Reading Roundup: November 2022

Liar's Poker, Make Your Bed, and The Personal Memoirs of U.S. Grant

This month we read:

• Liar’s Poker by Michael Lewis

• Make Your Bed: Little Things That Can Change Your Life...And Maybe the World by Admiral William H. McRaven

• The Personal Memoirs of U. S. Grant by U.S. Grant

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Liar’s Poker by Michael Lewis

I’ve never read a book by Michael Lewis that is not highly entertaining, and Liar’s Poker is no exception. In the book Lewis (author of books like The Big Short, Moneyball, Flash Boys, The Blind Side, etc.) recounts his days selling and trading bonds at Salomon Brother’s in the mid-1980’s.

I enjoy anything I can find to read about Salomon Brother’s because it’s so instructive on what not to do as an investor or a business operator; all of which are extremely valuable lessons to learn vicariously, rather than first-hand, whenever possible.

The bond market was on fire in the 1980’s and Salomon was at the center of the party. The company rose to prominence trading and selling bonds and was single-handedly responsible for creating the mortgage bond market in the early 1980’s. This ultimately set the stage for the 2008 financial crisis a few decades later.

Lewis Ranieri spun up the mortgage trading market in the early ‘80s by buying undervalued mortgages from forced seller Savings & Loans corporations who were facing a crisis when Volcker crushed the housing market by raising interest rates to 20% in a successful effort to stamp out inflation. S&L’s were caught flat footed when they suddenly had to pay customers 14% on short term deposits while they held mortgages that were earning less than 10%. You don’t need a calculator to see this was very bad for the banks.

Congress provided a loophole for the S&L’s to offset some of their losses by selling mortgages and booking gains on buying mortgages from other S&L’s, a fancy accounting maneuver that basically resulted in the S&L’s swapping mortgages or moving them off their balance sheets. Salomon was there to facilitate these trades while keeping a huge slice of the profits for themselves. They did things like buying mortgages for 90 cents on the dollar from one S&L and turning around and selling them to another for 92 cents on the dollar a day later. The market was hugely inefficient at the time and it resulted in exorbitant profits for Salomon at the expense of its customers.

Michael Lewis began selling bonds for Salomon shortly thereafter and his job was basically to screw customers in order to earn money for Salomon traders in much the same fashion as described above. He quickly realized the absurdity of the situation. His stories are comical though they make you cringe at how willing and incentivized Salomon employees were to knowingly sell garbage bonds to institutional investors so the firm could profit (and leave the customers holding the bag). Predictably, this could only last for so long before the chickens came home to roost.

Not only were Salomon’s incentives grossly misaligned with customers, but they were grossly misaligned within the firm. Each group (government bonds, mortgages, corporate bonds, equities) was pitted against each other with the sole aim of generating the largest bonus for themselves at the end of the year. This led to a culture of back stabbing, cronyism and greed. Needless to say these incentives led to a bad combination that culminated in the firm relinquishing its perch atop the bond market. Ultimately the firm was mired in a massive U.S. treasury trading scandal (which prompted an emergency rescue from Buffett and Berkshire) and was later swallowed up and rebranded by what today is Citigroup. The company also spawned the founders of Long Term Capital Management, another disaster I wrote about a few months ago.

Thanks to mismanagement, poor capital allocation and terrible incentives, the one time king of Wall Street is now a footnote in financial history.

Dan

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Make Your Bed by Admiral William H. McRaven

Make Your Bed was written by a retired Navy Admiral and Navy Seal and was inspired by a commencement speech he gave to his alma mater the University of Texas. McRaven provides ten core tenants on how to have a successful life with examples from Navy Seal basic training and his active duty experiences to support each lesson.

McRaven’s ten lessons are:

1. Star every day with a task completed. He uses the example of making your bed every day. Have discipline to do one small task and many more important ones will follow.

2. Find someone to help you paddle. Maintain meaningful friendships in life, because no one achieves greatness alone.

3. Only the size of your heart matters. Whether embarking on a physical or mental task, it’s the size of the fight in the dog, not the size of the dog in the fight, that matters.

4. Life isn’t fair - drive on. Everyone gets bad breaks occasionally, even if you do everything right. Don’t complain or blame it on someone else; stand tall and move forward.

5. Failure makes you stronger. Use failures to better yourself. Learn from what you did wrong, apply it to the next problem you face, and use it as motivation in the future.

6. Dare to be great. You never know what you’re capable of until you’ve tried. In investing, Howard Marks talks about a similar dynamic and equates complete risk-aversion to returns-aversion.

7. Don’t back down from the sharks. “Bullies are all the same; whether they are in the school yard, in the workplace, or ruling a country through terror. They thrive on fear and intimidation. Bullies gain their strength through the timid and faint of heart.” Don’t give in to them, either literally or metaphorically.

8. Rise to the occasion and be your very best in the darkest moments. “At some point we will all confront a dark moment in life…that crushes your spirit and leaves you wondering about your future. In that dark moment, reach deep inside yourself and be your very best.”

9. Start singing when you’re up to your neck in mud. Hope eases the pain of losses. Some day everyone finds themselves neck deep in mud, and that is the time to sing loudly and smile to lift up those around you while waiting for morning to dawn.

10. Never ring the bell. Quitting is always easiest in the moment, but it’s almost always regretted down the line. Nothing worth doing is supposed to be easy.

The book is a fast read and the stories from seal training and active deployment are memorable. It’s hard not to be motivated after reading it.

Much like in investing, there is not anything overly complicated about McRaven’s suggestions on how to live a fulfilling, successful and meaningful life. It’s the ruthless application of simple principles over long periods of time, not their complexity or intensity, that produces the desired result over the long run. This point can’t be hammered home enough for investors who are impatient to get rich quickly or who allow temporary setbacks to derail their strategy.

Dan

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The Personal Memoirs of U. S. Grant

Grant wrote his memoirs while racing death. It is a classic image from American history: a cancer-wracked old man, sitting in a rocking chair on his front porch covered in blankets, his throat sealed shut after a lifetime of chain smoking cigars. Near the end he was unable to speak or eat but refused morphine in order to keep his mind clear enough to write.

The book’s prose is simple and direct. There’s a clear sense of motion, from beginning to end, much like Grant’s army. There’s a relentlessness to the book that mirrors Grant’s personality.

In 1864, near the end of the war, Herman Melville toured the front and wrote about it in his poem “The Armies Of The Wilderness.” Grant appears as “the silent General,” ominously still, “like a loaded mortar” clad in “plain garb.” Grant was the “strong silent type” and it comes through in his prose. There’s no fluff. Just the facts, ma’am.

The story begins with Grant’s recollection of West Point and the Mexican-American war. As quartermaster Grant managed the Army's supply lines. His experience and expertise prepared him for the realities of industrial warfare.

As SBF and FTX have demonstrated, it is insufficient to merely have big ideas and a bias towards action. “Move fast and break things” only works so long. There’s lots of behind-the-scenes grunt work that has to be done too. Companies need accounting and HR departments just as armies need quartermasters who can keep food and ammunition flowing to the front lines. Grant didn’t just excel in battle, he also excelled at logistics. Without efficient logistics, the North’s industrial advantage would be moot.

While at West Point and on campaign in Mexico Grant met many of the confederate generals he’d face in the Civil War. Having sized them up, he knew what risks he could and couldn’t run against them. Part of his military genius was that Grant didn’t just play his cards, he also played the man.

Once, after capturing a rebel fort, Grant recalls chatting with the captured third-in-command officer:

I had been at West Point three years with Buckner and afterwards served with him in the army, so that we were quite well acquainted. In the course of our conversation, which was very friendly, he said to me that if he had been in command I would not have got up to Fort Donelson as easily as I did. I told him that if he had been in command I should not have tried in the way I did.

Grant cared about results and merit more than pomp and circumstance. He was deeply humble. Upon promotion to Lieutenant-General and Commander of the Armies of the United States, an exalted rank last held by George Washington, he simply had the gold-braid shoulder bars sewn to his “traveling suit,” a dusty private’s uniform. 

When Grant met General Lee at Appomattox to negotiate the surrender of the Army of Northern Virginia, he was still wearing and old, worn out private’s uniform. Lee was dressed like royalty.

Most of the book consists of detailed accounts of military actions and campaigns. They are much more detailed than you’d find in a normal biography or military history. Grant frequently quotes from his letters to Generals with instructions for troop movements. 

Therefore, I would not recommend this book for the casual reader looking for an intro to Grant or the Civil War. Instead, start with Ron Chernow’s Grant or Bruce Catton’s A Stillness At Appomattox.

Grant concludes the book by saying: 

The cause of the great War of the Rebellion against the United States will have to be attributed to slavery… It is probably well that we had the war when we did… our republican institutions were regarded [by the nations of Europe] as experiments … and monarchical Europe generally believed that our republic was a rope of sand that would part the moment the slightest strain was brought upon it. Now it has shown itself capable of dealing with one of the greatest wars that was ever made.

Matt

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The Best Of The Rest

• Morgan Housel: Getting Wealthy vs Staying Wealthy

  • Good investing is not necessarily about making good decisions. It’s about consistently not screwing up.

• Bronte Capital: When Do You Average Down?

  • You must not average down (much) on highly levered business models.

• Howard Marks: What Really Matters

  • It’s clear from observation that security prices fluctuate much more than economic output or company profits. What accounts for this? It must be the fact that, in the short term, the ups and downs of prices are influenced far more by swings in investor psychology than by changes in companies’ long-term prospects. Because swings in psychology matter more in the near term than changes in fundamentals – and are so hard to predict – most short-term trading is a waste of time . . . or worse.

• Benjamin Graham’s 1955 Testimony

  • With respect to undervalued securities in general, not special situations, that would be based upon a process of security analysis which shows by a study of the company’s balance sheet and income account that it is selling for considerably less than its intrinsic value, which in general can be defined as considerably less than the value of the company to a private owner”.

• Michael Mauboussin Interviews Todd Combs

  • [Combs] reiterated that they don’t do macro, and they don’t predict the future at all. What they do instead is take the world they’ve been given in the present, without having to understand the future. They ask if inflation is secular or cyclical. (Warren and Todd were talking for hours this past Saturday and they didn’t talk about inflation for more than 30 seconds.)

  • In a deflationary environment they would ask how this business would perform in 10% inflation. Never just extrapolate the current environment state. Cyclicals always look cheap at the bottom and expensive at the top. Always invert. Combs thinks about it like “a hot water faucet. Sometimes it takes some time to warm up and when you feel it you might gently scald your hand, the more inflation goes the more the Fed is going to be after it, and it can lead to recession. It works like a pendulum.”

• Crypto reinvented centralized finance, but forgot the Central Bank

  • Having compressed most of the mistakes made by finance over the centuries into just over a decade, cryptocurrency speculators may finally be discovering the fundamental flaw of trying to build an alternative to government-backed finance: no government backing.

• Ten Questions with Todd Combs (page 25)

  • [Buffett] said, “I read 500 pages a week,” referencing the huge stack he had walked into the room with. “Any of you can do that, and the knowledge just compounds over time.”

  • Charlie Munger compares [investing] to the parimutuel system for betting on horses. Everyone may know who the best horse is, but if it is more than reflected in the odds, then it won’t pay off. You want to find the great horse that no one else thinks is a great horse.

  • I read about 12 hours a day. Our offices are like a library. So I read annual reports, conference call transcripts, trade magazines, etc. Most things are routine, mundane, and obvious but every once in a while you find something interesting worth digging into.

• Matt Levine: FTX Had a Death Spiral

  • The problem is that FTX took its customers’ money and traded it for a pile of magic beans, and now the beans are worthless and there’s a huge hole in the balance sheet.

• TikTok Lowers Ad Revenue Targets for Next Year

  • TikTok has lowered its target for this year’s advertising revenue to $10 billion from at least $12 billion, Chief Executive Shou Zi Chew told staff in an online meeting that took place in recent weeks…TikTok is among the tech companies feeling the pain from the stumbling digital-advertising industry, as advertisers cut back on marketing budgets amid global macroeconomic headwinds.

• Matt Levine: FTX’s BlockFi Rescue Didn’t Work

  • Basically FTX took in a lot of real money and … lost it somehow … and convinced itself that the money was still there because it still had a lot of tokens that it had made up? And those tokens did have a market value ; they traded in cryptocurrency markets, and so you could calculate how much FTX’s stash of those tokens were worth at their market prices. Of course if FTX had actually tried to sell all those tokens the price would have cratered, so that market value was not real , and now it has collapsed.

• Matt Levine: The Nickel Market Almost Broke

  • A fact about financial markets that occasionally produces strange results is that the total market value of a thing is, conventionally, (1) the amount of that thing that exists times (2) the price of the last trade. So Bloomberg tells me that there are about 304.5 million shares of GameStop Corp. stock outstanding, and they closed at $25.60 yesterday, so GameStop’s market capitalization — the total value of its stock — is 304.5 million times $25.60, or about $8 billion. Nobody recently bought or sold all of GameStop for $8 billion, and if somebody did, the price would probably not be $8 billion.

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