FINANCE MARK

Interest Rates and Inflation look set to remain higher for longer, at least according to Ken Griffin and Howard Marks, and (presumably) Bill Ackman and (seemingly) Jerome Powell.

#InterestRates #Inflation

If it feels like the US is lurching from debt crisis to debt crisis, that might be because it is. At the time of recording, congress is considering whether to raise the “debt ceiling”. Again. The debt ceiling is the limit on how much the US government can borrow overall, including to satisfy already approved expenditures. The debt ceiling currently sits at $31.4 Trillion. The government currently is looking to raise the ceiling so that it can borrow more in order to fund new and existing expenditure.

This is not the first time we have been in this situation. Debates over the debt ceiling occur almost every year. Indeed, by the time you see this, we might have moved onto yet another debt ceiling, well above the $31.4 trillion limit that currently exists. Indeed, the debt ceiling has increased nearly exponentially since the 1940s.

This is not just in ‘nominal terms’. Even after adjusting for inflation, the debt ceiling has increased monumentally. The increase in debt cannot merely be explained by the US dollar devaluaing.

Let’s explore the debt ceiling further.

How did we get here?

The US did not always have a debt ceiling. Before 1917, there was no debt ceiling. However, a debt ceiling emerged in 1917 with the Second Liberty Bond Act. This solidified in 1939 with the Public Debt Acts. Henceforth, the US was to have a form of Debt Ceiling, even if the exact parameters changed over time.

The US had moved away from a Debt Ceiling in 1979. The Gephardt Rule deemed the debt ceiling to increase with each budget. However, congress repealed this rule in 1995. This has exacerbated debt related concerns, leading to myriad stand offs over the debt ceiling.

The current approach means that – in the United States – congress must pass both a budget and a debt ceiling. That is, congress can approve expenditure that is not funded either through revenue or through existing debt provisions. Conversely, congress can increase the debt ceiling above its present requirements, or even suspend the debt ceiling. In practice, this often means that parties tussle over both the budget and over the debt ceiling.

What happens if there is no agreement?

Congress might not agree on a debt ceiling increase in a timely manner. If there is a protracted impasse, this can trigger significant consequences. If the impasse persists, the US might default on its debt. Let us explore some of the ways that congress might manage debt related disagreements.

1.       Government shutdown: A government shut down involves furloughing workers and shutting down various facilities. The furloughed workers are ordinarily not paid during the shutdown but are awarded back pay, where relevant. Contractors are not paid. This can save money in the short term. However, it is costly thereafter. The costs involve dents to the US’s reputation, back pay, rectification for deferred work, overtime when workers ultimately need to catch up on work, and revenue and productivity foregone. Shut downs have been relatively common.

2.       Extraordinary measures: Treasury has several possible extraordinary measures available. These often involve deferring savings and investment. For example, they can include suspending investments in the Thrift Savings Plan for the retirement fund for federal employees. However, this is relatively short term as treasury would ultimately need to catch up on the foregone investments.

3.       Sales: The government could sell assets in order to meet short term requirements. For example, the government has sold gold. However, in theory, the government could sell myriad other assets if necessary.

4.       Money printing: In theory, the US government could print money in order to make payments. However, this would damage government credibility, set a dangerous precedent (i.e., the other party could attempt to orchestrate it), undermine Federal Reserve independence, and be inflationary.

5.       14th Amendment: It is possible that the idea of a Debt Ceiling is unconstitutional. However, this is unsettled and would ultimately be for the court to determine. The logic is that, under the 14th Amendment, the debt of the United States “shall not be questioned”. This is sometimes taken to mean that congress cannot take measures that would prevent the government from paying debt (i.e., where it must raise new debt in order to pay for existing unpaid obligations). However, it is not clear that merely refusing to raise the debt limit would violate the 14th amendment. And, in any case, this would be a matter for the courts to determine.

If the impasse persists, the US government could default on its debt. This would be highly costly as it would cause the US’s credit rating to decline. In turn, this would increase the required yield (and interest rate) on government debt. This would make funding the government more costly both immediately and, especially, for future generations.

Why is there a debt ceiling?

Why then is there a debt ceiling? The debt ceiling appears to create inconvenience. A shut down or a default would be costly. There are likely two overarching reasons:

1.       The Debt Ceiling is intended to restrain government spending. If congress must ask for more money in order to fund expenditure requirements, it might discourage excessive spending. Further, it can enable opposition parties to force spending concessions, thereby mitigating a structural deficit. Ideally, this mechanism would not be necessary. However, in an environment where parties prefer to increase spending and that spending is unfunded, this can confer some discipline.

2.       The Debt Ceiling can force parties to work together. In so doing, it helps to avoid one party steamrolling over the other party. This is because the dominate party might be able to pass a budget, but that party might not remain in power after midterm elections. Therefore, the heretofore dominant party that wants to increase spending might have restraint imposed on it. In so doing, the debt ceiling forces negotiation.

Regardless of its merits, or otherwise, the Debt Ceiling appears here to stay. It is therefore incumbent on parties to reach a Debt Ceiling resolution. Importantly, this does not mean that parties should merely acquiesce to untrammeled spending increases. Rather, it means that the party who wishes to undertake more debt must make its case and must highlight how that additional debt is beneficial and generates economic growth without exacerbating structural deficits or saddling future generations with unproductive excessive debt.

Anheuser-Busch’s stock price has fallen more than 3%, and lost $4 Billion on the back of the Bud Light / Dylan Mulvaney controversy.

The background scenario is that Bud Light (an Anheuser-Busch brand) secured Dylan Mulvaney as an ambassador. Dylan Mulvaney is an influencer and trans activist. She has been polarizing. Some people reacted vitriolically to this. Kid Rock, for example, filmed himself unleashing on a stockpile of Bud Light. There have been calls to boycott Bud Light and Anheuser Busch.

The boycotts have erased significant value from Anheuser Busch (ticker: BUD). BUD’s stock has fallen some 3.2% since Dylan Mulvaney was announced as ambassador. It is worse after adjusting for broader market movements. BUD’s cumulative abnormal return is -4.2% between 3 April and 14 April.

Many boycotts are short lived and their economic impact limited. Thus, there are questions over how long the bud light boycotts will last and how much they will erase from Anheuser-Busch’s revenue.

The precipitous fall thus begs the question of whether now is the time to ‘buy the dip’ in anticipation of BUD’s stock price recovering. However, as attractive, and as popular as buying the dip has become, there are good reasons to be cautious about doing so.

Warren Buffett has suggested that “we’re not through with bank failures”. However, depositors need not be concerned. So, what exactly did Warren Buffett say? And, what are the trading implications

Warren Buffett suggested that more banks might fail. He specifically alluded to issues with banks’ balance sheets and the problem of assets being held above their true value. This could imply solvency issues: if there is a rapid deposit outflow, banks might not be able to meet all those deposits. It could also generate cash flow issues if those loans have a lower interest rate than banks must pay to raise funding.

Should depositors worry? Warren Buffett suggested that depositors need not worry about collapses. Implicitly, he assumes that the FDIC will insure all deposits. This implies that any bank failure might be regarded as a systemically impactful event, forcing the FDIC to intervene. This is paradoxical since Warren Buffett also suggested that banks might fail. Indeed, if all deposits are insured, then there is no reason for a bank run; and thus, no reason for a failure.

Who pays for the banking issues? SVB and Signature Bank depositors were “bailed out” and their deposits fully insured. A narrative persists that the tax payer has bailed out the bank or depositors. Warren Buffett has countered this narrative. He notes that the banks failed and shareholders were wiped out. He also highlights that banks – not the government – fund FDIC insurance. Thus, taxpayers do not directly fund the deposit insurance.

Why did Warren Buffett sell bank stocks? Why then did Warren Buffett sell bank stocks? He was circumspect. However, he indicated a general wariness of banks’ balance sheets, overall. This applies to large banks, not merely small banks. Warren Buffett did not indicate that any of his former holding would face financial disagrees. However, he did suggest that they were less attractive than he previously thought. Hi signaled confidence in Bank of America, owing to his belief in Brian Moynihan and the Bank of America Team.

Jamie Dimon has noted that the banking crisis was 'hiding in plain sight' and that regulators already knew about SVB's risks, however had seemingly not acted upon them. He has also warned that the crisis is not yet over and has cautioned against regulatory overreach.

Jamie Dimon highlights that SVB’s interest rate exposure, hedging (or lack thereof), and risk management issue were known. The nature of its deposit book was also suspected given that SVB actively courted VC funds, startups, and tech firms. Regulators had intereacted with SVB over its issues. However, it appears that little changed with SVB’ operations. SVB ultimately collapsed. Thus, the banking crisis was ‘hiding in plain sight’. And, the its ramifications are still ongoing, with the crisis ‘not yet over’.

Jamie Dimon also pushes back against ‘knee jerk’ regulatory responses and regulation for the sake of regulation. Rather, he favors calibrated regulation that can address - and mitigate - the risks that banks such as SVB faced. These could include analyzing banks’ capital requirements, and whether the capital requirements should adjust based on the bank’s interest rate risk, desposit concentration, and loan concentration.

Michael Burry has said that he was “wrong” to say “sell” in February 2023. Of course, after he tweeted “Sell”, the market surged and then did a round trip. In hindsight, that was indeed wrong. But, aside, from what materialized in hindsight, what else might be behind his admission?

Michael Burry’s tweets are often opaque. However, it is worth exploring what his thought process might be to see whether we can draw new insights about what is happening in financial markets.

But why did the US bank fail? Should we expect the Great Depression and heightened volatility all over again for the financial system? Or are there more company specific factors at play in the SVB collapse?

Let’s see how the banking sector disaster unfolded, causing US regulators to step in in the collapse of Silicon Valley bank.

Check out my Angel Investing/VC course: https://financeacademy.gumroad.com/l/vcpe/siliconvalleybank

Warren Buffet and Berkshire Hathaway have revealed a significant investment in transport infrastructure. They have spent $8.2 Billion to acquire another 40.4% of Pilot Flying J. This is in addition to the 38.6% that they acquired in 2017 for $3.2 Billion. Berkshire Hathaway now owns 80% of Pilot Flying J and the acquisition values the company at $19.8 Billion.

Pilot Flying J is one of the largest ‘travel center’ operates in the US. It operates truck stops and gas stations in 44 US states and six Canadian provinces. It has over 650 such centers. They have also indicated partnerships and agreements with GM and Volvo to expand EV charging.

This is a sizeable bet on transport infrastructure and raises the question of why Berkshire Hathaway much a large investment.

There are likely several reasons for investing so heavily in transport infrastructure, and Pilot Flying J specifically.

* Management Team: Berkshire Hathaway has emphasized the importance of a quality management team. Pilot Flying J’s team appears set to continue and Jimmy Haslam appears set to remain involved.

* Inflation and economic issues: Transport infrastructure provides some resistance in challenging economic times. While travel might decline in a recession, there is always a baseload level of necessary transport. Further, while oil prices can fluctuate significantly, gas stations’ margins can increase with inflation.

* Future plans: Pilot Flying J has indicated that it will expand into EV charging. This offers some growth opportunities if they can obtain significant market share. It also shows a clear strategy to mitigate reductions in internal combustion fleets.

* Market position: Pilot Flying J has a relatively strong market position. According to Berkshire Hathaway’s 10k filing, Pilot’s top 15 diesel customer account for less than 15% of Pilot Flying J’s sales, and the top 10 suppliers account for less than 50% of the fuel purchases. Further, they are a relatively large ‘travel center’, placing them in a strong competitive position.

* Stable infrastructure like earnings: Warren Buffett’s letter to shareholders highlights a desire for quality earnings coupled with capital growth. The combination of solid earnings at Pilot Flying J has resonances of dividend paying companies. Further, the EV related strategy suggests future capital growth prospects.

These factors likely explain Warren Buffett’s and Berkshire Hathaway’s interest in Pilot Flying J.  

Student debt relief is controversial. Many former students struggle under significant debt loads. However, many others never attended college or have already repaid their loans. The Biden administration has announced student debt relief of up to $10,000. However, this has been challenged at court.

Michael Burry has not criticized student debt relief.

Michael Burry makes several inter-related points.

* Student debt issues are due to students choosing bad colleges or majors and that these majors would never enable them to repay their loans.

* Bailouts create bad incentives. This would encourage students to continue pursuing low paying degrees.

Michael Burry was silent – at least in this exchange – about how student loans are structured. However, the question is whether he has a point.

Are college majors the problem?

College majors can be a problem. Many majors pay poorly. Michael Burry does have a solid point in many respects. Myriad college rankings exist. Myriad outlets publish graduate salaries. Thus, for many majors, people can do due diligence.

Michael Burry does miss nuance. Many poorly paying majors are in education. This creates a challenge. The government – and society – could have an incentive to encourage people to study education. Reducing college costs might achieve this, albeit with the unintended consequence of not necessarily incentivizing high achievers. Alternatives exist. These include performance bonuses for highly performing teachers so as to make the debt load sustainable.

It is also important to note that some colleges are predatory and hype themselves, or degrees, in a misleading manner. This does not absolve students who do badly from failing to obtain a job. However, it does mean that some claims warrant closer scrutiny. Fortunately, many rankings do precisely this. And it is important to do due diligence.

Unintended consequences?

Michael Burry is correct to highlight unintended consequences. If the government bails out people from their bad decisions, it enables them to repeat those decisions safe in the knowledge that they get all the upside but pay less of the downside. In this context, bailouts are not “free”. The tax payer pays. However, the person receiving the bailout is unlikely to pay the full cost via taxes: rather that is likely to come from other tax payers.

Michael Burry might overstate the concern in some respects: a one off $10,000 payment might not shift behavior by itself. However, the concern is that there is no obvious limiting principle. Why only one payment? Why only $10,000? Why stop with this cohort of people? The lack of limiting principle opens the bailout to expansion. And, even a non-zero chance of this can create unintended consequences.

Michael Burry therefore does make a valid point. He might overstate some of the risks. And his comments might lack nuance. However, he flags genuine concerns with the loan forgiveness plan that the Biden administration should address when providing debt relief.

Warren Buffett has slammed democrats and critics of stock buybacks. In Berkshire Hathaway’s annual letter to shareholders, Warren Buffett has labeled them as ‘economic illiterates’ and ‘silver tongued demagogues’. Is Warren Buffett correct?

The buyback critics argue that buybacks are nefarious. They argue that CEOs might engage in a buyback to reduce the number of shares outstanding, thereby mechanically boosting earnings per share and hitting bonus targets. Buyback critics also suggest that buybacks divert cash from internal investments that would otherwise create value.

Buyback critics are incorrect and the assertions are not evidence based. A recent large scale study found no evidence that CEOs use buybacks to hit earnings targets. This study also found that firms buyback stock using surplus cash. That is, firms invest in profitable projects first and buyback stock from the surplus second. This is laudable. Excess cash holdings are often associated with value destruction. And, the decision to return excess cash to shareholders reduces such a risk. Buybacks thus enable an efficient redeployment of capital, which ultimately creates more economic growth.