The Risk of Market Value
In 1984, Warren Buffet gave a speech about value investing at Columbia University. Here is a quote from that speech:
“it is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference. They just don’t seem to be able to grasp the concept, simple as it is.” Warren Buffett
Not about risk management but, if you can get your head around Buffett’s comment about upside, there is a logical counterparty about downside.
“Either the idea of buying dollar bills at $2 seems risky to someone immediately or it never will. If the response is, ‘if that is what the market rate is’ then just dig into your pocket and look for some dollars to sell.” Dave Ingram
In the book “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History”, Greg Zuckerman tells just how difficult it was to be among the few investors who saw that the US mortgage market was overheated – that the market value of the houses and the securities written on the mortgages on those houses were all dollar bills being traded over and over again at $2.
But that was aggressive trading. The risk management response with that knowledge would been to stay away. And many, many financial institutions did stay away. All of the press went to the firms that played that game to their and all of our detriment.
So the Paulson story of good to read because it tells about the other side of some of the trades. And there always in another side, no matter how poorly the press chooses to cover it.
And the other side of the risk mismanagement by the largest banks and AIG is the risk management of the firms who were not exposed to overpriced mortgage securities. But it is hard to make a story about the exposures that those firms did not have.
Which is one of the puzzles of risk management. Sometimes the greatest successes are when nothing happens.