value investors, our business is to buy bargains that financial market theory says do
not exist. We’ve delivered great returns to our clients for a quarter century—a dollar invested at inception in our largest fund is now worth over 94 dollars, a 20% NET compound return (note: as of YE 2005, this number was $55, which means the fund almost DOUBLED over the past TWO years!). We have achieved this not by incurring high risk as financial theory would suggest, but by deliberately avoiding or hedging the risks that we identified. In other words, there is a large gap between standard financial theory and real world practice. Modern financial theory tells you to calculate the beta of a stock to determine its riskiness. In my entire professional career, now twenty-five years long, I have never calculated a beta. This theory urges you to move your portfolio of holdings closer to the efficient frontier. I have never done so, nor would I know how (note: this is where quant's head's explode!) I have never calculated the alpha or beta of my firm’s investment performance, which is how some people would determine whether or not we have done a good job.

Some people stick to elegant theories long after it is apparent that the theories do not
explain reality. The Chicago School of Economics has said the financial markets are efficient.  They conveniently explain away Warren Buffett’s incredible investment record as aberrational.  The second richest man in the country is a value investor; he built his net worth gradually over nearly 50 years of successful investing. And his net worth continues to grow handsomely! Fifty billion dollars are a lot of aberrations! Rather than abandon their theorizing to study Buffett exhaustively to see what lessons could be learned, too many people cannot bear to re-examine their faulty theories.

Before you guys rip my head off for this veritable heresy (HE CAN'T EVEN CALCULATE BETA, HA!), take a step back and try to un-learn all of your MPT; forget your scandalous quant dreams of RenTech-esque perfection, and embrace the empirical evidence before you:

It is easy to peruse stock tables from the comfort of your office or living room and declare the market efficient. Or you can invest other people’s capital for a number of years and learn that it is not. What is amazing to me is that...the burden of proof somehow is made to fall on the practitioner to demonstrate that they have accomplished something that so-called experts said couldn’t be done (and even then find yourself explained away as aberrational). Almost none of the burden seems to fall on the academics, who cling to their theories even in the face of strong evidence that they are wrong.

Seth Klarman is a value investor, although as he points out, this definition embraces a slightly wider array of complex securities and strategies applicable to today's far-more evolved (and ye,s I use that word somewhat in jest) financial world:

At the very core of its success is the recurrent mispricing of securities in the marketplace. Value investing is, in effect, predicated on the proposition that the efficient-market hypothesis is frequently wrong. If, on the one hand, securities can become undervalued or overvalued, which I believe to be incontrovertibly true, value investors will thrive.

As he puts it, the reasons for his tremendous success seem immediately obvious - almost too-much so - that you sort-of want to bang your head against a wall in one of those "Duh, why didn't I think of that?!?!" moments.  This may very well be the most obvious, yet most apropos point he makes throughout the entire speech:

Institutional constraints and market inefficiencies are the primary reasons that bargains
develop. Investors prefer businesses and securities that are simple over those that are complex. They fancy growth. They enjoy an exciting story. They avoid situations that involve the stigma of financial distress or the taint of litigation. They hate uncertain timing. They prefer liquidity to illiquidity. They prefer the illusion of perfect information that comes with large, successful companies to the limited information from companies embroiled in scandal, fraud, unexpected losses or management turmoil. Institutional selling of a low-priced small-capitalization spinoff, for example, can cause a temporary supply-demand imbalance. If a company fails to declare an expected dividend, institutions restricted to owning dividend-paying stocks may unload shares. Bond funds allowed to own only investment-grade debt would dump their holdings of an issue immediately after it was downgraded below BBB by the rating agencies. Market inefficiencies, like tax selling and window dressing, also create mindless selling, as can the deletion of a stock from an index. These causes of mispricing are deep-rooted in human behavior and market structure, unlikely to be extinguished anytime soon.

Even more obvious, when he describes his strategy, it becomes (if it hasn't already) immediately clear that he is not a man of high-brow, self-aggrandizing style.  The strategy is simple, although it requires patience many investors lack, as often times, its a "hurry up and wait" proposition:

My firm’s approach is to seek situations where there is urgent, panicked or mindless
selling. As Warren Buffett has said, “If you are at a poker table and can’t figure out who the patsy is, it’s you.” In investing, we never want to be the patsy. So rather than buy from smart, informed sellers, we want to buy from urgent, distressed or emotional sellers. This concept applies to just about any asset class: debt, real estate, private equity, as well as public equities.

That Buffet quote, above, may very-well sum up Klarman and the uncanny results the Baupost Group have achieved.  Wait for others to screw up, and then pounce on the opportunity, profiting out of others' weakness.  Whatever criticisms can be levied upon him, or the strategy he espouses, one thing is absolutely incontrovertible, and that is his consistently market-beating performance.  And in the end, as they say, money talks, BS walks.

Thank you to Dr. Adrian Saville for his help with this article.