Monday, April 26, 2010

Learning the "Boring Stuff"

A couple of years ago I read a book called The Power Broker: Robert Moses and The Fall of New York. Written by Robert Caro in the mid-1970's, it is an exhaustive study of how the influences of an unelected official - Robert Moses - came to play a major role in shaping modern New York City.

One of the key aspects of Robert Moses's power was his ability to understand the details of the laws that were being written. In fact, Moses was so adept at writing new laws and regulations that politicians - from the governor of the state of New York to the mayor of the City - came to totally rely on Moses.

Problem was, Moses often had his own agenda, and would often draft legislation that would make sure that his vision of what should happen would be the one adopted. Political figures would often become furious with the power that Moses had garnered, only to find that they had been out-maneuvered by Moses by legislation that he had written and they had signed (but never read).

Moses became known as the man who "got things done" in New York, and for many decades was a major figure on the political scene.

I have been reminded of Robert Moses on several occasions in the last few weeks in recent news events since it seems that those who are willing to sweat the "boring" details often come out ahead.

For example, in Michael Lewis's new book The Big Short, he talks about several major investors who made fortunes betting against the housing market through shorting various mortgage-backed securities and derivatives.

How did they know which ones to short? Simple: they read all of the boring details of the securities and the derivatives. This information was available to all, but most never bothered to actually study the securities.

Our whole investment process seems to encourage only superficial analysis. For example, when an IPO is introduced, usually investors are given hours to actually do any in-depth reading on what is being offered since they are "sophisticated" investors.

Or take the rating agencies, who seem to be guilty more of lax work requirements than any real culpability in the credit markets debacle. Relying on models, and forced to work under very tight time constraints, the agencies viewed the mortgage-backed market as a money machine, where ratings were issued under a formulas that the underwriters helped to develop. Now the agencies look silly, of course, but in the middle of the last decade very few actually did the legwork to try to understand the risks.

The SEC's recent filing against Goldman Sachs seems to me, at least, to be a protest against someone who actually bothered to do their homework. The SEC claims that Goldman should have told their clients that a hedge fund manager was betting against the very securities they were selling them. Well, maybe, but it appears that very large investors were willing to rely on the words of a Goldman salesperson rather than do any in-depth work on their own.

The recently passed health care bill was more than 2,000 pages long - how many do you think have read the whole document? I bet in years to come we will find people who have made serious money studying the new laws and acting in ways that those who voted for the bill never intended.

Then there are the proposed new financial regulations now being debated in Congress. Most likely our legislators are reacting to summaries prepared by their staff, since this too is unlikely to have been seriously studied.

I don't know why legislation has become so voluminous. The Civil Rights Act that LBJ pushed through Congress in 1965 was only 6 pages long, but clearly was an important piece of legislation. Come to think about it, the length of the Constitution is probably no more than two or three pages, yet has survived for more than 200 years.

More to follow