Archive for January, 2014


January 27, 2014

CONSUELO MACK:  This week on WealthTrack: Two financial champions were firing on all cylinders in 2013. What’s their plan to finish in the winners’ circle again this year? Wall Street’s reigning king of economists Ed Hyman joins investment legend Bill Miller next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. What kind of a year will 2014 turn out to be? Which economies will thrive and which will falter? Where will money be made and lost?  We have two financial superstars with us to answer those questions and they will be with us for the next two editions of WealthTrack.

One has been an exclusive television guest here every year since our launch nine years ago. He is Ed Hyman, Chairman of independent institutional research firm, ISI Group. Inc. Ed has been ranked Wall Street’s number one economist by institutional investors for an unprecedented 34 years in a row. Continue Reading »

RUSSO & WEITZ – DYNAMIC VALUE DUO – Transcript 1/03/2014 #1028

January 27, 2014

CONSUELO MACK:  This week on WealthTrack, a dynamic duo of super value investors! Wally Weitz of the Weitz Funds and Tom Russo of Gardner Russo & Gardner search high and low for extraordinary bargains but find them very different places. Two great value investors are next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. This week for our first show of the New Year, we have a WealthTrack exclusive with two outstanding value investors together on television for the first time, although they are good friends and have known each other for many years.

Wallace Weitz is the founder, president and portfolio manager of the Weitz Funds where he started the flagship Weitz Partners Value Fund as a private partnership thirty years ago. Since its 1983 launch, this Morningstar favorite has racked up market and category beating returns. Weitz now co-manages Partners Value, Weitz Value Fund and Hickory Fund but is the sole manager of the Partners III Opportunity Fund. Although his funds tend to have low turnover rates, Weitz is an active manager. He will go through periods where the values in the market are so compelling to him that he becomes fully invested. Other times when he sees limited opportunities, he will trim positions and raise large amounts of cash. Right now he is carrying about 30% in cash in Partners Value.

Tom Russo is a partner in the investment advisory firm Gardner, Russo & Gardner where he has run the Semper Vic Partners Fund for nearly a quarter of a century. Since Semper Vic’s 1990 launch it has also delivered market beating returns. Russo, who also has very low turnover in his funds, tends to stay fully invested and specializes in holding global brand name companies mostly based overseas and many family-controlled.

Although their view of the values in the market are very different as are most of their holdings, they have one big thing in common. Berkshire Hathaway is one of the largest holdings in each of their portfolios and they are huge fans of Warren Buffet. Before we discussed those similarities, I asked them about where they diverge- how difficult it is to find value in the current market.

WALLY WEITZ:  Very difficult. We look at companies one at a time and measure the business value and want to buy at a deep discount to that, and that doesn’t exist in this world. We found two or three new companies in the fourth quarter, so obviously it’s not zero, but we’re not enthusiastic about the price we’re paying, so we’re taking little positions and hoping the market will go down.

CONSUELO MACK: And 30% in cash?

WALLY WEITZ:  Thirty percent plus or minus in the stock funds in cash, yeah.

CONSUELO MACK: So Tom, but you on the other hand, a value investor, are pretty fully invested.


CONSUELO MACK: But that’s all the time. Right?

TOM RUSSO: It is. I tend to be fully invested. Insofar as my allocation for most of my investors, it’s just for a small portion of their funds with the idea towards accessing the kinds of businesses that I focus on which have a very long horizon. They’re global businesses that are investing against the future for quite a long time. In assets, for example, one of the things you have to wrestle with is that with upfront investing that’s quite considerable, the P/E ratios for those businesses are often overstated because the earnings component of that ratio is burdened by the investment spending that takes place when you’re building out the network for a Nestlé or a Heineken around the world.

WALLY WEITZ:  But I think Tom and I both think about business value versus price, not statistically cheap P/E or price to book and that sort of thing. We’re thinking about discount to the value to a business person, and a company that actually grows, that actually has stability and a great 10 or 15-year runway is worth a lot more than some very ordinary cyclical company that may have a low price/earnings ratio. So we would agree on that, and if you looked at our portfolio today compared to 10 years ago, you would find our average P/E much higher and the quality of our companies much higher.

CONSUELO MACK: But the difference is that you do an analysis of the business value versus the price. Right?

WALLY WEITZ:  Right, right, right. We measure not only the price to value of every individual stock, but we look at the weighted average price to value of the whole portfolio, and so in March of ’09, our weighted average price to value is like in the 40%  range. Today it’s like close to 90%, and that doesn’t mean it’s going to go down.


WALLY WEITZ:  Well, it probably will go down temporarily, but the point is the odds of doing very well from a 90% is a lot lower than the likelihood of doing well from 40% if we’ve measured it right, and so we’re just trying to play the odds and put the odds in the investor’s favor, and even though we’re 30% in cash, we are 70% invested, and we’re invested in Berkshires and Transdigms and Liberty Globals and companies that there’s some overlap with Tom, but the conceptual overlap is very considerable.

CONSUELO MACK:  So what changes are you making in your portfolio based on what’s been happening in the market?

TOM RUSSO: There are rebalancing portfolio changes that take place regularly and that often occurs in part because some position has moved up to a higher percentage weight than it probably warrants in light of the events and its share price and the resulting discount to its intrinsic value. You have that movement up, and it’s often happening at the same time as other businesses for reasons that might not bear merit have gone down in value. And so their discount from their intrinsic value deepens, and so on the balance, that rebalancing adds value I think from moving from the overweight, less undervalued to the less weighted, more undervalued. You know, the one thing I would say is the amazing thing about the 40% discount scenario that Wally referred to in March of ’09, the issue was you had to get up from under the table to see those values, because in March of ’09 it was a really scary time.

CONSUELO MACK: Right, the world seemed to be falling apart.

TOM RUSSO: It was extremely important at that time that you just kept your investors invested, because their instincts were to just pull out of the market, and with a full investment sort of bias, I go through the same type of swings that Wally does, but at some point I think a value to the investor is just to know that the businesses have an embedded direction, and the market can swing as it does, and we can add some value through the rebalancing, but at the end of the day, it’s better to own great businesses than not.

WALLY WEITZ:  It was good to have cash in March of ’09, and we couldn’t wait to get it invested, and it really helped the rebound off the bottom, and I think it’s times like that that sort of reinforce the idea for me of being comfortable with high cash positions when things are expensive, because it seems that the opportunity cost of the cash… I mean, I don’t worry about it earning zero. Sometimes zero is the best there’s going to be.

CONSUELO MACK: Better than losing it, too.

WALLY WEITZ: But having cash in times of distress is important, and that’s really what investors pay us for, whether they realize it or not. It’s so that we will be investing or staying invested at bottoms and not letting them panic and shoot themselves in the foot.

TOM RUSSO: All out of the market is a risky position even though it may be driven by a fear of risk. Being all out of the market is itself a risky position, and that’s why we try to balance back and forth with the percentage weight. The notion of having cash and the value of having cash can also surface within the companies.

WALLY WEITZ: Absolutely.

TOM RUSSO: So Nestlé in 2011, the second half of 2011 had a terrific opportunity to make three acquisitions that built their franchise substantially stronger in China. Most of the world had fled China in the second half of 2011. Chinese stocks had collapsed, and the market wasn’t rewarding anybody for being anywhere close to China, much like today, but Nestlé went into that market and bought a beverage company, bought the largest confectionary company and bought Wyeth’s infant formula business exactly because they could at compelling prices, and then on top of that they might go in and buy back some stock during a downturn. If they have cash and they have a long-term mindedness, they will build more value for us during those sharp downturns than not.

WALLY WEITZ: And Berkshire in March…

CONSUELO MACK: So let’s talk about Berkshire because we’re talking about some differences and similarities, but the two of you, your largest holdings or one of your largest holdings is Berkshire, so talk about Berkshire, Wally.

WALLY WEITZ: Well, Berkshire is a collection of businesses that Warren’s put together over 50 plus years that generate excess cash. They send a billion or two home to Omaha every month for him to reinvest, and he does let cash pile up at times, and so when we got into the financial crisis and Goldman, they needed money badly on that Sunday afternoon, he was able to get fabulous terms and the same for GE and the same for Bank of America. There are plenty of people who have high IQs or who are driven or are great business minds or a lot of these other characteristics. Warren has them all, and what’s great about Berkshire from my point of view is it will be a totally different company if you were to just look at it every 10 years, but the organization of it and what he’s doing with the cash flow will be consistent, and so you can close your eyes, and maybe every time I’ve been on your show you said, “Well, what’s the one stock?” and I’ve said, “Well, Berkshire Hathaway,” because you can leave it alone and trust Warren to reinvent.

CONSUELO MACK: To transform it?

WALLY WEITZ: Reinvent it as needed and continuously over time and be totally disciplined. There’s criticism in some paper recently about Warren’s investment record isn’t so great because he uses leverage, because he has $75 billion in float which is like an interest-free loan for him, but there’s a lot of people who have access to leverage and have blown themselves up in a much shorter period than 50 years, and so for him to be able to keep buying the stocks that look kind of boring to people on the outside, the Cokes and the American Expresses and so on, and do it for 50 years and compound at 20 plus percent and do it in a very tax-efficient way for the investors, it’s …

CONSUELO MACK: Extraordinary. So you were just telling me that if you look at what Warren Buffett’s doing, his most recent acquisitions, the big ones, Exxon Mobil.

TOM RUSSO: Yeah, I think Warren …

CONSUELO MACK:  IBM.  Tell me about your analysis of the IBM and Exxon Mobil.

TOM RUSSO: I’ve just been struck by how obvious and how plain and how straightforward those investments are, and how enormously dull they are and how boring, and in a marketplace that’s full with stories, to see where Warren puts the capital and it’s completely ignored. Often if we have an interview in a forum like this, people say, “Why on earth would you talk in a forum like this? Because after all, won’t people copy you?” Warren’s always said that he’ll do things publicly. He’ll talk about it publicly and it’s just too dull for most people, and these are two stocks that are just too dull, but there’s absolutely no reason, if properly harnessed, that they couldn’t clearly deliver a double in which case Warren will have added another $17 billion in value to his shareholders.

WALLY WEITZ: And part of the purchase price comes from zero or negative cost, interest-free loan, indefinite-length loan from the float.

CONSUELO MACK: Right, from his cash.

WALLY WEITZ: So even if it only does 10% a year, the leverage makes it 15.

TOM RUSSO: And there’s something…

WALLY WEITZ: But they have to last, and they have to survive, and they have to not disappear overnight, and those two companies I think he believes have that. They start with that.

CONSUELO MACK: But let’s get off Warren, because I feel like so he’s a one-off, but you two invest in companies for a long term, and you told me, Tom, that for instance Heineken is… because I said, “So you’re still owning Heineken.” You said, “No, but it’s a totally different company than it was 10 years ago.” So tell me about the kinds of management that you look for that aren’t just Warren Buffett.

TOM RUSSO: I think the lesson that’s most powerful from Berkshire, to answer your question, is companies have to have the capacity to suffer when they want to expand, and so we look for businesses that have, first of all, the opportunity to expand, the capacity to reinvest that arises from the extent of history in many instances. Nestlé happens to be in 190 countries around the world, 75 active businesses around the world because they came from a small Swiss country base, and they grew organically. Heineken grew around the world because there are only 13 million Dutch drinkers of Heineken beer, and even thought Heineken beer in Holland is…

WALLY WEITZ: They over indexed, though.

TOM RUSSO: Oh, yeah… is so much more than a breakfast drink, as they call it, at some point there are only that many hours in a day, they had to look elsewhere and with them traveled their brands.

CONSUELO MACK: But that’s also a family controlled business, Heineken, whereas Nestlé is not, but that’s another thing that you two look for in kind of the initial screen is management that you can trust. So tell me about the screen of management, why management is so important, Wally.

WALLY WEITZ: Well, Tom talks about the ability to suffer. He’s talking often about families that have multi-generations. They’re completely committed to the thing and committed for the next generation.  We’re looking for the same sort of thing in a different form. We want the Buffetts, the John Malones, the…

CONSUELO MACK: Liberty Media.

WALLY WEITZ: Liberty Media.

CONSUELO MACK: I mean, you’ve invested with Malone for a long time.

WALLY WEITZ: People like the guy who runs Transdigm. It’s all about the company for him and doing a great job, and so they’re not only able to execute well. They’re smart about reallocating the capital they generate, and they can stop. You know, they just avoid listening to Wall Street. There’s a great book that was out in the last year or so called The Outsiders by Thorndike, and he profiles, what, 10 different managers, and it’s Henry Singleton and it’s Buffett,  you know, companies who …

TOM RUSSO: Tom Murphy.

WALLY WEITZ: Tom Murphy.

TOM RUSSO:  A big deal.

WALLY WEITZ: Who ignore Wall Street and do what they think is right for the company. Now, if you ignore Wall Street and do what’s wrong for the company, that doesn’t do any good, but…

CONSUELO MACK: But who can do that now besides a Warren Buffett and a John Malone? I mean, who can survive to get to that?

WALLY WEITZ: Well, a John Malone has super voting stock.

TOM RUSSO: I think that’s where you get the benefit from family controlled companies. I mean, I have probably 60% of the companies I have in the portfolio are still run by the founding families. They may have obviously professionals actually executing, but the perspective and the capacity to sustain a long-term investment is given to the management because of the strength of the controlled vote. Even yesterday there was the news that Discover Network was looking at acquiring Home & Garden TV Network. It’s called the Scripps Network, but that business didn’t exist 12 years ago. It came out of the Scripps company on the vision of a couple of managers, and they put together resources from television and broadcast and the newspaper business, and they came up with a proposal, and the family backed it and said, “We will back you,” to the tune of $150 million of operating losses over the four or five years to invest in the business.

CONSUELO MACK:  That’s unusual.

TOM RUSSO: And in today’s world particularly so, because around every corner lurks an activist, and if an activist knew that Scripps was in the midst of doing an investment for the future and came knocking on the door and said, “We demand results today,” they would most likely, if the company didn’t have control share, they would trigger the divestiture or the reduction of that effort which would be at the long-term harm of investors. So we have Wall Street that always demands something each quarter and then now this new force of activism that comes along in the midst of something that might be good long term, shakes the tree to get current numbers back a little bit higher, and then declare victory, and it may come at a horrible cost to the business, and that’s where the family control to assure them sort of a go-away pill when somebody comes along and asks for immediate results. It allows them to focus on the long term. That makes a big difference.

WALLY WEITZ: The super voting stock is more common in media land, and that really helps. That’s how Malone keeps people at bay for Liberty companies. That can work both ways. We owned TDS, Telephone Data Systems, for eight or ten years, and it was just a horrible experience because it was a family-run business.  They passed up multiple, really good opportunities, and we finally gave up and went away. So it’s not perfect, but you need the strength of character, and it doesn’t hurt to have the voting control.

CONSUELO MACK: But also activist investors can work to your favor. Right?

WALLY WEITZ: Well, they can work in our favor as…

CONSUELO MACK: As a shareholder.

WALLY WEITZ: As a shareholder, yeah, and there’s some… I mean, activist is applied to a lot of people, and there’s some loud, obnoxious activists that I really don’t welcome into our companies, but on the other hand, somebody like ValueAct, Jeff Ubben, I think has been very helpful to a lot of companies, and we’re glad when he comes into one we already own, and when he buys a new one, we take a harder look at it. He came in and got involved in Valeant Pharmaceutical and …

CONSUELO MACK: Which has been a very successful holding for you.

WALLY WEITZ: … it’s been a terrific stock for us the last year, year and a half. Now, there’s things to be scared about there, too, but he brought in a new CEO that had a totally different business model and approach and focused on the better part or the safer part of pharma land and got out of the things that were more dangerous that had patent cliffs and took a lot of R&D and that had reimbursement issues and focused on others, and he’s made a series of acquisitions and made huge cost cuts, and that can go too far. I mean, Teledigm maybe took it too far in the ‘80s, but it’s been a very successful thing, and it was ValueAct that really triggered that change and built up the comp system. You know, Charlie Munger always talks about the incentives being the most important part of any equation, and having the right comp for the senior leadership is really important.

CONSUELO MACK: So not stock options necessarily while you’re there.

WALLY WEITZ: Right. They pay their own money. They buy stock with their own money, and they stand to make an enormous score at the end but only after five or ten or fifteen years and at much higher stock prices. So the incentives need to be right.

CONSUELO MACK: So I have about five minutes left in this conversation. I can’t believe it. It’s gone way too quickly.  So let me at least get the One Investment out. So if there were one investment that you wanted to put in somebody’s long-term diversified portfolio, Tom, what would it be?

TOM RUSSO: You know, I have so many that I’d like to put in.

CONSUELO MACK: I know you do.

TOM RUSSO: In fact, they’re the same holdings that I have across the board, but I guess at this moment it might be Heineken, and it might be Heineken Holding Company, and the holding company gives us a little bit of an extra return kicker, because it’s the vehicle through which the family, the Carvalho family controls the company, but it trades at a perennial discount to the operating company shares, so we buy it at a discount, but as it sits today it trades for about six and a half times enterprise value of the EBITDA which is one measure of cash flow multiple, and it trades for about 12 times net income, a little less than that. It’s delivered to us investors because of the vision and control of Charlene and Michel Carvalho, the Heineken heirs, a vastly expanded universe in which they can invest going forward.  So they are 20% exposed to developing emerging markets 10 years ago. They’re 70% exposed to developing emerging markets today.  That includes FEMSA in Mexico, Asia Pacific, India. They have an involvement in India. All this comes from …

CONSUELO MACK: All a lot of beer companies.

TOM RUSSO: It’s all beer.


TOM RUSSO: In this case, it is a beer business. It’s not like some Diageo which has beer and also spirits. Now, I have equally large holding in SABMiller, equally large holding in Anheuser-Busch InBev. It’s just that in this case for some reason right now Heineken’s valuation is much lower than the rest, and that’s why of the group I would say that would be the one. Very clear stewardship from the family, and a management that doesn’t have to look over its shoulder when they act for fear of having an activist come along.

WALLY WEITZ: Right, 3G must have their eye on them.

TOM RUSSO: I think there’s all sorts of rumors about global consolidation in the industry and the rest, but at the valuation levels plus the opportunity to redeploy capital based on the steps that they’ve taken in the past five years, I think that’s probably a good investment.

CONSUELO MACK: Now it’s Wally’s turn. One Investment.

WALLY WEITZ: I’d slide Berkshire in as a bonus pick.


WALLY WEITZ: Because I’ve already…

CONSUELO MACK:  It has to be cheaper than class A, Tom…

WALLY WEITZ: I’ve done it three times before. So I try to think of another one where you have management you can trust to reinvent the company as needed, and the extreme case of that would be one of the Liberties, and I would pick Liberty Media. LMCA is the symbol. It’s now at the moment about 100 and some dollars a share worth of Sirius XM radio which they got for zero cost, and another $35 or so of Charter Communications which they are now using to try to go after Time Warner. You have John Malone. You also have another $10 or so of their public companies and another $10 of private companies, but you have a pool of really good assets in the hands of an active, smart, good manager, so it will look totally different five years from now. It’ll look totally different 10 years from now, but if somebody had to put something away, that would work.

TOM RUSSO: What is the market price?

WALLY WEITZ: Well, the market price is about a high 100, 145 to 150. Our valuation really is 160 or 65, so it’s not cheap. Nothing is cheap. Nobody should buy anything because we mentioned it today, but if you had to own some, I’m going to be happy to own that five years and ten years from now I think.

CONSUELO MACK: We’ll have to leave it there unfortunately, but that’s … so I could see Tom thinking about it right now. Wally Weitz, thanks so much for coming in and seeing us from Omaha. We really appreciate it, and from Pennsylvania, Tom Russo. Thank you so much for joining us on WealthTrack again. Great to have you two here.

TOM RUSSO: Thank you very much.

WALLY WEITZ: Thank you.

CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: make sure you have some “boring” investments in your portfolio. Tom Russo and Wally Weitz just described Warren Buffett’s habit of buying quote-unquote “dull” companies such as IBM and Exxon Mobil that other investors aren’t interested in. Purchased at the right price, what these so called “boring” companies can offer is a history of survival, adaptability, and financial heft which gives them the ability to invest when they need to, buy back stock and pay out dividends. Over the long term those qualities can really pay off.

Next week we have our annual exclusive New Year outlook with ISI Group’s Ed Hyman, the Street’s number one ranked economist for more than 30 years running. This year Ed will be joined by Legg Mason’s legendary Great Investor Bill Miller, who is back at the top of his game.  The first of our two part series with them starts next week. In the meantime, please visit our website, for more of our interview with Wally Weitz and Tom Russo in our Extra feature. And connect with us on Facebook and Twitter. Have a great weekend and make the week ahead a profitable and a productive one.


BRIAN ROGERS – NOTHING IS CHEAP – Transcript 12/27/2013 #1027

January 27, 2014

CONSUELO MACK:   This week on WealthTrack while the weather outside is frosty this week’s Great Investor guest says the market is frothy! T. Rowe Price’s Brian Rogers warns the Bitcoin, IPO and social media crazes are possible signs of market storms ahead, next on Consuelo Mack WealthTrack.    


Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. One of my favorite images of 2013 comes to us courtesy of last week’s guest, Jim Grant of Grant’s Interest Rate Observer and his art director artist, John McCarthy. Instead of Uncle Sam commanding citizens to enlist in the army in World War One and Two this cartoon portrays Uncle Ben Bernanke directing us to invest in the U.S. stock market.  The Fed’s unprecedented stimulus policies including buying hundreds of billions of dollars of bonds, even with the start of tapering, and keeping short term interest rates near zero for five years  have certainly helped boost the appeal of stocks compared to bonds and other interest bearing investments.


All financial things considered, the year has been a good one for most investors. The U.S. stock market has been strong, small company stocks in particular have been outstanding performers. The economy is recovering, resuming its leadership role as an engine of world growth. As the independent research firm, Cornerstone Macro, told clients recently: The energy and manufacturing renaissance is continuing.  U.S. industrial production is at record highs. Unemployment has dropped to a five-year low and inflation remains contained. Even Washington has gotten its act together in a couple of  areas- for the first time in years Congress and the Senate reached and passed a budget deal, avoiding a shutdown and scaling back mandated sequester cuts. And the budget deficit is shrinking to 4%. All proving once again that miracles can happen!


This week’s guest wears many hats that give him both a global macro view and a micro one. He is Great Investor Brian Rogers, Chairman of the highly respected investment and asset management firm T. Rowe Price as well as its Chief Investment Officer and the longtime manager of the T. Rowe Price Equity Income Fund which he has shepherded since its 1985 launch.. A Morningstar favorite, the fund has delivered consistent category beating returns over the years with less volatility than the market. I began the interview by asking Rogers why he is more confident about the state of the world than he has been since the financial crisis.

BRIAN ROGERS:  I think it’s primarily because the world is a safer place financially today than it was four or five years ago. When you think of what’s transpired over the last four or five years, how global economies have slowly recovered from the ’08, ’09 downturn, how the global financial system is in such stronger position today than it was, markets have rebounded strongly since 2009 obviously. That can be a good or a bad thing for investors, by the way. It’s been a good thing.  It begs the question what it will be prospectively, but I think economic growth, I think the whole financial crisis is well behind us, and I think investors and the global financial system are both in better places.


CONSUELO MACK:   So let’s talk about what you said. It could be a good thing and a bad thing. It certainly has been a great thing that the markets have rebounded as much as they have since the lows of 2009. However, looking at what you’ve been telling clients, I’m going to quote T. Rowe Price. “Risk reward is more balanced, and we should be risk aware.” What do you mean by risk aware? What are the risks that we should be aware of?


BRIAN ROGERS:   Well, Consuelo, I think what that all means is that prices are up a lot since the bottom, and so it’s not uncommon to find stock market indices up 150, 160 percent since 2009, ditto on the bond market. So if you’re a high-yield bond investor, you’ve made almost as much money as you have in equities, and what risk aware really means is be sensitive to risk after prices have appreciated. Be aware of the risk you’re taking when you make a new investment, because valuations are higher. The global financial backdrop is much better as we briefly mentioned, but with higher prices come higher risk, and so that’s what we’re saying when we say be a little bit more risk aware than you’ve been over the last five years.


CONSUELO MACK:   Okay, because I think certainly most of us have been, you know, frightened over the last five years, because there seemed to be so many risks. So there’s kind of a more complacency now in the market, and that’s a risk in and of itself. Right?


BRIAN ROGERS: Oh, without doubt.  I think you always make more money when you’re terrified, and to the extent we were all terrified back in 2008 and 2009, we had a great subsequent five-year period. Now the backdrop is better. Financial conditions are more appealing. Investors, I think without doubt, are a little bit more complacent today, and I think that’s something that you have to be wary of.


CONSUELO MACK:  So another thing that T. Rowe Price has said in a recent presentation to clients was that investors are finally, U.S. investors especially, are finally rotating back into stocks after fleeing them, but they may too late is what T. Rowe Price said.


BRIAN ROGERS: Well, yeah.


CONSUELO MACK: Is it too late to get into the market?


BRIAN ROGERS: No, I don’t think so. I think it depends on what you invest in and what you buy. I think the great rotation has been a mild rotation. To me it hasn’t been a great rotation thus far, so the money moving from fixed income funds to equity funds has been a slow but steady pattern, and I think that’s probably a good thing for the long term. I think when you think about prices being higher, it just puts a burden on the investor to make better decisions. So a company that in 2009 might have been selling at 10 times earnings, in today’s world might be selling at 15 times earnings.  Now, that doesn’t mean buying a company at 15 times earnings or, for that matter, 18 or 20 times earnings will be a bad investment, but it simply means that your return expectations have to be tempered, and you might not be making 15 or 20% a year in an investment prospectively. You might be making five to ten percent a year, and so you have to really temper your expectations and have more realistic assessment when you’re buying stocks at higher valuation levels.


CONSUELO MACK:  One of the themes that you’ve been talking to clients about is… And I love this. This title is what if nothing is cheap. So my first question to you, is nothing cheap right now, kind of looking at all of your investment choices and the different asset classes that you oversee as a Chief Investment Officer at T. Rowe Price. Is nothing cheap?

BRIAN ROGERS: Well, very few things are cheap. Consuelo, when you look around the world, I always start with the fixed income markets, because there is a predictability of returns in fixed income. If you buy…


CONSUELO MACK: From the income.


BRIAN ROGERS: If you buy the 10-year Treasury, you know over 10 years you will make today 2.8 percent a year.


CONSUELO MACK: Right, and you’ll get your money back if you hold to maturity.


BRIAN ROGERS: And you get your money back. We won’t talk about reinvestment risk and all that, but you know your return will basically be 2.8%a year. When you think about equities, again equities at 15 or 16 times earnings in the U.S., after the type of rebound we’ve had since 2009, many studies would suggest that you might earn between five and ten percent, maybe six, seven, eight percent a year over the next few years.


CONSUELO MACK: Right, versus what you’ve been making which is definitely double-digits over last five years.


BRIAN ROGERS: Over the last five years, yeah, compared to the long-term average of nine or ten percent. When you look around the world, there are different markets, so lots going on at different parts of the world. The global fixed income markets, I would say the prospective returns are similar to those of the U.S. which means modest, and I think in different equity markets, I think there’s all sorts of exciting stuff going on in Japan. A big question about Europe’s recovery, how sustainable it is, and then you have investing in emerging markets which has been a tricky place for the last couple years and an area where I think there’s pretty good opportunity over the next few. So if you think about that 2.8% starting fixed income return, as an investor you have to ask yourself, are you willing to take the risk of investing in equities to try to earn that five to ten percent?  And if you take the midpoint of that five to ten and say your expected return from the equity market might be seven, seven and a half, is that enough to compensate you for the risk of volatility relative to that 2.8%?




BRIAN ROGERS: I think the answer’s yes, but I think again you just have to be a little bit more careful. You can’t indiscriminately throw money into the equity market and hope to make 15 or 20 percent a year. You just have to be more careful.


CONSUELO MACK: I don’t want to leave the fixed income market right away, because I guess 21 percent of T. Rowe Price’s assets under management are in U.S. bonds, I think fixed income. So how risky are bonds? I mean, what’s your advice to investors who want that certain return, and it’s kind of a non-correlated asset. It’s a balance in your portfolio. It gives you income. How risky are bonds?


BRIAN ROGERS:   I think bonds are fairly risky now, Consuelo, and you don’t think of bonds as being risky, but most people don’t anyway, but it feels as though from the starting yield levels and given how at some point the Fed is going to cut back on its asset purchases… And I don’t even worrying about tapering anymore. I mean, if I were the chair of the Fed, I would have begun to taper a long time ago, because I think we’re in a good economic recovery now, and the Fed doesn’t have to be acting quite the way it is, but when you get into duration math which is something I’m reluctant to do on your show, and you think of the risk in fixed income investment if rates increase, you could easily have very low single-digit returns or negative returns in the fixed income market over the next couple years.


CONSUELO MACK: So your advice there for a strategy, again, from the Chief Investment Officer of T. Rowe Price as far as bonds are is to what?  Shorten your maturities.


BRIAN ROGERS: Shorten your maturities, shorten your duration.


CONSUELO MACK: You’ve got about $30 billion in assets under management now at the T. Rowe Price Equity Income Fund. The yield is under two percent. You’ve had a really good year in 2013. Historically you look for undervalued dividend payers, so is there any such animal now as an undervalued dividend payer?


BRIAN ROGERS:  No, I think there are, but I think it’s so much harder. Every day when I look at my portfolio, I think there are so many more things to sell than to buy, and I think that often takes place at times after markets have appreciated. So I think there are interesting things to do, but I think they are much fewer in number. We’ve raised our cash a little bit over the last couple of quarters.




BRIAN ROGERS: To almost seven percent which isn’t too high, but it’s the direction of the movement that’s important. There are very few signs of equity market stress where you can really capitalize on uncertainty and be a contrarian today, and so I think that’s the value investor’s challenge in today’s world.


CONSUELO MACK: So what’s your overall strategy? What kind of companies are you holding?  What kind of returns are you expecting?


BRIAN ROGERS: Consuelo, what we’re focused on right now are companies that have lagged the market over the last couple of years and consequently are inexpensive because of that.  So there aren’t many of those, by the way, so in today’s world, if a company is flat in 2013 and has a P/E of 10 or 11 or 12 and a dividend yield of three percent or something, you know, that’s a pretty interesting investment opportunity to us, and we can talked about some specifics if you’d like, but there aren’t many. There really aren’t many and, again, I come to work every day, and I look at some of the holdings we’ve had that have been really successful investments, and they’re great companies, but their valuations are less appealing, and their dividend yields have declined as prices have increased, and so these are really like benchmark blue chip American companies.




BRIAN ROGERS: Such as like 3M, American Express, you know, fine companies, and we’re not selling because we don’t like the company. It’s because we’re less attracted to the stock price, and we always try to make that distinction between company quality, management performance, long-term return potential and today’s valuation, and we try to balance those couple of things out.


CONSUELO MACK: Is dividend growth a big part of the strategy? So you’re talking about total returns as opposed to what’s going on in the market, per se, or…?


BRIAN ROGERS: I think the perfect company for us, Consuelo, is a company that has a decent dividend yield today and can continue to grow that dividend over the long term.


CONSUELO MACK: Right, so give us some examples of companies that, if I were to look at the Equity Income Fund, you know, these are the kind of companies that you have always had for the last 18 years in the portfolio that represent the kind of companies that you want in the fund.


BRIAN ROGERS: Well, you know, over the last since ’85, we actually have a couple of the same companies in the portfolio for that whole period. One would be J. P. Morgan Chase and its predecessor companies. Another would be Exxon Mobil which way back when was just Exxon.   We’ve had an investment in Johnson & Johnson for many years. Those would be three that I would point to which have had a great track record of creating value for investors, have had really good dividend performance over the long term, and the stocks have done very well over the long term admittedly with big ups and downs in the short term.


CONSUELO MACK: Right. Talk about J. P. Morgan Chase, with what’s going on now with Dodd-Frank, with the Volcker Rule, the various governments around the world are arrayed against the banks. They want to rein them in, and J. P. Morgan Chase, Jamie Dimon seems to have a huge target on his chest. So what do you do in a situation like that where a company is really under tremendous regulatory pressure, and they’re being fined billions of dollars it seems like every other day?


BRIAN ROGERS:  Well, I think it’s probably a testimony to J. P. Morgan Chase’s strength that with all the fines and all the controversy, how well the stock’s done and how well the company’s done from an earnings and growth standpoint over the last one, three, five and ten years, and it’s done a fine job navigating its way through the crisis. I view what’s happened regulatoraly and politically as being grossly unfair to some of these companies and not just to J. P. Morgan Chase but to Bank of America and a number of financial services companies.


CONSUELO MACK:  So why?  Because the other side of… The critics of the banks would say, “Look, they got us into the mess of the financial crisis, and they made a ton of money and basically we can’t let them get in a situation where the taxpayers have to bail them out again.” That’s what the other side is saying.  So what’s your response to that?


BRIAN ROGERS:  Well, I think the blame for the financial crisis, Consuelo, can really be spread around to a number of people. I mean, there was bad lender behavior, appraiser behavior, mortgage originator behavior, Wall Street financial engineer behavior. There was a lot of bad behavior. There was bad political behavior, back to some of the incentives designed to spread home ownership to everybody and, in some cases, folks couldn’t afford it.  So I think there’s plenty of blame for the financial crisis. When I think specifically of J. P. Morgan Chase, and I view the role that they played in helping us get through the financial crisis in terms of the Bear Stearns transaction, the Washington Mutual transaction, those were major institutions that almost took us over the brink.


CONSUELO MACK: Right, and the government basically said you’ve got to take these things over.


BRIAN ROGERS: That’s why I view unjust as an applicable term here.


CONSUELO MACK: All right. So looking at the changes in the regulatory environment for a J. P. Morgan Chase, for instance, I mean, how different is the business model going to be, and how profitable is it going to be in the future?


BRIAN ROGERS:  Well, I think profitability will be impaired by some of the regulatory change. I think the basic business will not really be affected. I think all of these companies will have to hold more capital which is probably a good thing, and one of the reasons I think the global financial system is in much better condition today is because the leading financial institutions have much more liquidity and much more capital.  So if there is another market crisis in the next couple years, it probably won’t be because the residential mortgage sector took us over the brink. It will be something else, and so I think the companies have been healing. I mean, they’re good corporate actors. They care about their investors, and I think that’s an important thing to keep in mind.


CONSUELO MACK:  So a company that might surprise one if you’re looking at an equity income and the kind of track record that you have is Apple, and it was noted by Morningstar in a report I think that while the growth managers at T. Rowe Price were selling Apple, that the more value-oriented managers such as yourself were buying Apple. So talk to us a little bit about Apple.


BRIAN ROGERS:  Well, Apple was a company about a year ago under a lot of pressure, and Apple had been a great performer for many years, and really towards the end of 2012 into early 2013 the bloom really began to fall of the rose, and the stock weakened sharply over the course of the first half of 2013, and we looked at it in the springtime and thought, okay, the stock has gone from 700 to 400 roughly. The P/E multiple is now 10. They’re buying back stock at a frantic pace. They have a nice three percent dividend yield, and there’s a lot of investor controversy, and we love trying to identify controversy and to ascertain whether or not we can benefit  from really what’s a short-term panic, and so we looked at Apple in the springtime. I thought, you know, the stock’s way down. The valuation appeal is pretty high. It’s a yield stock which Apple had never really been, and so we made an investment in the springtime in Apple, and it’s rebounded since. So we’re always looking for companies like that that have struggled, where there’s uncertainty, where the investor concern creates a valuation opportunity, and there are a lot of things going on like that today. I think mean, even simple electric utilities now are very much out of favor.


CONSUELO MACK:  They are. I mean, it’s so funny because you had mentioned to me earlier that telecom and utilities were where you’re looking, and if I look at just about every major brokerage firm, they’re saying, you know, sell, underweight telecom and utilities, and you’re looking at them.


BRIAN ROGERS:  Well, the stocks are basically up a little bit to down over the last year, and because of that and because of the fact everything else is up 20 or 30%, all of a sudden in a relative sense they look pretty inexpensive. So whether it’s Entergy which is kind of an electric utility in the Gulf Coast region or even plain old-fashioned Ma Bell, AT&T with a five plus percent dividend yield, having lagged everything for the last 18 months price-wise. Both those look as relatively safe, risk-aware investments for the investor who wants exposure, who’s looking for dividend income but who does not want to take on too much risk.


CONSUELO MACK: You mentioned emerging markets earlier in the interview, so talk to us about what you’re seeing as opportunities in the emerging markets,


BRIAN ROGERS:  Well, as a sector, the emerging markets sell about 10 times earnings, so when you look at European valuations or U.S valuations, that’s probably a five multiple point difference.  The cash flows coming out of the sector have been large, so investors are moving in the opposite direction, perhaps not unlike investors selling Apple, and sentiment is pretty negative, and the fundamentals are, over the long term, ought to continue to be pretty good, and so many of the emerging market country governments are in better shape than some of the developed market governments.


CONSUELO MACK: Oh, absolutely. Their investment grade


BRIAN ROGERS:  Their investment grade, and population growth is high. The demographics are good, and I think over a five or ten-year period from here, they’ll present very interesting opportunities. So valuation is attractive. Sentiment is bad. Institutions have been moving out, and I think over a long-term period, I think it’s a very interesting area to explore.


CONSUELO MACK: So you’re talking about both stocks and bonds.


BRIAN ROGERS:  Oh, I think primarily equities.

CONSUELO MACK: Primarily equities.


BRIAN ROGERS:  Because from equities you will benefit from that long-term demographic growth case.


CONSUELO MACK: You also mentioned Japan.


BRIAN ROGERS:   Well, Japan is one of those markets and economies.Had I been a global strategist, I would have called for the turn in Japan 10 years ago. That would have been, what, 10 or 12 years into the big Japanese bear market.


CONSUELO MACK:  Right, exactly.


BRIAN ROGERS:  And so it took 20 years, not 10 years for Japan to really turn. And I just think there’s a lot of pent-up potential in Japan. It’s been a great market this year, and I think you can’t correct 20 years of underperformance and a 20-year bear market generally with one year of rebound, and I suspect over the next couple of years the Japanese market will be a very interesting and continuously rewarding place, and I think we’re probably in the second or third inning there, so I think it’s an area investors should focus on or pay attention to and try to capitalize on it if possible.


CONSUELO MACK: Talk about constant surprises in the financial markets. Who would have thunk that Japan would be a very interesting place, exciting place to invest.


CONSUELO MACK: One Investment for a long-term diversified portfolio, what would your choice be?


BRIAN ROGERS:  Consuelo, there are so many great ones.


CONSUELO MACK: I was going to say, how many companies do you have in your portfolio as it is?


BRIAN ROGERS:  Right now we have investments in roughly 115 companies.


CONSUELO MACK:  Right, and I’m asking you to choose your… Right.


BRIAN ROGERS:  I think one really interesting idea for the long-term is Deere.




BRIAN ROGERS:  And Deere is a stock that, not unlike some of the utility stocks or telecommunication companies, is down this year. In response to that price weakness, they announced a buyback of about 25 percent of the company. Great dividend history, two and a half percent, maybe a little bit less than a two and a half percent dividend yield right now, and when you say long term, buy and hold, don’t worry about, I think in 10, 20, 30, 40, 50 years, Deere will still be making the equipment that feeds the world. And when you say one for the long term, I think the company will be… It’s been around for a long time. It’s going to be around for a long time. It’s under performed.  It’s inexpensive. It’s a really high-quality company, great source of income, great source of benefiting from capital allocation and a unique franchise globally.


CONSUELO MACK:   And I have one final question for you. You and I had talked earlier about that one of the things you’re watching are the pockets of craziness in the market and what’s that telling you. So talk about a couple of the pockets of craziness. Bitcoins, for instance, I know are one.


BRIAN ROGERS:   Yeah, Bitcoin is absolutely crazy, absolutely crazy. I think there is a little bit of froth in the IPO market.


CONSUELO MACK: Initial public offerings

BRIAN ROGERS:  A lot of things coming to market. I think the way certain what I will call new age or social network companies are being valued is I’d call it a yellow flashing warning as opposed to a red stoplight like we saw in 2000 at the height of the dot com bubble. I think there are warning signs there, and I think investors would be prudent to pay attention to. The whole Bitcoin thing, I mean, you have to have a currency that is geared to or based on something and not simply a Greater Fool, Tulip Mania kind of concept here, because the last time I checked there was no real economy or series of gold bars or central bank supporting a virtual electronic currency, and so if I were an investor, I would steer clear of that.  If I were a regulator, I would pay an awful lot of attention to what’s going on there.


CONSUELO MACK: And again, it’s telling you that those are flashing lights of frothiness that…

BRIAN ROGERS:  Yeah, I think the whole Bitcoin market is like a 10 or 12 billion dollar market I think, so it’s very small, but I think that type of behavior, that type of very aggressive investor behavior, speculative behavior never happens at the bottom.


CONSUELO MACK: So Brian Rogers, it’s such a treat to have you here on WealthTrack. We appreciate it so much, chairman, CIO and portfolio manager of T. Rowe Price. Thanks very much for being here.


BRIAN ROGERS:  Consuelo, great to be with you.

CONSUELO MACK:   At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Consider rebalancing your portfolio.  The vast majority of the great investors we talk to, Brian Rogers included, periodically trim their winners when they become overvalued by their metrics and add to their laggards when undervalued. The practice applies to individual securities, as well as asset classes, mutual funds and ETFs. Since the market bottom in 2009 and more recently as well, U.S. stocks have been the global winners, small company stocks in particular, so consider trimming there.  Whereas emerging market stocks have lagged, time to potentially add there. In the bond universe consider trimming some top performing high yield bonds and shifting to some much shorter maturity treasury notes and T-bills for safety and stability, and tip toeing into high quality emerging market government and corporate bonds for long term appreciation and diversification.


I hope you can join us next week for a WealthTrack television first:  Two top value investors Wally Weitz and Tom Russo sit down together to talk about their very different portfolios and their mutual hero Warren Buffet. Also on our website Extra feature we will continue our conversation with Brian Rogers and ask him what worries him most in the markets. For those of you connecting with us on Facebook and Twitter keep communicating with us. In the meantime, have a great weekend and a very happy New Year celebration. We look forward to helping you make it a profitable and a productive 2014!

JAMES GRANT & RICHARD SYLLA: THE GREAT FED DEBATE! – Transcript 12/20/2013 #1026

January 27, 2014

CONSUELO MACK: This week on WealthTrack as the Federal Reserve celebrates its 100th birthday, is it a cause for rejoicing or despair? Two financial historians, NYU’s Richard Sylla and Grant’s Interest Rate Observer’s James Grant debate the case for lighting candles or snuffing them out- next on Consuelo Mack WealthTrack.

Hello and welcome to this special edition of WealthTrack, I’m Consuelo Mack. What is the proper role of a central bank? Can any institution prevent or control the booms or busts that dynamic market-based economies produce? Can they control interest rates and inflation, or insure robust employment? Should they try to?

Those are questions being raised anew as the Federal Reserve officially marks its one hundredth anniversary. On December 23rd, 1913, President Woodrow Wilson signed the Federal Reserve Act into law. As the current Federal Reserve describes it: “the Federal Reserve Act stood as a classic example of compromise- a decentralized central bank that balanced the competing interests of private banks and populist sentiment.” That rivalry and tension between private financial interests and populist sentiment is alive and well today and has been with us since earliest days of the republic.

Prior to 1913, populist forces killed two attempts to establish a permanent central bank. The nation’s business was financed by state banks, but it was also disrupted by a series of financial crisis and bank runs. Financier and banker JP Morgan had to come to the rescue twice- first in the banking panic and depression of 1893 and again in the banking crisis of 1907.

Calls for reform of the banking system became widespread. It took years of debate before the Federal Reserve Act of 1913 was signed by President Wilson, creating a decentralized system of 12 reserve banks with branches around the country and independent decision-making powers.

It wasn’t until the 1920s that the buying and selling of Treasury securities was coordinated as a monetary tool to influence the availability of credit.  Even so, the new Federal Reserve system didn’t seem to have much effect on the market crash of 1929 or the Great Depression that followed. Thousands of banks and businesses failed and one in four Americans was out of work.

In response, President Franklin Delano Roosevelt’s New Deal brought big changes to the financial system and the Federal Reserve. One of the biggest, the Glass-Steagall Act of 1933 separated commercial banking and investment banking and gave the Fed authority to supervise multi-bank holding companies.

The Banking Act of 1935 changed the Fed’s structure by establishing the Federal Open Market Committee as a separate legal entity and removing the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board. But it wasn’t until the 1951 Treasury-Fed Accord that the Fed gained the independence to pursue monetary policy on its own.

Meanwhile the Fed’s duties continued to expand. The 1977 Community Reinvestment Act required the Fed to ensure banks lent to low and moderate-income individuals. And the Federal Reserve Act of 1977 codified the Fed’s dual mandate of stable prices and maximum employment.

The Fed has been widely blamed for the double-digit inflation of the 1970s. But starting in 1979, the new Fed Chairman, Paul Volcker, took on the role of the nation’s number one inflation fighter, hiking interest rates to restrict credit and cut off inflation. His painful, recession-inducing strategy succeeded in killing inflation. His successor, Alan Greenspan, continued to use monetary policy to “serve as a source of liquidity to support the economic and financial system” from the market crash of 1987, the bursting of the tech bubble and the terrorist attacks of 9/11.

But it wasn’t 9/11 that revolutionized the Fed’s role. It was the subprime mortgage bubble, which morphed into a global financial crisis in 2008. Under Fed Chairman Ben Bernanke, the Fed invoked emergency authority to launch a series of new programs and assistance packages to rescue global financial markets and economies. The Fed also slashed short term interest rates to record lows in 2008 and have kept them there ever since. Nearly four trillion dollars of stimulus later, the Fed continues its activist role. In the words of Ben Bernanke, the Fed has “come full circle back to the original goal of preventing financial panics.”

Should that be the Fed’s goal and can it really succeed in doing it? Joining us are two WealthTrack favorites, each a respected financial historian and author.

James Grant is the Editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value-oriented and contrary minded journal of the financial markets” that is considered to be a must read by many institutional investors. He is a vocal critic of current Fed policy.

Richard Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics, Entrepreneurship, and Innovation at the New York University Stern School of Business.

I began the interview by asking them to go back to basics: what is the role of a central bank?

JAMES GRANT: Well, one might start with the role that was assigned in legislation 100 years ago. It was to lend against sound collateral. It was to create a market in commercial paper, meaning business loans. It was to furnish so-called elastic currency and it has to be a lender of last resort, and that was it. Oh, yes. They added “and for other purposes” and we have all too many of the other purposes, but my suggestion is the Fed think more about the roles for which it was created rather than the ones it has arrogated to itself.


DICK SYLLA: Since the 1970s, the Federal Reserve has had the obligation to stabilize the price level. That was there for a long time, but an added obligation was to generate high levels of employment, and so this is called the dual mandate. The Fed had a dual mandate. We talked for the last 30 years about the dual mandate of the Fed. The Dodd-Frank Act of 2010, I think, added another item. The Fed is not only supposed to stabilize the price level and give us the maximum amount of employment, but it’s also to foster financial stability. So the Fed now has those three things to do.

CONSUELO MACK: So my question, though, is what do you think the role should be?  We know there’s this long litany of ever-expansive roles that it has, so…

JAMES GRANT: Well, Dick has just told us what it can’t do.

CONSUELO MACK: …would you say that was one of the original goals?

DICK SYLLA: Yeah, I think traditionally a central bank was responsible for stable prices, and that happens to be what they might be pretty good at. Most economists, I’m one, think that the Federal Reserve actually has the power, the tools to stabilize the price level. There’s a lot of evidence in favor of that. It’s much less certain that they can do much to change the unemployment rate, reduce the unemployment rate.

JAMES GRANT: See, the Fed has got into its head that it can improve the future before it comes to pass. The Fed has morphed from central banking into kind of a seat of the pants central planning. It has these models don’t you know, very, very complex, a lot of differential equations. They don’t work, but they do give the Fed the seeming intellectual authority to do so many things that common sense would tell you that simply the Fed cannot do.

For example, the Fed now is in the business of manipulating the structure of interest rates. It is in the business of suppressing some interest rates, and new thing, it is in the business of talking up the stock market. In other words, Dick mentioned stabilizing prices. The Fed is manipulating prices, especially on Wall Street. It’s a very new thing.

CONSUELO MACK: Has it been an effective price stabilizer? And stabilizing prices I’m assuming means that they don’t go up or down too much.

DICK SYLLA: I would say in the long run the Fed has not really been all that effective, because the 20th century was a three percent inflation century. You know, there was some low inflation, some very high inflation, but you can compare it with the previous period of the 19th century when prices in 1914 were not very different from what they were in 1815 according to pricing. So the 19th century was a zero inflation century without the Federal Reserve. When the Fed came in, we had basically a three percent inflation trend ever since then, but I don’t think we can entirely blame that on the Fed. There was something called World War I. There was something called World War II, and…

CONSUELO MACK: The Korean War, The Great Society Program.

DICK SYLLA: Yeah, and if you look back at those periods, it turns out the Federal Reserve was sort of conscripted to be part of the government’s financing machine, and the Secretary of the Treasury told the Fed what to do. In World War I, it was to lend a lot of money to banks so they could buy first liberty bonds and then victory bonds.  In World War II, the Secretary of the Treasury commanded the Fed to keep the interest rates no higher than two and a half percent on long-term bonds and three eighths of one percent on a Treasury bill, and so the Fed was told what to do.  We did not have an independent central bank. So I’m saying there’s…

CONSUELO MACK: Until 1951. Right.

DICK SYLLA: 1951. Then the Fed was freed from the control of the Treasury but, of course, the worst inflation we had was from 1965 or ’66 through 1981, which ended up with double-digit inflation in ’79 to ’81, and the Fed had a lot to do with that inflation. It was using the wrong models. Jim talked about the Fed uses the wrong models. I think they were definitely using the wrong models in the 1970s. Then Paul Volcker came in. He knew what to do, and he’s become sort of an American hero since that time, and 30 years after he whipped inflation, now he has his Volcker Rule passed.

CONSUELO MACK: So Jim, would you give the Fed the role of stabilizing prices?  Is that a fair role to give?

JAMES GRANT: No, no. Prices ought to be determined, it seems to me, through what they call future price discovery; that is to say, the unplanned and unmanipulated dynamics of free people making choices in the marketplace. You know, the time of terrific technological progress one would expect the general price level to kind of dwindle, because every day lower and lower prices is how Wal-Mart’s made a pretty good business about that. Prices dwindled a percent or so a year, one and a half percent or so a year in the last quarter of the 19th century. People kind of liked that. They regarded it as a sign not of deflation but of progress.

Now we have a Fed that wants us to know that prices must not go down. Well, in order to assure the prices don’t go down, the Fed creates lots and lots of credit that creates lots and lots of distortions, some of which end up from time to time in crises. This price stability is a very glib thing to say. It sounds very, very… it sounds commonsensical off of the tongue but it is, in fact, not so.

CONSUELO MACK: So I guess the issue is, can any institution really in an economy such as ours and in a world that we live in which is so dynamic, really be chartered…?

JAMES GRANT: Well, no.  If it could, the Soviet Union would still be in business. The idea of the humble but wonderful institution of the price mechanism, the price system, is it is what makes free economies work. It’s how work is measured and how goods are allocated. It’s a pretty cool system, and the Fed without an explanation really why is interposing itself between that system and us.

CONSUELO MACK: If you talk to most people on Wall Street and in the country, they feel that without the Fed, we would have had financial Armageddon. So Dick, I mean, does the Fed have a role in what Bernanke is saying, is to prevent financial panics?

DICK SYLLA: Well, Jim mentioned that one of the obligations of the Fed traditionally… and this is not just the Fed but central banking history going back to an Englishman named Bagehot, I would even say back to Alexander Hamilton… the central bank should come to the aid of the market in a crisis. Crisis is typically when almost nobody wants to lend to anyone else, so a central bank, when nobody wants to lend to anyone else, the central bank is supposed to keep lending on good collateral at a high rate of interest. You know, recently the Fed lent on dodgy collateral at a low rate of interest, so that’s a corollary I guess to the old rule.

JAMES GRANT: Also to solvent institutions.

DICK SYLLA: To solvent institutions, right.

JAMES GRANT: Violated their own…

DICK SYLLA: …but if you bring in collateral, whether you’re solvent or not, at least the Fed … if the collateral is good, then you can make the loan. So I think the Fed, you know, I think we do need it. Most people say we need a central bank to act as a lender of last resort. That’s the term, end of crisis.

CONSUELO MACK: So would you give the central bank that, Jim, that we do need a central bank that is the lender of last resort?

JAMES GRANT: We don’t need one. We can have one that will do less harm if it sticks to that kind of business, but the trouble is the Fed- this is a trend that’s been in operation over the decades- the Fed has presided over the decay of finance, and it has presided over the degradation of the dollar. By decay of…

CONSUELO MACK: And how so?

JAMES GRANT: By decay of finance, I mean by the integrity of private financial institutions. An example, before 1935, say, the stockholders of a bank were responsible for the solvency of that institution. If the capital was impaired, if the bank went broke, the courts came after the stockholders for a capital call to restore the bank to working order. Now we have, of course, the FDIC. We have the socialization of credit. We have the sidewalk superintending of almost every detail of our financial lives, but notice that in 2008 almost every major financial institution, certainly in the city of New York, was functionally insolvent. Now, how did that happen?

I submit to you that finance and central banking are different than almost any other set of phenomena in modern life. Most things we see progress. We see cars work better. We don’t shave with a cutthroat razor anymore. We don’t use sextants at sea. Progress. Right? In banking, what we see is the cyclical insolvency, virtual or actual, of things like Citicorp. Right? We see retrogression in finance rather than progress, and I say that the retrogression can be laid at the feet of the Fed and of the regime behind it.

CONSUELO MACK: But how so? I mean, why is the Fed to blame basically for the problems that the banking industry had?

JAMES GRANT: Well, the Fed is the creation of a system of paper money and of socialized and subsidized credit. Now, Dick mentioned that the Fed was dragooned into financing the First and Second World War. Nobody ever quits from the Fed in protest or the outrage of being seconded or being dragooned by the government. Right? They just go along with it. Let the record show that Dick is laughing sympathetically at this.

CONSUELO MACK: So is the Fed responsible do you think, as Jim says it is, for the degradation of our currency, for the problems that we have with the mismanagement of the financial institutions and basically for the financial crisis? Was it a contributing factor to this global financial crisis that we’ve just experienced?

DICK SYLLA: Well, I think it was a contributing factor. I wouldn’t be quite so…

CONSUELO MACK: And how did it contribute, Dick? What’s your take on the problems that the Fed has created?

DICK SYLLA: Look over the economic financial history of the last 10 to 15 years. You know, we had a late 1990s dot-com bubble which sort of burst in 2000, and by 2001 the U.S. economy emerged into a recession. The Federal Reserve then pushed interest rates to very low levels and held them there for a couple of years, and that’s when the housing bubble began.

CONSUELO MACK: Right, and this was under Alan Greenspan.

DICK SYLLA: It was under Alan Greenspan, but Ben Bernanke was on the Federal Reserve Board then, and so we got this housing bubble going, and I think the problem isn’t the Fed’s monetary policy so much as its regulatory policy. I mean, it was not… the Fed is one of our regulators. Maybe one of our problems is we have too many regulators. We have the Commodity Futures Trading Commission, the FDIC …

JAMES GRANT: Six of them.

DICK SYLLA: … the Comptroller of the Currency, the Federal Reserve, and they sometimes…

CONSUELO MACK: And they’re all doing different things and ..


JAMES GRANT: Or worse, the same thing.

DICK SYLLA: Or maybe somebody thinks, well, you know, this other person will regulate. This other agency will regulate, so I don’t have to, but in the end maybe none of them regulate as much as they should.

JAMES GRANT: But the city of London flourished for decades and decades without a bank failure and without a regulator. I mean, you can walk into Goldman Sachs and look around, and you’re never sure if the person you’re looking at, except by, I don’t know, maybe the color of his socks or something, is a federal employee or one of the paid help. These regulators swarm over these institutions, and still there’s “too big to fail” anxieties.  These anxieties are well founded. These institutions are leveraged, and they operate under the supposition that the government will be there in time of stress. So the apparently innocuous and indeed necessary idea of lender of last resort I say has become distorted such that the government is now guaranteeing underwriting risk that individuals ought to be bearing for themselves.

CONSUELO MACK: So another interesting development is that when the Fed in the Community Reinvestment Act, for instance, was given the job of making sure that banks lent more to low-income individuals and low-income communities, I mean, again it just seems that… but this is Congress, Dick. Right? The Fed’s roles are ever expanding. It’s given more and more oversight to do more and more, I mean, political things, in fact.

DICK SYLLA: Yes, well, we have to remember that the Federal Reserve is a creature of Congress. Congress created the Federal Reserve. Congress oversees the Federal Reserve. Congress asked the Federal Reserve to do all these things such as the Community Reinvestment Act. You know, you go out and make sure that banks lend to people who aren’t such good risks.

JAMES GRANT: You know, Consuelo, what…

CONSUELO MACK: So it’s not the Fed’s fault, Jim. It’s Congress’ fault. Right?

JAMES GRANT: Congress ought to pay more attention to its, as Dick said, creature. We have not really talked about the nature of the dollar of which the Fed is a steward. The dollar from Alexander Hamilton’s time until about Richard Nixon’s time was to find as a weight of something, that something being gold …


JAMES GRANT: … mostly something silver, sometimes both. Since 1971, the dollar has been kind of faith-based. It has been a piece of paper. It’s been a concept to a degree, and now increasingly it is pixels, computer pixels. The Fed materializes these on computer screens, but in the absence of a definition of the dollar, the Fed can create as many of these things as it deems expedient, and its definition of expediency comes from its mathematical models which I attempted to lampoon into, smirk at earlier in the session.

CONSUELO MACK: But can you lay the blame for going off the gold standard at the Fed’s feet?

JAMES GRANT: No, no. The Fed was the agent of this, but still, we can still hate it for other reasons, Consuelo.

CONSUELO MACK: So if you had your druthers, Jim Grant, and you were in charge of Congress…

JAMES GRANT: Now we’re talking.

CONSUELO MACK: Yeah, so now we’re talking. So what would you do with the Fed?

JAMES GRANT: Well, I would recall the founding legislation. I would go back to that.  I’d read the founding legislation and let us reinvent this institution.

CONSUELO MACK: You mean the 1913 Federal Reserve Act? You wouldn’t go back to Alexander Hamilton and…

JAMES GRANT: I would at least go back to the founding legislation and ask whether we have made progress over these past 100 years. Now, every institution must adapt. Right? The United States Navy has missiles that John Paul Jones did not anticipate. The difference with money is that it is not physics. Right? Money is about human behavior, and we have let the would-be physicists, namely these mathematical economists, into running this institution behind their formula, behind their models, and Congress has let this happen. Congress ought to take this institution by the scruff of its neck and ask it, “What for Pete’s sake are you doing?” You materialize $2 trillion in the past like six or eight weeks. Are we sure that’s what we ought to be doing? You’re doing $85 billion a month, and the financial markets shudder at the prospect of them doing $84.5 billion a month. Is this the right way forward? At least let us ask some common sense questions.

CONSUELO MACK: Dick, what would you do if you were in charge of Congress?

JAMES GRANT: I’m in charge of Congress.

CONSUELO MACK: I just reappointed.

DICK SYLLA: I know that if Ron Paul had become President, Jim Grant was going to be his candidate to be head of the Federal Reserve.

CONSUELO MACK: So I understand, unbeknownst to Jim, he found that out later that he was going to be the Fed Chairman under Ron Paul.

JAMES GRANT: Well, it apparently didn’t happen.

CONSUELO MACK: No, I guess it didn’t.

DICK SYLLA: I think the Fed, you know, it defines price stability as the consumer price index basically.

CONSUELO MACK: Which gets changed all the time.

DICK SYLLA: It gets changes all the time, and there hasn’t been a whole lot of inflation in the consumer price index in recent years. The Fed, by what it’s trying to do, it could say that it did a very good job, but Jim mentioned there are some other prices in the economy, like Wall Street’s prices, like the stock market and interest rates. The Fed seems to have, I think almost deliberately trying to push the stock market up. I mean, I’ve watched this stuff for 40, 50 years now, and this is the first time in my memory when it seemed to be official U.S. government policy that the stock market goes up, and the Fed likes this because it thinks that when the stock market goes up, people who own stocks feel richer. They’ll go out and spend more money, and the unemployment rate will come down.

JAMES GRANT: The portfolio of balance channel, I think, Dick, is the phrase you’re looking for.

DICK SYLLA: That’s right.

CONSUELO MACK: Well, so a former Fed official said that he calls quantitative easing the biggest backdoor bailout of Wall Street of all time. Would you agree with that?

DICK SYLLA: Well, there’s some truth in it, because whenever last…

CONSUELO MACK: You don’t agree.

JAMES GRANT: It’s front door.

CONSUELO MACK: We’re going to have to leave it there, but thank you so much and, if I had the power, I would appoint both of you, a committee to be in charge of Congress to redefine and perhaps recharter the Fed but, Dick Sylla, it’s so great to have you here from NYU Stern School of Business and Jim Grant from Grant’s Interest Rate Observer. Thanks so much for joining us.

JAMES GRANT: Thank you, Consuelo.


CONSUELO MACK: At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Whether you agree with them or not, pay attention to what the Federal Reserve is saying.

Ever since 1978, when the Humphrey-Hawkins Act required the Chairman of the Fed to testify in front of Congress twice a year about its objectives and plans for monetary policy, the Fed has become increasingly more forthcoming. The Bernanke Fed has made a point of being more transparent as has Fed Chair nominee Janet Yellen. The Fed is arguably the world’s most powerful financial institution. It influences the economy and it moves markets. Understanding their thinking has never been easier. Just go to their website, and click on News & Events for their latest meeting minutes and commentary.

I hope you can join us next week. We will sit down for a rare interview with Great Investor Brian Rogers, long time portfolio manager of the T. Rowe Price Equity Income Fund, a consistent Morningstar favorite. In the meantime, to see more WealthTrack interviews and previous programs, just go to our website, And for those of you on Facebook and Twitter, we look forward to connecting with you. In the meantime, have a Merry Christmas and make the week ahead a joyous, profitable and productive one.


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