DempseyTV

A fitting title as we begin Mar. 2009. Equity markets have been down six straight months. The Dow Jones was down 15 of the last 17 weeks.

There is a very strong tendency for people to exaggerate the importance of recent events and recent performance. It is human nature. You turn on the t.v., read a paper and whatever is on seems more important at the time than in retrospect. Probably the greatest mistake in investing is exaggerating the importance of, and extrapolating, what happened lately. What has happened over the last 3 and six months has substantially changed the psychology of a lot of people in the direction of betting these recent conditions will continue.

Floyd B. Odlum made a fortune in the Great Depression

So, I’d like to introduce you to Floyd B. Odlum, who died in 1976. He was an investor by profession, CEO of Atlas corp. Functionally he was an opportunist. He made a fortune in the Great Depression by buying up the deeply discounted shares of publicly traded investment trusts, the toxic assets of his day. We can have no finer role model in this, our Great Recession.

None of us can know the future, but like Odlum, we can make the best of a sometimes unappetizing present.

Let us travel back in time to 1930, the first time full year of the great slump. Nobody knew there would be a second such year, let alone a third. They were as much in the dark about the future as we are. In August 1933, the New Yorker magazine ran a profile of Odlum. “His cheerful behavior during this period was a recurring source of wonder and irritation to his friends.”

At one of the most painful moments in the country’s financial history, he was saying “I believe there’s a better chance to make money now than ever before.” As investors we are always so conflicted. We seek out bargains at the mall but shun them with our investment dollars. We loved internet stocks in 1999 at sky high prices, then hated them at $2 per share. Long term U.S. bonds are snapped up today at 3% yields but despised at 14% and more in the early 1980’s.

Odlum’s big idea was to buy dollar bills for 50¢.

Buying Dollar Bills for Fifty Cents

Great investors, world class opportunists, adapt to the times. What makes Odlum a guide and beacon for 2009 is that he saw across the valley of despair. Quoting from a Fortune magazine article about him from 1935: “He has no great faith in the immediate future of the market, whereas he was willing to bet his fortune on the market’s eventual future.” Odlum was bullish on America, as many of us are and should be. But he put money at risk only when the odds seemed right – when the investment has a price tag low enough to afford a margin of safety.

The silver lining of the Great Depression was of course, the prevalence of low price tags. Thankfully, to a lesser degree, it is the silver lining of our Great Recession.

Hi. Thank you for tuning into 21st Century Income. Today we are talking about what we hear in the news called the subprime “mess,” the subprime “fiasco,” mortgage “meltdown,” and the many fixes that you are seeing on TV, put forth by the president or Treasury Secretary Paulson. So without taking too much of our time talking about how we got to this place, suffice it to say that the simplistic reason is that for the first time on any grand scale, you have the people who lend money being separated from the people who are actually going to pay that money back.

Securitization allows banks to disregard repayment of loans

In previous times, when a bank lent money, the bank cared deeply about whether they were repaid or not. Today, in the modern world, we have something called—a process—that’s called securitization. Securitization means that the bank makes the loan and then the bank sells that loan off, packages it up with other loans and sells it off to investors. When the bank completes that sell, they have now been paid back. What actually happens to that loan—and whether the borrower can actually afford it or not—is really not of consequence to the bank, certainly at the time they made the loan. What we are learning now is that it may in fact have consequences for them.

How can we be opportunistic?

What I want us to focus on, as 21st century investors: how can we be opportunistic? What’s obvious is that we live in a time of great turbulence, financial turbulence, and a time of many financial excesses. As a result of those excesses and the turbulence that comes from them, it creates opportunities and it creates chances for good investors to be opportunistic.

If you recall and you go back and look at some of my previous blogs, if you are a 21st century investor, what that means is that you have to think in terms of decades. You have to think in terms of, how do I build a stream of income that is going to last me for many years into the future—what might be decades.

Think like a ‘real money investor’

That immediately makes you start to think, or should make you start to think, like what we call a ‘real money investor’. What’s a ‘real money investor’? A big pension fund, insurance companies, endowments, people like Warren Buffet. It means people who are not buying with borrowed money. People who are buying with long-term time horizons. As a result of this turbulence, there are great investments to be made right now that will bear fruit three years from now, five years from now. That’s how a real money investor thinks. That’s how a big insurance company or a big pension fund thinks.

In the 21st century, generating 21st century income means, you have to be opportunistic; it means you have to have very flexible thinking. And it also means that you need to think a little bit differently. By thinking differently, it means—when you have a very long term time horizon, you can make opportunistic investments.

Portfolio lenders do not engage in securitization

So there are very, very interesting finance companies, interesting banks, small banks (Banks that were doing this whole securitization were many of the big banks, the household names that you know.) But the smaller banks, the banks you might see in your local town, small community banks, which are called portfolio lenders—being portfolio lender means that they don’t actually sell those loans. They keep those loans on the books. Kind of the old-fashioned way, so to speak.

Investing in portfolio lenders is great way to generate income for future years

Now, one of the consequences is that as everyone has become scared of subprime, scared of CDO (Collateralized Debt Obligation), all these acronyms, they of course have sold all the stocks of all the banks. Many of the smaller, regional banks have very good dividends, dividends in the range of four, five, six percent with a history of increasing dividends. Remember, 21st century income—you have to generate ever-increasing income for years out into the future. Well, what a great way to do that—by opportunistically buying very, very conservative, well-run banks that have a history of increasing their dividends, whose stock prices have been absolutely decimated because we live in a very fast-paced world, where as soon as there are any of these disturbances, pretty much everything gets sold immediately.

Cost of money for portfolio lenders will decrease

Let me go back to being opportunistic and thinking. One of the consequences of this whole subprime, CDO dislocation, for lack of a better word, is going to be, rightly or wrongly, a lowering of interest rates. A lowering of interest rates means that what’s called the yield curve—shorter rates versus the longer rates—becomes more positively sloped; it looks sort of like a hockey stick. Banks lend money long term, and their cost of money is a short term rate. So what is going to happen is as the short term rates go down, the banks are going to be able to make more money going forward. If you think about some of these smaller banks we are talking about, these regional banks, they are going to have a lower cost of money in the future, in the very near future. Their cost of money is going to go down. The rate that they are going to charge is going to either stay the same or perhaps even go up because some of the bigger banks might be pulling back in some of these various mortgage-lending areas. It’s a great way for portfolio lenders to step in and provide loans, provide liquidity.

So being a 21st century investor, thinking like a real money investor, you can think opportunistically about acquiring some of these companies at what I believe, three or five years from now, are going to look like bargain basement prices. These are companies, banks that have a history of increasing dividends, that are conservatively run. You can put them in your portfolio and enjoy those dividends for many, many years to come. That’s one example [of strategies to generate retirement income]. We will be back with more. Thank you.