Financial Post - Diane Francis

BCE skewered by Jarislowsky

Diane Francis — Fri, 08 Aug 2008 12:00:00 GMT

I’ve spent this week happily in Quebec – the eastern townships with friends, Montreal with smart business men and four days in the booming mine area in the province’s north with other directors of a gold mine company I'm involved with.
As is often the case, I had lunch with Stephen Jarislowsky of money management giant, Jarislowsky Fraser. He is my favorite stock market and corporate “scold”.
Stephen is an irascible billionaire money-manager who never pulls punches about anyone or anything. No enemy was left unmentioned, notably those in public companies with whom he had dust-ups. But because our visit was mostly social, I inbterviewed him only briefly and about the world's biggest leveraged buyout, BCE takeout by a couple of U.S. private equity outfits and the Ontario Teachers Pension Plan. The deal has been hugely controversial, and questionable. Bondholders were skinned alive, lost then won then lost in courts. Shareholders approved a deal to close in June which didn't and, even so, new owners have started to tear the place apart and stop dividends.
Ontario Teachers' ownership exceeds the 30% limit on pension ownership and the American equity participation exceeds the 25% limits on telecom ownership.

Here’s our little chat:
Q: BCE?
A: “It’s outrageous that the board of directors took $1 billion from BCE’s bondholders. It’s also just plain stupid that the Supreme Court of Canada, in a 7 to 0 opinion, briefly heard the case and overturned the Quebec Appeal Court’s unanimous 5 to 0 opinion upholding the rights of bondholders.”

Q: The Supreme Court’s overturning of the Quebec Appeal Court’s unanimous decision in any other issue would have sparked a constitutional crisis? What was this all about?
A: “The whole field of investor law is a joke in Canada. What was allowed to happen to BCE bondholders is unbelievable. The dividends were cut for BCE shareholders to reduce the price paid. The board did not look after the bondholders as well as the shareholders. The Quebec Appeal Court’s decision was the correct one.”

Q: Wasn’t this lack of protection for bondholders in the fine print of the deal?
A: “In Canada, the board is responsible to the company and not the shareholders or bondholders. Thomson Reuters just sold bonds and had a clause which stated that bondholders were not protected or subordinate to shareholders. We would not buy bonds like that which mean that they can go from As to junk based on board decisions in the future.”

Q: How is it that BCE is now run by the buyers even though the deal hasn’t closed?
A: “It’s unacceptable.”

Q: Will BCE get the debt it needs to close the deal?
A: “I don’t know. The banks have been out of control and are now having difficulties.”

Q: What legal reforms should occur in Canada?
A: “Much work needs to be done and I am setting up a foundation with others to come up with legislative ideas. Take Conrad Black. He stole more money in Canada than he did in the U.S. and he wasn’t even pursued here. We do not have police or securities commissions who are on the ball. We do not have specialized courts who understand what to do. Suing in Canadian courts is not a remedy because it takes ten years to get anywhere and why should shareholders have to suffer when a board has done something wrong?”
“Arbitration, not lawsuits, is the best way to handle disagreements and problems.”

Q: Why has BCE been so badly managed for so long?
A: “All the company did for decades was go to Ottawa and ask for higher rates of return. They blew money on bad investments and never fixed their customer relations problem. This is a company that has been disliked as much as Air Canada with its hated, high-handed employee behaviour toward customers. That still hasn’t been fixed. I used to have lunch with Michael [Sabia, former CEO]. I like him but he never fixed it.”

Romney versus Hillary 2012

Diane Francis — Thu, 07 Aug 2008 09:36:00 GMT

Romney pulled himself out of the vice presidential sweepstakes this week after putting himself in. This is to enable him to run in 2012 even if McCain wins this fall because McCain will likely not serve a second term due to age. Likewise, Hillary has withdrawn, although not formally. She is nowhere to be seen. Nor has she been spotted on the VP short list, much less campaigning vigorously among her supporters to switch their allegiance to Obama.
The Clintons are not only failing to help the Democrats but are sabotaging the party. They are betting that Obama will lose, and trying to help make that happen. They are waiting for 2012, Hillary's hidden agenda which became obvious to me this spring when she left aside partisan concerns and began to personally attack Obama.
This broke all the rules, left a bad taste in her followers' mouths and provided ammunition for Team McCain to use.

Where are the best running mates?
Both Romney and the Clintons are not willing to help, nor to risk losing or failing as vice presidential candidates. Ironically, Romney withdrew as polls showed a marked improvement for McCain. The Romney calculation here is a no-lose proposition: if McCain loses, Romney as his running mate will disappear from politics forever; but if McCain wins with another vice president, Romney can still contest for the nod because vice presidents are always overshadowed.
Romney's departure also avoids the embarrassment of not being chosen.

Clinton factor
Hillary's calculation is to sabotage Obama and wait four years by which time Bill will have rehabilitated his reputation as an opportunist who is willing to make money off nasty dictators or with questionable business types. She will run for Senate again and he will take up a position at a university as well as his foundation doing good works and plotting their return to the White House.

Her silence speaks volumes. Her absence is encouraging her supporters to consider McCain. Many of her backers, mostly middle-aged women, are upset and feel robbed by the upstart Obama. They also feel she has been slighted by him despite Hillary and Bill's unacceptably bad behaviour during the primaries when they played the race card, the inexperience card and elitist card.
Bill Richardson, disliked by the Clintons for backing Obama, has been dispatched to repair the situation and promised to help them raise money to pay down their campaign debts. I wouldn't be surprised if the Clintons had threatened to leave the party or join up forces with McCain if such an about-face was not done.

The main event
Meanwhile, the contest between Obama and McCain has deteriorated into the first demographics election. McCain is invoking "geezer power" and has cast himself in the role of the cranky, techno-phobic older part of the population. He is running against young people, and using ads with compare Obama with spoiled, dysfunctionals like Britney Spears and Paris Hilton.

At the same time as this maneuvering, there is also some Swiftboating going on, involving these and other vice presidential possibilities:

1. Bill was bashed again for being churlish about Obama. More to follow.

2. More references to Romney's business career and Bain Capital that made him rich by closing plants, offshoring, downsizing, job cuts and tax avoidance techniques. More to follow.

3. The alleged existence of a love child fathered by Democrat John Edwards. More to follow.

4. The murder or suicide of Democrat Jim Webb's right-hand guy. More to follow.

Backdrop to this are several facts. Polls from early June demonstrated a 3% bump for Obama if Hillary is beside him on the ticket against McCain/Romney. Another in July showed an 8% bump for Obama with Hillary. But in 1980, polls showed Carter way ahead of Reagan until he was crushed in the debates, giving Reagan a landslide.

China deserves Olympic Gold

Diane Francis — Wed, 06 Aug 2008 12:00:00 GMT

Obese Chinese girls in tutus: Same problems as the rest of us only more so. Getty

I’m a shameless fan of China’s. No nation in the history of the world has accomplished so much for so many in so little time.
May it continue, and I believe it will despite the many cracks which are beginning to appear.
Beijing governs one out of every five human beings on the planet on a piece of real estate that’s significantly distressed. This is the most over-populated, therefore polluted, place on earth despite a dramatic generation-long one-child policy aimed at stemming the birthrate.
Even so, the country of 1.3 billion people continues to grow by the population of Canada annually and must create at least 200,000 jobs per week to absorb new workers into its economy.

Beijing 2008
This week China will strut its stuff as host of the Olympic Games and, by so doing, will expose itself to more scrutiny and criticism than ever before.

But it’s important to consider the context of criticisms in light of what the Chinese have been able to accomplish through hard work, smarts and much luck.
China has lifted living standards by harnessing and offering to the world the services of its huge, cheap labor pool and talent. It has not attempted to become rich by conquest or by terrorism. The Chinese are not pulling ripcords and aiming to destroy civilization. They are competing against us which is, after all, the western way.
Their goal is indoor plumbing for all, clean drinking water, decent housing, middle class trappings and a better future for their children.
What’s most admirable about China is that it has gotten slowly ahead on our terms, the old fashioned way. It has applied the work ethic and makes things the rest of the world wants and can afford.
The result is China feeds, houses, clothes, educates and looks after the healthcare needs of more people than any jurisdiction. Its middle class grows every year by 25 million. It has one of the highest literacy rates in the world because its little girls are educated, unlike most other developing nations. It has grown its economy since 1978 to US$3 trillion GDP. (The U.S. is US$14 trillion and the EU slightly bigger).

Pride of country
China is proud and should be and the games will be its time to show off its technology, abilities and material progress. But all the attention, and attendance by thousands of journalists, will spotlight the shortcomings too.
For weeks, there have been the predictable pollution stories. The censorship stories. The outbreaks of violence among disenchanted citizens who know that now is the most propitious time to tell the world about perceived injustices.
There also will be journalism at its worst: parachuting in hotdog commentators with laptops whose job will be to feed back the prejudices held about China by the folks at home.

Go China Go
All of this aside, my hope is that China’s technocrats continue to pull off this economic miracle, providing jobs and opportunities for their giant country.
Every year, it becomes more of a challenge despite the iron fist government. Last year, there were an estimated 20,000 violent protests within the country, muted by press censorship. These involved issues that challenge all governments such as pollution, expropriation, jobs, education, health care, regional disparity, corruption, among others.
The Chinese deal with these in the same manner other countries do: through compromise, crackdowns or denial.
Whatever the outcome, these are the growing pains of a nation struggling to enhance the lives of its people and to make ends meet. I wish China continues to earn Gold Medals for its economic growth and so should everyone else in the world . A de-stabilized, or impoverished, Middle Kingdom would likely mark the end of history.

Bottled Water: consumer stupidity

Diane Francis — Mon, 04 Aug 2008 12:11:00 GMT

All-too familiar site of unnecessary waste and expense. Getty Images

Bottled water is the biggest consumer/taxpayer ripoff ever. It is also a public scam because of the costs to taxpayers and the environment. Some studies show that the water is no better than tap water (and often is tap water) which means that consumers are really buying bottles that use petroleum and expend huge amounts of energy in their manufacture, transport (water is heavy) and distribution. Then there's the cost of garbage pickup, recycling or burying this junk in landfill sites.

Bottled water manufacturers should be charged huge taxes to cover all these costs and consumers should have to pay deposits to insure that bottles are recycled.

From the consumer viewpoint, the absurdity of bottled water purchases is illustrated in the slides below, prepared and sent to me by University of Toronto geology Professor Andrew Miall. He has written many books, but most recently "Canada Rocks" about the country's geological history. I met him while participating, along with many other authors, this past weekend at the Saskatchewan Festival of Words in Moose Jaw. Water usage and water pollution are areas of interest to him as a geologist.

This photo was taken by Miall in a Canadian store and the calculations, as to costs, are his.

Here's another slide listing the reasons why the stuff is a joke:

Obama vs. McCain: young vs. old

Diane Francis — Fri, 01 Aug 2008 11:56:00 GMT

Millennial generation: diverse, collaborative, apolitical and eventually in charge

Here they come
The socio-economic backdrop to the economy, and Presidential election, is the millennial generation, bigger than the baby boomers. This group votes and spends with their mouses and is tech-savvy, ironic and politically influential. Millennials, born between 1983 and 2003, is a cohort so large that its members will be game-changers as were the boomers.
The millennials’ mentality has become another industry. It is a sociological filter through which things are being viewed by people who market everything from political candidates to content, soapsuds and financial services. The same demographics exist in Canada.
For instance, boomers like Williams Sonoma, Starbucks, cruises to Antarctica, designer labels but also NASCAR, television, causes and political heroes.
Millennials shop online, are diverse, pessimistic, engaged in social networking and technology, watch John Stewart make fun of the media and politics and are not idealistic. They use TiVO to tape programs and zap through commercials, they buy new hot technologies they can afford and snap up Echos which are cheap fuel efficient cars that get from A to B.
Millennials are changing the political landscape, according to Morley Winograd who wrote the “Millennial Makeover”. He was a senior policy advisor to Al Gore when he was Vice President.

Redrawing the map
This generation will redefine society in the U.S. because it is bigger, population-wise at nearly 100 million, than is the previous record-holder, the baby boomers, born from 1946 to 1964, which number 78.2 million, he wrote.
“This is the largest generation in American history. Every 80 years there is the rise of a civic generation who are at the cusp of historical change,” said Winograd when he spoke at the PdF technology conference in New York City in June that I attended. “The last civic generation was the GI Generation born between 1901 and 1924 [Reagan, Nixon, Carter, Bush Sr.], then the boomers [Clinton, Bush] who are a divided but idealistic generation.”
“American history suggests that about every 80 years a civic generation emerges to make over the country,” wrote Winograd in a lengthy article this year. “This year the civic-minded millennials are coming of age and promising to turn the political landscape, currently defined by idealist baby boomers such as Clinton and George W. Bush, upside down.”
So far, the millennials are less fragmented than the boomers. Most voting-age millennials are Democrats, but boomers remain as divided as ever polarized into two solitudes and ranging from former hippies and activists to buttoned-down, establishment Republicans.

Both candidates are in betweens
Interestingly, neither John McCain nor Barack Obama are from the two game-changing generations.
“McCain is from that generation born between 1925 and 1945 which is the only generation that never elected anyone as president,” said Winograd.
(Reagan was born in 1911, Carter in 1924, Bush Sr. in 1924, McCain in 1936).
Obama is also from a generation that has yet to elect a president. He’s a Gen X-er who is 45 years old and born in 1962, has written in his autobiographies about the generational divide and how he learned to distance himself from the “dramas of the baby boomers” like his mother or Hillary and Bill Clinton. That’s why he is a very cool, unflappable candidate.
Most Gen-Xers became apolitical in order to withdraw from all the cacophony and polarization of their baby boomer parents, said Winograd.
But the success of Obama’s campaign has been to Gen-Xers but also to his online outreach which has drawn in millennials. Ironically, his background is a plus to this new cohort which is the most diverse, and tolerant, in history.
“About 40% of this 100 million are African American, Hispanic, Asian or mixed race,” said Winograd. “They support Democrats two to one. They were scared by 9/11 and probably 40 million will vote in this election and race is not even a consideration.”

Wall Street shorts ruin markets

Diane Francis — Thu, 31 Jul 2008 14:50:00 GMT

A crackdown on "naked" shortselling was just announced by the SEC and the OSC should move to do the same immediately.
The Fed's bailout south of the border of major financial institutions -- from Freddie and Fannie to Bear Stearns, IndyMac et al -- finally forced the SEC to stop naked shorts, shorting on downticks and other predatory practices that have gone on with SEC blessing for years.
(Interesting how the SEC ignored pleas from companies for years who were being shorted, and lied about, but now that Wall Streeters themselves are involved it's finally doing something. But I digress...)

Market abuses
Here are the two worst examples of capitalism being ruined by predators: "Pump and dump" is about touting stocks fraudulently then selling them out at profits to suckers. "Short and distort" is about betting the price will go down then making up lies to drive down the stock for a profit. Both are fraud.
So this is what Christopher Cox, SEC Chair wrote in the Wall Street Journal a few days ago:
"Already, heeding one important lesson, both the Securities and Exchange Commission and the Fed have strengthened liquidity and capital tests for the firms we regulate. Another central lesson is that financial institutions, which depend on confidence, are uniquely vulnerable to panic fueled by suspect information and market manipulation.

Ruining companies
"A run on a bank can take hold quickly, and can be fatal. In the wake of IndyMac's demise and Bear Stearns's desperate sale to JPMorgan Chase, even far-better capitalized financial firms may be threatened. What's needed now, therefore, is reliable information for investors, and confidence that trading can be conducted without the illegal influence of manipulation that can fuel stampedes.
"When an irrational panic is fueled by false rumors that investors believe must be acted on immediately -- lest everyone else get out first -- market integrity is threatened. In such circumstances, it is the job of market cops to provide a measure of confidence that information about public companies is accurate -- and when it is not, to punish those responsible.
Later on he opined:
"That has led the commission to consider simply eliminating the "reasonable grounds" alternative altogether. This is essentially what the SEC did for the financial firms for which the American taxpayer is now on the line. It is also what the commission is even now considering for the broader market.
"We are also exploring other remedies to "distort and short" and naked short-selling abuses, such as the reporting of substantial short positions (akin to the long-standing requirement to disclose significant long positions). All of this comes on the heels of the agency's recent elimination of other exceptions to Regulation SHO, and our March proposal of a new antifraud rule targeting naked short selling."

Too little too late for many
Nice work Chris but it's just a thinly disguised bailout for your buddies on Wall Street. Never mind the real companies like the one which follows, Fairfax Financial of Toronto, which has had to fight with its own money.
And OSC? Get with the program okay?

A Canadian victim wins a victory
An allegation to the Internal Revenue Service by a short-seller about tax evasion by Fairfax Financial Holdings Ltd. is untrue, according to an audit by the IRS released this week.
The complaint was made about a 2003 Fairfax transaction by Institutional Credit Partners (ICP) in the U.S.
Fairfax has been dogged by this and other false complaints and rumors by ICP and others who are short-sellers, according to Fairfax court documents. The insurance conglomerate sued 22 short-sellers, hedge funds and analysts in the U.S. for
US$6 billion.
"ICP and others before them have relentlessly and very publicly asserted that Fairfax's 2003 purchase of ORH [Odyssey] shares and subsequent tax consolidation constituted tax fraud,” said Fairfax legal counsel Paul Rivett. “The closing of the 2003 and 2004 [IRS] audit covering this transaction establishes definitively that these damaging accusations were, as we always maintained, false.”
ICP is the last defendant, sued by Fairfax, to try and have the lawsuit dismissed. Its request will be heard in a New Jersey court next month.
The other 21 defendants have lost their dismissal attempts and appeals. One defendant, an individual, has been indicted for fraud involving another situation.
The Fairfax problem is related to the wider issue of naked short-selling policies which the Securities and Exchange Commission has begun to address with reforms.
In a speech this week entitled “Short and distort”, SEC Chairman Christopher Cox decried some practices and announced some changes to rules. Fairfax’s Rivett called for protection in Canada from distortions.
"I don't believe that the concerns about the spreading false rumors and abusive short selling, which the SEC is currently investigating, stop at the Canada-U.S. border. As we stated in our lawsuit, Fairfax has been the target of a host of malicious and false rumors designed to destroy our reputation and business, including rumors that the RCMP were raiding our offices, Prem Watsa [Fairfax Chair] had fled the country, and that we were engaged in all sorts of purported frauds. My hope is that the Ontario Securities Commission and Canadian law enforcement officials are co-operating with the SEC and will also look carefully at market manipulation cases involving `short and distort’ tactics in Canada or against publicly traded Canadian companies,” he said.
It’s press release was issued tonight and added that: Fairfax Financial Holdings Limited (TSX and NYSE: FFH) announces that the Internal Revenue Service (IRS) has completed its regularly scheduled examination of the 2003 and 2004 U.S. Federal income tax returns of Fairfax’s U.S. subsidiaries included in Fairfax’s U.S. consolidated tax group, including Odyssey Re (NYSE: ORH) and Crum & Forster. The 2003 and 2004 tax years for these subsidiaries are now closed.
“As part of the examination, the IRS reviewed the purchase of Odyssey Re shares by Fairfax in March 2003 and the issuance by Fairfax of debentures exchangeable into shares of Odyssey Re in payment for that purchase. No changes were made to the above-mentioned consolidated 2003 and 2004 tax returns with respect to that purchase of shares and issuance of exchangeable debentures or the inclusion of Odyssey Re and its subsidiaries in Fairfax’s U.S. consolidated tax group as a result,” read the release.
Fairfax Financial Holdings Limited is a financial services holding company which, through its subsidiaries, is engaged in property and casualty insurance and reinsurance and investment management.

Here is the Fairfax legal case which I wrote about in October.

Don't steal Florida yet

Diane Francis — Wed, 30 Jul 2008 13:41:00 GMT

I wrote a series of posts this winter about cherry picking properties in Florida and other sunbelt regions which were cratering in terms of real estate prices. I suggested paying about 60% what the asking prices were, roughly the price at the 2004 peak of the bubble. Now that's too high especially in these overbuilt regions.

There are no bids for routine properties. There is no mortgage money to buy them either.

Luxurious or special-feature real estate or regions are selling but slowly. Properties where owners can take back mortgages are moving, but at discounts. Medium or lower priced housing, including entire gated communities in Arizona or Nevada which were built on speculation, are shuttered without any closings on the horizon.

By the way, the real estate bubble was also a matter of demographics and was also worldwide, spurred on by The Fed's loose money policies. For instance, the same disastrous overbuilding occurred in Europe's sunbelt areas for its babyboomers in Spain and Portugal. Bankruptcies, foreclosures and business failures are up significantly in Spain.

The bottom line is that unless you want to buy something and stay in it for 20 years be very wary or rent. Things are going to get worse before they get better. The next shoe is beginning to fall as banks must go from merely writing down the defaulted interest on three months of mortgages to writing down the difference between their outstanding mortgage and what the properties fetch, or will fetch, on the market.

Banks are beginning to do this, or are beginning to face this, which is why Freddie and Fannie were backstopped so that they can mop up some bank messes. But estimates are that there will be 150 more banks to go under over this, mostly regions in the five most affected states: Florida, Nevada, Georgia, California and Arizona. Already, reports are that regional banks in these areas are teetering, two more were taken into protective custody by the FDIC last week in Arizona/Nevada and another 150 or so will succumb. Now Merrill Lynch's woes which will have a ripple effect on banks.

This will add to the deflation underway as banks pull in their horns, unable to lend because of their shrunken capital or to raise equity to replenish it in light of the situation.

Some, like Prem Watsa of Fairfax Financial, quoted in the blog ahead of this one thinks the credit contagion has spread into all credit markets and that the deflation of real estate and other assets, such as equities, could be as prolonged as Japan's 1989 real estate/stock bubble meltdown. That didn't end for 15 years.

UBS: used to be smart

Diane Francis — Tue, 29 Jul 2008 12:13:00 GMT

UBS gets a red light for its practices. Getty Images

Switzerland: Mountains of snow and dirty money
Market wags joke that UBS AG doesn’t stand for the Union Bank of Switzerland but for “used to be smart” instead.
This is because the bank has found itself in the middle of three controversies this year.
It began earlier in the year when UBS began a series of massive writedowns as a result of the asset-backed paper problems. It has posted the biggest losses and more are expected. Its Chair resigned, among others, as the total has reached US$38 billion.

Second shoe
Next, U.S. police, tax officials and Congress began to pursue and prosecute UBS and here is what has happened, according to a statement made last week by Senate Finance subcommittee Chair Sen. Carl Lewin:
“In late 2007, the subcommittee took the deposition of Bradley Birkenfeld, who worked for more than 12 years as a private banker in Switzerland, including four years at the Geneva office of UBS. In 2008, Mr. Birkenfeld was charged and pled guilty to conspiring with a U.S. citizen, Igor Olenicoff, to defraud the IRS of $7.2 million in taxes owed on $200 million of assets hidden in secret accounts in Switzerland and Liechtenstein. In connection with this prosecution, the United States also detained as a material witness a senior UBS private banking official from Switzerland, Martin Liechti, then traveling on business in Florida. These enforcement actions appear to represent the first time that the United States has criminally prosecuted a Swiss banker for helping a U.S. taxpayer evade U.S. taxes.”
A UBS official admitted to a number of questionable activities such as smuggling diamonds out of the U.S. to Europe in toothpaste tubes to help American taxpayers hide money from the Internal Revenue Service. He said his behavior was not unusual within the ban.
“[UBS] is one of the world’s largest financial institutions, the world’s largest manager of private wealth and a public company of international renown,” said Senator Lewin during last week’s hearings. “Yet, as you will hear today, UBS has an estimated 19,000 so-called `undeclared accounts’ for U.S. citizens with an estimated US$18 billion in assets that have been kept secret from the IRS.”
The travel records show that about 20 UBS Swiss bankers made about 300 trips to the United States since 2003, often traveling together to UBS-sponsored functions designed to attract wealthy potential clients.

Third shoe
As if that’s not bad enough, last week UBS was also attacked by Andrew Cuomo, Eliot Spitzer’s replacement as New York’s Attorney General.
Cuomo has sued two units of UBS for allegedly selling as safe and liquid investments certain risky securities, or auction-rate instruments.
“Not only is UBS guilty of committing a flagrant breach of trust between the bank and its customers, its top executives jumped ship as soon as the securities market started to collapse, leaving thousands of customers holding the bag, said Cuomo’s statement.

Canada eh?
There has also been an expose of LGT Group in Liechtenstein for tax evasion, with some 100 Canadians implicated.
So where are Canada’s politicians and regulators? Tax officials are supposedly investigating but there should be public hearings with culprits named publicly. UBS undoubtedly also targeted Canada for cheaters so let’s find out who these people are as well as their accountants and lawyers.

Fairfax Financial beats bad markets

Diane Francis — Mon, 28 Jul 2008 14:27:00 GMT

Prem Watsa, Chair of insurance conglomerate Fairfax Financial Holdings Ltd., began to worry about a credit meltdown a few years ago. So he and his investment team devised a defensive strategy. Today, Fairfax is in great shape financially, despite lousy markets.
The company has even defied gravity and two weeks ago its credit was upgraded. This reflected its stellar investment performance on its US$19.8 billion investment portfolio, good operations at its underlying insurance companies and a jump in shareholders’ equity from US$2.856 billion in 2006 to US$4.8 billion today.
In 2007, Fairfax, Canada’s largest property and casualty insurer, posted profits of US$1.095 billion compared with US$227.5 million in 2006. In 2008, as more bad news hit markets everywhere, Fairfax’s profit soared to US$631.8 million in just the first quarter.
Watsa is the founder and controlling shareholder of Fairfax and stays out of the limelight. However, this week, he gave The Post an interview and we talked about Fairfax’s contrarian philosophy and about the dangers in markets that lie ahead.
He was born in India and attended one of its prestigious IIT super-universities. He graduated in chemical engineering then immigrated to Canada to join his brother, at his father’s request, attended the Ivey School and became a money manager.
In 1985, he fashioned Fairfax along the lines of Warren Buffett’s business model: It became a property and casualty consolidator and managed their pools of capital. Fairfax is an acronym for fair and friendly acquisitions. And Watsa’s son is named after Buffett’s inspiration, Ben Graham, Godfather of “value investing”.
Another major influence has been the late Sir John Templeton who died this summer at 95 years of age. A bronze bust of Sir John, a mutual fund pioneer and philanthropist, occupies a prominent place in Fairfax’s boardroom in downtown Toronto.
Fairfax’s philosophy has paid off. Since 1985, book value has gone from US$1.50 per share to today’s US$250 a share.

Q: Everybody else is running for the exits and melting down and Fairfax just had its credit rating upgraded so how did you pull this off?
A: “Very simply it goes back to this 100-year storm concern of ours. We took action that reflected our belief that everything was headed downward. Predicting rain doesn’t count, but building an ark does. And that’s what we did. We built an ark and we had a little bit of good fortune. This is why our rating went up.”
“Our focus has had a tremendous effect on our results. Last year we made in excess of US$1.1 billion and in the first quarter of 2008, US$631 million. Our capital, shareholders equity in 2006, was US$2.9 billion and it grew by 50%.”

Q: What was your thinking that led to these results?
A: “We have always taken a long term view and in 2003 we started worrying. We were concerned about asset-backed paper. We saw the moral hazard in all this credit that we saw was being blended and blown out. This was because interest rates were dropped to 1% to bail out the technology companies after the bubble burst in 1999 and we saw that this would lead to the real estate and auto loans and credit card problem. We saw that half of consumer spending was from home equity loans. So we protected ourselves. Credit default swaps are why our ratings went up.”

Q: How does that work?
A: “Bond spreads were low, abnormally low because of the credit problem. [Five-year government bonds compared to corporate bonds]. We did swaps but results were not immediate. By 2006 we were down by 75% in that portfolio, but we are long term investors so we took a deep breath and bought more to average down. In July 2007, two of Bear Stearns’s hedge funds failed and in August the crisis occurred. Then our results turned.”

Q: How much has Fairfax made by worrying and buying credit default swaps?
A: “The total in swaps has been US$455 million at the end of March and so far US$1.1 billion has been realized and another US$1 billion unrealized. We have a ton of cash.”

Q: Why has Fairfax predicted better than most others?
A: “You have to be worried a few years ahead of time, then take long term views and positions. History shows that there are 100-year storms and 50-year ones. In 1929, a 100-year storm, only 10% survived the market crash and it was only those who were negative in 1925 and did something about it. Back in 2003, there were signs this would happen.”

Q: How are your investments structured now for the future?
A: “We are not in commodities and missed out on that run-up totally. Value guys miss those cycles. What we do is buy stocks but hedge them against the S&P. Right now, about 25% of our capital is in Treasury bills; 50% is in short-term Canadian or American government bonds and 25% is credit default swaps (5%) and in stocks which are fully hedged.”

Q: What do you mean by value or long term investing?
A: “Our earnings are lumpy [varied]. We have never had guidance in 23 years because we have ups and downs and take the long term view. In 22 years, we have lost money twice but our book value and equity has grown dramatically. We just keep working hard and our insurance companies are operating very well.”

Q: Will long term deflation of real estate and assets affect your property and casualty premium income?
A: “Down the road but it’s not a worry.”
(Fairfax premium income has grown by 104 times since 1985.)

Q: Is this a 100-year or a 50-year market and what’s the difference?
A: “The 100-year is a Depression. The 50-year is what happened to Japan in 1989 to 2003. We don’t know yet.”
“Japan’s Nikkei index went from 40000 in 1989 to 7500 in 2003 and for 15 years no stocks went up. Stock and real estate markets collapsed. This points out another fact. Our worry is not inflation, but deflation as occurred in Japan. Deflation means it is difficult to rev up an economy through lowering interest rates or stimulus such as deficits or infrastructure spending. This is what Japan found for all those years. Deflation means you have to wait until everything gets digested and that might take a few years.”

Q: Your strategy meant that Fairfax missed the commodities and emerging markets run-ups. Any regrets?
A: “Individuals and foundations diversified into oil, commodities and emerging markets and these went up 50% to 100% in the short term. Value investors miss these short cycles. Now the emerging markets have all reversed their gains. Many investors are in commodities [through extreme leverage] and have pushed up prices. These commodity prices are not sustainable.”

Q: Can we talk about some challenges. Fairfax and others are being audited by the Securities & Exchange Commission about certain accounting practices? What is the status of this?
A: “It’s unresolved. 30 or 40 of us have cooperated with the SEC. A couple of companies have been fined. From our viewpoint, there is nothing to add.”

Q: What’s the latest with the short selling attack mounted a couple of years ago against Fairfax by several hedge funds in the U.S.?
A: “In July 2006, we sued these funds. They have attempted to have our case dismissed, but we have won in court against these motions to dismiss, and appeals. We face just one more dismissal attempt by a fund in August. Then it will be a trial. One defendant has been indicted on fraud charges.”

Q: What influence did Templeton have on your investment strategy?
A: “I met with him, beginning in 1978, every year and would go down to see him in his Lyford Cay home in the Bahamas. He was a long term investor and was very prescient about markets. Like him, I take the long term view, buy the best and short the worst.”

Q: Are you still worried overall?
A: “Risks are spreading to all credit markets and yes this is very worrisome.”

Q: You don’t usually give interviews so why now?
A: “We put our heads down and worked hard and have gotten results. Once in a while we will talk if we have anything to say.”

(Photos: National Post. Watsa at 2002 NYSE listing ceremony; Watsa lecturing to students at Ivey and Watsa March 2008)

Obama, McCain brand strategies

Diane Francis — Sun, 27 Jul 2008 13:54:00 GMT

Marketing maneuvres
The U.S. Presidential election is a battle between two brands – Team Republican versus Team Democrat. It’s not about selecting an individual to be President because nobody really knows the people or what policies they will end up imposing. So perception is everything and it’s obvious that the “Mad Men” or Madison Avenue types are fully in charge and scripting everything that they can.

Here is my assessment of the brand burnishing underway so far.
McCain’s biggest impediment is that he is elderly and has had serious health problems. But he has turned this around by arguing that his age translates into experience, something very necessary in taking on the world’s biggest job as President.
Team Obama, however, knows that polls show that age is more important to voters than even race and that experience doesn’t necessarily translate into good judgment or respect.
To counteract those brand challenges, Obama’s handlers organized a tour abroad that has been successful in making him look Presidential.
To underscore the age problem, they have been cultivating Obama’s image as a “gym rat” who spends lots of time exercising daily, something McCain cannot do. The message is that Obama is young and vigorous and the consummate Alpha Male who shot a three-pointer hoop in Iraq and was cheered by the troops for doing so.

The Mac attack
In retaliation, McCain has been cranky over Obamamania. The hidden code, understood by older voters, is the familiar who-does-this-whippersnapper-think-he-is. These people are fed up with pushy kids or grandchildren or bosses younger than they are.
This age group is also, like McCain, uninterested and intimidated by technology which explains why McCain has made a fuss about needing his wife to turn on his computer. Meanwhile, Obama walks around with a BlackBerry.
The underlying Republican message here is that old-fashioned experience, not upstarts and new-fangled gadgets, are what the world needs. In other words, vote McCain.

Another Mac attack
Also interesting to watch, however, is McCain’s newest tactic. As an American populist myself, I know that voters hate big elites from big government to big business, big labor unions and big media. So Team McCain is now trying to place Obama in the pocket of the media elite, thus portraying himself as the underdog maverick just trying to fight the good fight against big media.
(This argument is totally specious. Republican claims that Obama is an elitist fly in the face of the fact that he has pulled himself up and overcome racism and a humble. deprived childhood. Meanwhile, McCain was a silver spooner, born into the U.S. military elite and married to a very wealthy beer heiress who has private planes and many homes.)

Dem will strike back
Obama will counter-punch in coming weeks by telling his rags-to-riches, self-made story and will be seen, along with his family, in humbler surroundings. The Kansas grandmother will eventually be interviewed and a running mate will be picked who can reinforce his modesty and likeability. He will outperform McCain in the debates.
McCain, for his part, will continue to cast himself as the ordinary guy and super-patriot, unbeholden to big elites. He will pick fights with the media because Americans hate columnists or the New York Times or CBS telling them what to think and who to vote for.
In the end I believe Obama will win because McCain is aligned with the unpopular Bush regime. But until then, it's a high-stakes branding chess game no different than selling soap or cornflakes or SUVs or Brad Pitt only a lot more important to humanity.

McCain: Dumb and dumber?

Diane Francis — Thu, 24 Jul 2008 02:39:00 GMT

Whoops, says Lieberman, who whispers a correction in McCain's ear at a press conference this spring.

Is McCain losing it? Is he in his dotage?
McCain made a serious error – the latest in a series of foreign policy inaccuracies – that raise red flags about his cognitive abilities these days.
The mistake was in answer to a CBS interview this week which was not broadcast but leaked to the press.
The elderly Senator said that the “surge” strategy in Iraq, which he endorsed, sparked the “Anbar Awakening” which is credited with reducing violence in the country.
That is factually incorrect.
The “surge” took place after the “Anbar Awakening”. The significance of this is that Senator McCain would like the public to believe that the surge is solely responsible for improvements in the Iraqi situation while Senator Obama has, quite rightly, also credited the “Anbar Awakening” which involved the Sunnis and Shiite government going after militias and Al Qaeda opportunists in their country.
For McCain to confuse these is only explicable as dishonest revisionism, ignorance or forgetfulness. This is not a matter of debate. McCain was dead wrong in his comment and CBS needs to explain why it helped cover up his huge gaffe by editing out that answer in the interview.
McCain said: “Because of the surge we were able to go out and protect that sheik and others. And it began the Anbar Awakening. I mean, that’s just a matter of history.”
In fact, that is not true: The so-called Awakening occurred before Bush and his regime even considered the surge of last year.

Duh?
If this was the only mistake McCain has made it would be one too many. But there have been others, also egregious, which may add up to a possible pathology of problems.
There’s the issue of “Czechoslovakia” which Senator McCain has mentioned in remarks several times now even though that country ceased to exist in the mid-1990s. It broke up into the Czech Republic and Slovakia and while hardly earth-shattering, it’s worrisome in a leader to not even know the names of two countries.
Then who can forget the major mistake he made while on his tour abroad. He confused Sunni with Shiite and had to be corrected, on camera, by his Middle East “brain” and buddy, Senator Joe Lieberman.

Old, dumb and proud of it
Perhaps most alarming is his professed ignorance of computers, the Internet or even how to turn a laptop on or send an email. He said his wife has to turn it on for him and he still doesn't get it. Then get a load of this joke and others he made about how he finished 894th out of 899th in Annapolis as a student during a "townhall" with geeks at Microsoft two weeks ago.
The last time a slacker like this one got into the White House, we ended up with a war in Iraq that was totally unnecessary.

Obama: More Alpha than McCain

Diane Francis — Wed, 23 Jul 2008 13:19:00 GMT

Obama with General Petraeus and Senator Chuck Hagel touring war zone.

This week Barack Obama just graduated from being the presumptive Democratic candidate to becoming the presumptive President of the United States.
His tour of the Middle East and Europe has been a branding triumph. He has received a hero’s welcome, fawning press attention and validation for his plans to withdraw all combat troops from Iraq by 2010 from the Iraqi Prime Minister himself.
This, combined with Obama’s poise, height and three-point basketball shot in front of troops, assures his Alpha Male-ness. It's all designed to ease the minds of those American voters who may have been leaning in favor of the “old guy” McCain to serve in the Head of State role.
It’s also caused McCain and his Talk-Radio bigots, left behind, to whine like little girly-girls over perceived media slights to their candidate.

All in all, it's been a well-executed campaign and events, staged and otherwise, are slowly removing the question marks raised concerning his candidacy. Obama's brand is being burnished.

The age thing
We're told last week that Obama has become something of a "gym rat", spending at least one hour a day shooting hoops or working out. This exercise has been stepped up somewhat, a regimen which nicely underscores his youth, fitness and vigor compared to his septuagenarian opponent. Age matters more than race, according to polls, and the Obama team is underscoring the age gap whenever possible.

The anger thing
Presumptive First Lady, Michelle Obama, concerns some voters because of her anger. This is somewhat valid because she looks fierce and has talked passionately and honestly about the difficulties that African-Americans like her have had to overcome.
To counteract her image, the Obamas agreed to give an interview with "Hollywood Access" involving their two daughters. This was to show the motherly, soft side of Mrs. Obama and her husband. He later said it was a mistake to allow the interview because their children were so young, but that was also helpful in drawing more attention to the interview, which was very sweet.
Clearly, Team Obama took a page out of the Chelsea Clinton involvement in her mother's campaign which was solely designed to soften her mother's "brand".

The African-American militancy thing
Rev. Jesse Jackson did Obama a huge favor by dissing him on a live microphone at Fox TV. It created a huge controversy, discredited Jackson for good and, more importantly, underlined the distance that Obama has maintained from the old guard activists of the past who frighten or annoy many voters.

The Muslim thing
Another raving preacher-ego, Rev. Jeremiah Wright, was also helpful. Obama quit the church and denounced Wright but the confrontation made it impossible for the Republicans to continue to spread rumors that Obama was a closet Muslim.

The Commander in Chief thing
General Wesley Clark clobbered McCain's claim that he was more qualified to be Commander in Chief when he said Obama had better judgment and that was more important than years spent in uniform or as a POW.

TransAlta: another one bites the dust

Diane Francis — Tue, 22 Jul 2008 13:36:00 GMT

Here we go again: Transalta is under siege. That will bring the takeouts of income trusts since October 2006 to 45, and $45.8 billion, mostly foreigners. If debt markets had not cratered virtually all of the 200 trusts would have been bought with debt by foreigners. Trusts represented 10% of the capital markets and are disappearing mostly into private equity to boot, thus shrinking investment opportunities for Canadians to boot.
The Tories and provinces continue to blunder along despite promises to lower business taxes which, by the way, still remain the highest among the OECD nations.
Nothing changes and the gigantic Tory blunder is camouflaged as a result of soaring commodity prices. This skews the numbers nationally and lulls leaders into believing their own press releases.

Third rate Tory government
As this trend continues, the damage to Canada's capital markets will be enormous, leaving only the widely-held banks to buy.
Instead of policies that fit the international realities -- such as a race to eliminate business taxes to provide a competitive advantage to local and new enterprises -- we get a so-called "competitiveness study" that declares Canada should lift ownership limits on telecoms and banking.
(Photo: Harper -- all hat and no cattle)

Debt meltdown summer notes

Diane Francis — Mon, 21 Jul 2008 15:02:00 GMT

The frightening credit meltdown is starting to manifest itself in many ways during these dog days of summer.
The world’s biggest takeover – Bell Canada Enterprises – teeters on the brink of failure as lenders worry about the unjustifiable debt load on the company and the greed of its old and new management which have suspended dividends to shareholders in order to chisel a few more billion dollars. They already mistreated bondholders who lost a Supreme Court of Canada bid and shouldn’t have.
Personally, the situation is starting to hit home with alot of us. I returned from a month-long holiday to realize that a mortgage I hold is in arrears from an individual who was, a year ago, flush. But he was then in great corporate indebtedness.
A friend of mine, who owns a huge storage facility, said five times’ as many customers who had rented units from him were in arrears as a year ago and virtually all have walked away from their belongings which are auctioned after several months in arrears.
I live in the middle of the biggest tourist area in Toronto, tony Yorkville, and the Americans have simply not come this year, say hoteliers and restauranteurs. Nor will they the next, thanks to their own concerns about inflation, job security and the slow-motion banking meltdown underway around them.

Caution: amber light
Clearly, this is no time to bottom fish for banks or other financial institutional equities or bonds. This is just the beginning of the ending which won’t be catastrophic in the long run, just painful in the meantime.
Banks in the U.S. have begun to start their second set of write downs. The first was the write off of unpaid interest after 90 or 120 days of default.
The next set will occur after foreclosures when they must write down the total difference between what the mortgage was and what the property fetched in the fire-sale.
Some estimate at least 150 of America’s 12,000 banks will go “under”, be rescued or “merged” like IndyMac. More significantly, it means that the overall capital of the banking system is about to shrink dramatically which means tighter credit for everyone and a lousy stock market.
Here in Canada 40% of our economy depends on exports to a battered, demoralized United States. While resources and commodities boom, the rest of Canada suffers from this slump and, in the case of the auto and auto parts sector, is sustaining a permanent downsizing.

Tourism about to turn red
The next damaging shoe to fall is going to be the passport requirements for Americans traveling back from Canada by road, rail or boat that are due to kick in this January.
Only 10% of Americans have passports, now required for flights, but the requirement will add $600 or more to the cost of skiing in Whistler or Tremblant for a family of four.
These challenges are why the Canadian dollar hasn’t continued to soar against the U.S. dollar despite record oil, metals and commodity prices.
Even Manhattan, where I live part-time, is booming with tourism but its publishing, advertising, media and financial worlds are retreating.
Real estate still goes up in value but sells more slowly, mostly bought as pied a terres or invesments by wealthy Europeans, Asians, South Americans and Canadians. An Italian family bought seven condos in my neighborhood for themselves to use last month.
Their agent said: "They believe in New York and America and love the low dollar. Go figure ‘cause some of us don’t."

Freddie and Fannie: despair not

Diane Francis — Mon, 14 Jul 2008 19:18:00 GMT

Here are some intelligent commentaries about the Freddie Mac and Fannie Mae “shoring up” south of the border.
My opinion is that the two financial intermediaries are not at the edge of an abyss but simply need some walking around money to prevent the mortgage and real estate sectors from completely drying up.
This is not dire but the usual ideological suspects are involved in the debate. Republicans are blaming the government-backed mortgage companies, which did nothing wrong, and the Democrats are blaming the marketplace.
The culprit? Lack of government regulation in markets.

Here are some interesting takes:
The Economist
The econbrowser.com
The New York Times
The Wall Street Journal
Finally, for sport, here’s that old Gold Bug, and chronically incorrect doomsayer.

As these banks merge or are bailed out in coming months (see my blog yesterday as to why) watch for a lower U.S. dollar against many currencies; firm gold prices and polling support in the U.S. for Barack Obama and the Democrats, and against McCain the Rs for creating this mess.