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Simple survival lessons

Sep 17, 2008

In order to avert the worst collapse the world financial system could have ever seen, the US Federal Reserve has come to the rescue of the 'about-to-die' AIG Inc., the world's largest insurance company. The US central bank has loaned the insurer US$ 85 bn for a 2-year period in lieu of a 79.9% stake in the company.

As Bloomberg reports, the Fed has indicated that this step was necessary because "a disorderly failure of AIG could have added to already significant levels of financial market fragility." The report further states that AIG's extinction could have cost the financial industry US$ 180 bn because the company provided insurance on more than US$ 441 bn of fixed-income investments held by the world's biggest institutions. This included US$ 58 bn in securities tied to subprime mortgages.

So, the Fed's step is seen as a good thing to avert a bigger crisis. But was this the right thing to do considering that it could send incorrect signals to the wrongdoers (who could now also hope of support from the Fed) is a question that remains unanswered.

  • Also read - An ethical degree

    AIG's stock has already declined almost 80% over the past 12 months on broader credit market concerns and those specific to the company. While this has sent chills down the spines of investors in the ill-fated company, they've still done better than their peers in Lehman, whose stock is down 94% during the same period.

    So, is the problem there with the entire financial system? It seems like there is. But there still are companies that have managed to stay away from the crisis and have also seen their shareholders benefit from the same. Not all financial firms have made ill-advised and reckless decisions.

    Case in point is Warren Buffett's Berkshire Hathaway. The company's subsidiary, Clayton Homes (the largest maker and financier of prefabricated and mobile homes in the US) has managed to stay away from the crises that the mega financial institutions have been facing.

    As reported by Fortune, Clayton's loan delinquency rates (NPAs) have in fact remained stable during these times of turmoil - the rate was 3.26% at the end of June quarter last year, and it is now at 3.82%. In comparison, the delinquency rate in the traditional housing market is around 6.4%!

    And the reason behind the strength of Clayton's portfolio is simply that the company has been more careful about lending. As per the Fortune report, the company keeps all loans on its own books rather than offloading them to others by means of securitisation.

    Another important fact is that Clayton has lent to borrowers who can afford their monthly payments and who purchased their houses for shelter, not for speculation.

    The simplicity of Clayton's business and its risk averse strategies is what has paid for Berkshire as the company has been almost untouched by the subprime mess. And the benefits have been enjoyed by shareholders in the company. When most of the financial stocks in the US have lost anywhere between 75% and 90%, Berkshire's share price is up 1% over the past one year. And this is without much volatility during this period.

    Isn't it the 'weighing machine' principle of Buffett's teacher Benjamin Graham that is at work? Companies cannot make poor financial decisions without eventually having to deal with the consequences. And shareholders in well managed companies with ethical practices and visionary managements get rewarded over a period of time. Patience pays for them, as it has paid off for shareholders in Berkshire.

    These are some simple lessons for companies to learn as also for stock-market investors.

  • Also read - Lessons from Warren Buffett

    Remain calm during turbulent times. Do not follow the herd. Do not act rashly. Although the crisis in the financial sector is dragging the market as a whole down, there are several long term opportunities yet to be found.

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    Dec 6, 2021 03:32 PM