Concentrated in Financials, Don’t Invest in Banks at Any Price, Money, Lessons from Poker

Value Investing Blog

A reader, Mohammed Al-Alwan, graciously pointed out an interesting web-site for value investors.   Some interesting articles here:

Read about the issues of portfolio concentration:


We mentioned the struggles of Fairholme Funds holding concentrated positions in financial companies like Bank of America (BAC) and American International Group (AIG) here:

The Risks of Investing in Financial Firms

This article warns value investors from investing in banks at any price.


You will understand the risks from reading What has the Government Done to Our Money?  Posted here: From pages 56 and 57:

A bank, then, is not taking the usually business risk. It does not, like all businessmen, arrange the time pattern of its assets proportionately to the time pattern of liabilities, i.e., see to it that it will have enough money, on due dates, to pay its bills. Instead, most of its liabilities are instantaneous, but its assets are not.

The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but its bankruptcy is only revealed when customers get suspicious and precipitate “bank runs.” No other business experiences a phenomenon like a “run.” No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.

And let not forget the derivatives risk financial firms take:

Derivatives Risk – A Brief Rant by Michael S. Rozeff

Today I read a very technical article on credit derivatives as used by banks (and other institutions), and in the end I came away thinking “this is madness.” There are so many hairy problems involved here in attempting to price these things and no one knows the answers. I think answers are unobtainable. The assumptions being made about measuring risks are untenable. In an “Austrian” world, no one can predict them and past distributions do not suffice. Banks doing large amounts of trading in derivatives do not know what their risks are. However, astoundingly, huge sums of money are recorded as gains and losses on accounting statements based on estimates of risk parameters that no one actually is sure of.

I kept thinking that these banks are doing all this trading while having their deposits insured and the FED as a backup. This is a huge moral hazard problem. Mention was also made of the re-hypothecation issue that can set off unknown chain reactions of failures. The MF Global collapse is the canary in the mine. If the dollar had stayed anchored to gold, we would not have had the explosion in derivatives. They grew at first mainly as instruments to deal with the increased risks in interest rate and currency volatility. But now almost any company plays with these things. I have a hard time believing that it’s efficient for companies routinely to be using these as supposed hedges. It’s hard to find good reasons why such activities add value for stockholders.

The financial companies and banks have used them off-balance sheet and to create excessive leverage, while regulators allowed it. The whiz kids at these banks could wave mathematical models and jargon at them endlessly, as they are doing again at Basel where there is yet another vain attempt to control the moral hazard in banks. The last time around, sovereign debts were thought to be riskless and always excellent collateral. If ever a system cried out for a complete reset, it is the monetary system.

Another historical view of banking:

Money and the government:

Many believe that the U. S. Constitution says the government’s power to “regulate” money means the power to increase its quantity. No, the power to regulate money was placed in the “weights and measures” clause because that’s what “regulating” money meant. Silver dollar coins were the U.S. standard from the very beginning, and “regulating” the currency meant establishing a ratio between the silver dollar and other precious-metal coins that may circulate alongside it.

The Pure Time Preference Theory of Interest

If you want to understand how the Federal Reserve damages the economy by causing malinvestment through manipulating interest rates see:

And read this short article:

Consumers and entrepreneurs often speak of “the cost of money” when referring to interest rates. Modern lenders also refer to the interest they charge as “loan pricing.” Viewed this way, interest is viewed as if it were any other good. The cheaper a good the more affordable it is. And so the lower the interest rate, the more affordable. By dictating key interest rates, modern central bankers are believed to be alchemists, lowering interest rates to magically transform scarcity into prosperity.

Poker Lessons for Life

Let’s have some fun. Lessons learned from poker:

4 responses to “Concentrated in Financials, Don’t Invest in Banks at Any Price, Money, Lessons from Poker

  1. On the subject of portfolio concentration, there’s a really interesting article I spotted today “The one key to generating alpha and beating the market”. Their advice: “If you want to substantially beat the market, make sure you have an edge in every investment you make. And when you do have a true edge, and you’re confident in that edge, make your bet a big one!”

    On the subject of risk, I’ve recently been reading the writings of Nassim Taleb. He scoffs at most notions of measuring risk, esp. wrt the quants at the banks, with a battery of PhDs or no. He argues that the models are too idealised, and can’t take account of “black swans”. Their models are too “fragile”, as he calls it. Models which are fragile are prone to hidden risks. Interestingly, he offers a fairly simple way to detect the fragility of a model: you make perturbations to your model, and if you see that an adverse move is more significant than a favourable mood, then it’s likely that your model is too fragile.

    Interesting stuff.

    • You have caught on to Munger’s and Greenblatt’s secret: Load the boat when you can drive a truck through price and IV.

      In Greenblatt’s book on Special Sits, You Can Be a Stock Market Genius, he wrote about Sears being broken up. He really knows how to weight his opportunities. He probably had 35% or more of his portfolio in that.

      Note his analysis on Well Fargo in using leaps. He can’t analyze better, but he can pick his spots and push his best ideas.
      The question is how do you know?

      I call it the frozen flounder test–would you notice if you were smashed in the face with a frozen flounder? Yes! Then that is how obvious the opportunity should be despite the high degree of fear when the opportunity presents itself. W. Tilson calls the feeling, “Trembling with Greed.”

  2. Also, read his analysis of Fairholme (name not mentioned) here: This is a lesson in correlated bets of a NON-diversified portfolio. If wrong, you go down with the ship.

    • “Diversified means having positions in different industries”

      Peter Lynch was telling small-time private investors not to put all your savings in one industry. I guess Bruce didn’t get that particular memo.

      “This is a genuine portfolio from a big-name fund manager with a fantastic reputation whom politeness (and bad karma) prevents us from naming”

      Lol. I like the way he uses the word “genuine”, as in “yes, we’re really not making this up”. Do we get a prize for being able to identify the fund manager? I hope it’s not another tip from Jim Cramer, though. His last one worked out terrible.

      I hope you had a nice xmas, John, and I look forward to reading more of your enlightening articles.

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