The Giles Resolutions: Scandal and Bailouts in the 1790s

What has been will be again, what has been done will be done again; there is nothing new under the sun.

–Ecclesiastes 1:9

Political intrigue, allegations of financial impropriety, vicious attacks in the media, intemperate politicians, and anonymous trolling. These are all obvious characteristics of political life in America two decades into the twenty-first century and many observers bemoan the abandonment of more collegial days earlier in our history. It is part of our nature to idealize the way things used to be and, in the process, we are prone to forgetting that people who lived long ago were also subject to the realities of the human condition. As we celebrate Independence Day, it is interesting to take a look back at a period of history shortly after our founding when partisan politics was in its infancy and the stakes couldn’t have been higher for the opposing camps.

Thomas Jefferson

Despite George Washington’s efforts to forestall the development of partisanship, by 1792 his own administration was split into two camps, with Treasury Secretary Alexander Hamilton most forcefully representing the cause of the Federalists, who supported a more vigorous executive within a powerful national government, and Secretary of State Thomas Jefferson who was the champion of republicanism that sought to limit the centralizing tendencies of the Federalists. The broad strokes of this long-running dispute might be well known to those with a passing understanding of American history, but only those who have delved into the background in some depth can fully understand the vicious animosity and partisanship that easily rivals what we have experienced in modern times.

On February 25, 1791, President Washington signed the legislation establishing the first Bank of the United States. The establishment of the bank was an expansion of the power of the federal government supported by Alexander Hamilton and vigorously opposed by Thomas Jefferson and his allies who viewed the bank as an unconstitutional measure designed to benefit the business and investing community at the expense of the general population. One of the measures of the legislation was to establish a sinking fund that was designed to begin paying off the national debt, which had been expanded in 1790 at Hamilton’s urging when the debt of states was assumed by the federal government. Jefferson was named as one of the commissioners of the sinking fund.

Alexander Hamilton

Only one year after the bank was established, a credit crisis known as the Panic of 1792 was caused by speculation on the part of prominent bankers including William Duer, who was also a friend of Alexander Hamilton and previously served as the first Assistant Secretary of the Treasury. Duer and other speculators came up with a scheme to use large loans to corner the government debt market. United States debt securities were needed by those who had invested in the initial public offering of the Bank of the United States because the terms of the offering required them to pay for their stock in installments comprised of 25 percent specie and 75 percent government bonds. Gaining control of the government bond market meant that Duer and his partners could potentially reap a windfall due to the presence of forced buyers who needed to settle their installment payments.

The collapse of the scheme in February and March 1792 caused Hamilton to take measures to prevent a broader credit crisis. He utilized the sinking fund that was established along with the Bank of the United States to purchase government securities which had the effect of propping up prices and forestalling a broader crisis. However, the political fallout from doing so was severe and the acrimony easily rivals controversies we have seen in modern times. The crux of the dispute was whether Hamilton had authority to utilize the sinking fund as he did, and especially whether he was justified in purchasing securities at par when they were trading below par in the depressed market during the panic.

Dumas Malone covers this episode extensively in Volume 3 of his six volume biography of Thomas Jefferson which was published in 1962. Malone frames this dispute in the context of the long running acrimony between Hamilton’s Federalist faction and their opponents led by Jefferson, along with James Madison and others in Congress. The extent to which Jefferson himself led the charge to investigate Hamilton’s conduct has long been in dispute. Malone acknowledges that Jefferson was in communication with the members of Congress who launched the investigation but minimizes the extent of a larger conspiracy. During this period, Hamilton was far more vocal in what he was willing to say personally while Jefferson tended to operate more via surrogates. Much of this had to do with the personalities of the men, but the personal nature of the dispute is not in question.

One of Jefferson’s allies in the House of Representatives was thirty year old William Branch Giles, a fellow Virginian who was also close to James Madison. The resolutions that were introduced to investigate Hamilton’s conduct were known as the Giles Resolutions. Malone explains the crux of the charge against Hamilton in this extended excerpt:

Specifically, the question related to the price at which government securities might be bought in this process of debt reduction, and it was answered in Hamilton’s favor by the voice of the Chief Justice, who held that under the act they might be purchased at more than the market price, up to par value. The point is that Hamilton wanted to buy at par at that time, when securities were below par on the market. His major purpose, as he claimed, was to maintain the credit of the government, but numerous speculators, including his friend the notorious William Duer, had been caught in the sharp decline of securities. Hamilton wanted to stay the panic, but to the mind of Jefferson he was purposely supporting the speculators. Furthermore, Jefferson believed that the purpose of the Sinking Fund was to retire the debt — as much of it as possible and under the most favorable conditions. He may not have sufficiently appreciated the positive functions of the Treasury in maintaining the level of public securities, but his simple philosophy was one that unsophisticated citizens could readily understand. Like him, they could not see why the government should pay more for its own securities than it had to, for the apparent advantage of men like Duer.

Jefferson and the Ordeal of Liberty, Chapter 2

The Giles Resolutions were debated in the House of Representatives but all failed to win a majority which represented a resounding victory for Hamilton and his Federalist cause. Jefferson, always reserved in his public statements, was willing to be a little more open in a private letter to his son-in-law following the vote:

Others contemplating the character of the present house, one third of which is understood to be made up of bank directors & stock jobbers who would be voting on the case of their chief: and another third of persons blindly devoted to that party, of persons not comprehending the papers, or persons comprehending them but too indulgent to pass a vote of censure, foresaw that the resolutions would be negatived by a majority of two to one. Still they thought that the negative of palpable truth would be of service, as it would let the public see how desperate & abandoned were in the hands in which their interests were placed.

We can see from this private correspondence that Jefferson not only supported the resolutions, but that he knew that they would very likely fail but wanted the political point made that the Federalists were acting against the interests of the majority. He went on to explicitly characterize the “corrupt maneuvers of the heads of departments”, obviously in reference to Hamilton.

Jefferson resigned as Secretary of State at the end of 1793 and retired to Monticello to look after his long neglected farms and personal interests, but he never left the political scene in terms of his influence on his proteges who remained in government, and he was back in the political maelstrom in early 1797 when he took office as Vice President.

Our times could not be more different from the 1790s in myriad ways, with the most obvious being the speed of travel and the instant and nearly universal access to information. What has not changed is human nature, with all its political backstabbing, intrigues, and scandals. In 1790, people and information could not travel faster than a man on horseback could ride, and information was distributed on paper to those with the resources available to purchase it and who had the literacy necessary to understand it.

Today, politicians, journalists, and ordinary citizens can communicate instantly on platforms like Twitter and the velocity of information, and misinformation, is like nothing the world has ever seen before. It is interesting, and entertaining, to consider how the personalities of Hamilton, Jefferson, and others would have navigated the age of social media for their political benefit. It is easy to imagine Hamilton as a heavy user of Twitter, while Jefferson might be more inclined to put out press releases or let surrogates go to battle on his behalf.

Financial crimes and outright greed are also not new vices of our times, with financial bubbles, scandals and cronyism being as old as the nation itself. As an epilogue, however, we can return to the case of the notorious William Duer. Unlike the villains of the financial crisis of 2008-2009, most of whom have bounced back very nicely, Duer paid a very heavy price for his sins. He spent the rest of his life in a debtor’s prison and died in disgrace in 1799.

Recommended Reading:

Jefferson and His Time, a six volume biography of Thomas Jefferson by Dumas Malone

American Sphinx: The Character of Thomas Jefferson by Joseph Ellis

Founding Brothers: The Revolutionary Generation by Joseph Ellis

Availability-Misweighing Tendency

This mental tendency echoes the words of the song: “When I’m not near the girl I love, I love the girl I’m near.” Man’s imperfect, limited-capacity brain easily drifts into working with what’s easily available to it.

— Charlie Munger, Poor Charlie’s Almanack

This is not the article that I planned to publish today. Early last week, I came up with an idea for a timely article that I would post after the end of the second quarter. Imagine my surprise when I sat down on Saturday morning to download and review supporting data and found that the underlying assumptions for my article were entirely incorrect! I had fallen for one of the more common errors explained by Charlie Munger in his examination of the psychology of human misjudgment.

Berkshire Hathaway’s repurchase policy has long been a topic of interest in the value investing community due to the ever-increasing pile of cash that Warren Buffett has been unable to deploy. Repurchases have been quite minor in recent quarters since the policy was changed last year. During the recent annual meeting, both Warren Buffett and Charlie Munger reaffirmed that Berkshire could indeed make meaningful repurchases at prices judged to be well below intrinsic value. The significant drop in Berkshire shares in the weeks following the annual meeting led me to believe that the prospects for major repurchases had increased and that repurchase activity for Q2 was likely to be higher than in Q1.

Berkshire’s Class B shares closed at $218.60 on May 3, 2019, the day before the annual meeting, which represented the highest level for the stock since before the December 2018 stock market swoon. Following the meeting, the stock began a month-long decline taking the price down nearly 10 percent by May 31 when it closed at $197.42. The shares subsequently recovered most of the decline during June ending the quarter at $213.17.

Why present a paragraph covering the wiggles in the stock price over the span of a couple of months? Long term owners of businesses should not really care about short term stock price movements or even follow them closely. However, I was watching the price of Berkshire stock during the May stock market decline and the days immediately following the annual meeting were most available in my mind over the past several weeks. This led me to the incorrect assumption that opportunities for repurchase in the second quarter were greater than during the first quarter.

Daniel Kahneman, in his brilliant book, Thinking, Fast and Slow, explains that the ease with which events come to mind heavily influences our cognitive abilities and increases the risk of poor judgment:

The availability heuristic, like other heuristics of judgment, substitutes one question for another: you wish to estimate the size of a category or the frequency of an event, but you report an impression of the ease with which instances come to mind. Substitution of questions inevitably produces systematic errors.

Thinking, Fast and Slow, p. 130

The following exhibit from Berkshire’s first quarter report shows that the company spent $1.69 billion to repurchase Class A and Class B common stock during the quarter:

Source: Berkshire Hathaway Q1 2019 10-Q

We can see that repurchases for the quarter commenced on February 26 when shares closed at $201.90 and continued through the last trading day of the quarter on March 29 when shares closed at $200.89. Additionally, Berkshire’s disclosure in the 10-Q of the total share count as of April 25 suggests that modest repurchases continued into April as shares began to rise. The size of the repurchase from April 1 to 25 appears to be approximately 157 Class A share equivalents, and it seems likely that those shares were purchased early in April and that repurchase activity then halted as shares continued to rise.

The following charts (click to enlarge) show trading activity for Berkshire’s Class A and Class B common stock for the first half of 2019:

Source: Yahoo! Finance

We can see immediately that the decline in Berkshire shares in May only brought the stock back to levels that were far more common during the first quarter. If we assume that repurchases are probable in significant size under $205 per Class B share, there were 26 trading days between May 1 and June 30 when shares traded below that level at some point during the day. In contrast, there were 56 trading days during the first quarter when shares traded below $205.

We have no way of knowing what Warren Buffett’s current upper limit might be for share repurchases. We can only deduce what he is likely to do based on very recent history, which in this case leads us to look at his pattern of repurchases during the first quarter. It is notable that Berkshire repurchased shares at average prices in excess of $205 during the third and fourth quarters of 2018. Repurchase activity is going to depend on a number of factors including Mr. Buffett’s assessment of the current stock price relative to intrinsic value, which moves upward slowly over time, as well as alternate uses of cash.

The main point of this article isn’t to speculate on the magnitude of repurchases at Berkshire during the second quarter, although that would have been the intent of the original article I had planned to write based on my incorrect “gut feeling” about the May stock price decline. Instead, it serves to remind us that we can be our own worst enemy when it comes to falling victim to cognitive biases, even when we are fully aware of what those biases are and how they have impacted other people. Reading Kahneman and Munger and understanding how these biases work does not confer any sort of immunity on us as human beings. We have to continue to be vigilant to ensure that we are making decisions rationally rather than falling back on lazy heuristics.

It is also worth noting that those who focus too much on current events are at increased risk of falling for the availability-misweighing tendency. The concept of via negativa, or wisdom through subtraction, applies here. Focusing less on current news (and stock market quotations) and more on subjects of enduring value can insulate us against weighing events of the recent past too heavily. Although I refrain from actually updating the quotations in my investment tracking spreadsheets very often, I do follow market activity every day reasoning that my overriding philosophy will prevent me from reacting rashly to short term news. In this case, my misjudgment only resulted in planning to write an article that wasn’t supported by facts. However, the outcome could be much worse if it involved an actual investment decision. I don’t think that I would make a stupid investment decision based on rash judgments precipitated by short terms news. But am I certain? Perhaps a lower information diet shunning day to day market news is in order.

Disclosure: Individuals association with The Rational Walk LLC own shares of Berkshire Hathaway.

The Appeal of 21st Century Stoicism

“People who are excited by posthumous fame forget that the people who remember them will soon die too. And those after them in turn. Until their memory, passed from one to another like a candle flame, gutters and goes out. But suppose that those who remembered you were immortal and your memory undying. What good would it do you? And I don’t just mean when you’re dead, but in your own lifetime. What use is praise, except to make your lifestyle a little more comfortable?”

— Marcus Aurelius, Meditations 4:19

Marcus Aurelius would be shocked to learn that his set of haphazard personal notes have not only survived but have come to resemble a scripture for practitioners of stoicism living more than eighteen centuries after his death. Far from being forgotten, Marcus has achieved the sort of posthumous fame that he never anticipated, did not seek, and would not have cared about in the least. To read Meditations in the early twenty-first century is to delve into a set of very personal observations that Marcus composed for his own purposes while dealing with the myriad challenges he faced as Emperor of Rome. As Gregory Hays points out in the introduction to his translation the notes are “spiritual exercises composed to provide a momentary stay against the stress and confusion of everyday life: a self-help book in the most literal sense.”

Far from being stuffy and inaccessible, Meditations is approachable and contains wisdom that we can readily relate to today. The fact that human nature, at its core, has remained unchanged over the centuries despite enormous changes in the structure of society makes the problems Marcus dealt with ones that we can identify with today. Depending on our background, we can take snippets from his text and relate it to subjects like business and investing. But stoicism is more than a set of isolated quotes and has little to do with the “stiff upper lip” stereotype commonly associated with it. Stoicism is a philosophy of ethics and a guide for how to live a virtuous life in accordance with our nature.

Given the approachable nature of Meditations itself, I was skeptical when I began reading How to Think Like a Roman Emperor. Too many people tend to gravitate away from primary texts and seek out interpretations when going to the original source provides more value. It would be hard to improve upon the clarity that Marcus himself provides. However, cognitive psychotherapist Donald Robertson has written a worthwhile book that illustrates how stoicism remains relevant to readers with modern-day problems. Meditations itself is not thematically structured with Marcus’s wisdom on various topics scattered throughout his text. Robertson uses historical events to illustrate how Marcus would counsel us to deal with topics such as speaking wisely, following our values, conquering desire, tolerating pain, dealing with fear, and managing anger.

A common, but naive, criticism of Meditations is that one must take its content with a grain of salt given that the life of a Roman emperor must necessarily have been totally different than what ordinary people experience, then and now. While there is no doubt a kernel of truth in that sentiment, Marcus had to deal with many of the problems facing people today. After a vigorous early adulthood, Marcus fell into a pattern of dealing with chronic illnesses, yet he still led his armies into battle when needed, and did not spare himself from physical hardships. For many years, he shared power with his brother who exemplified none of the virtues of stoicism and instead fell under the spell of all sorts of vices that have afflicted humans throughout history. Marcus also dealt with a rebellion and challenges to his power with equanimity, restoring his authority without seeking revenge, even though his own wife had a role in conspiring against him.

Physical frailty afflicted Marcus for most of his life and had a clear impact on his writing. Some of the most powerful passages in Meditations have to do with how one should approach physical pain and the ultimate demise that all of us are destined to experience.

“As he aged into his fortes and fifties … he became physically frail, and that seems to be how subsequent generations remembered him. Writing in the fourth century, for instance, the Emperor Julian imagines Marcus’s skin looked diaphanous and translucent. Marcus even referred to himself in a speech as a weak old man, unable to take food without pain or sleep without disturbance. The Meditations also mentions him obtaining remedies for coughing up blood and spells of giddiness. He particularly suffered from chronic chest and stomach pains. He could manage only small amounts of food, taken late at night. Scholars have offered different diagnoses, the most common being chronic stomach ulcers, although he probably suffered from multiple health problems.”

How to Think Like a Roman Emperor, p. 159

Marcus did turn to his court physician who prescribed a concoction that included a small quantity of opium, but when it made him drowsy he stopped using it, only resuming when the quantity of opium was further reduced. He chose to deal with pain by attempting to see pain for what it is, and localizing the pain in his own mind to the specific location of the body where it was happening, refusing to add to its severity by allowing it to dominate his mind. Robertson notes that Marcus’s attitude toward pain amounted to cognitive distancing, or having the ability to withdraw or separate one’s mind from bodily sensations. Modern cognitive-behavioral therapy advocates acceptance of unpleasant feelings, noting that pain becomes more painful when one struggles against it but the burden is often lightened if the sensation is accepted for what it is and viewed at a distance.

Does it make sense to read a book like How to Think Like a Roman Emperor as an introduction to stoicism? I think that the answer to that question is no because Meditations itself is not only very clear but should be approached with fresh eyes by readers who are new to these concepts. If one reads a secondary source prior to reading Marcus himself, one’s interpretation and view of Meditations will necessarily be impacted. However, this is not a criticism of Robertson’s work itself, just the concept of reading the opinion of others before you are exposed to the original thinking for yourself. I would even advocate skipping the introduction to Meditations written by translator Gregory Hays until after reading Marcus’s text itself.

Everyone has a unique set of life experiences and comes to stoicism from a different place. Reading any good book can become like a conversation with the author, if the reader allows it. The twenty-first century reader of Meditations will bring to the conversation different specifics than a reader several centuries ago but will share the same underlying human condition. Your initial conversation with Marcus will be most meaningful if it occurs unfiltered and uninfluenced by the experiences and thinking of others. Once you come to your own understanding of Meditations and make your own notations about how it applies to your life, it could make sense to seek out the opinions of others. In that context, a book like How to Think Like a Roman Emperor can be time well spent for those who are looking for concrete applications of stoicism to modern day life.

Disclosure: The Rational Walk received a review copy of How to Think Like a Roman Emperor.

Wernher von Braun and The American Moonshot

“It wasn’t luck that made them fly; it was hard work and common sense; they put their whole heart and soul and all their energy into an idea and they had the faith.”

– John T. Daniels, recalling the first airplane flight by the Wright Brothers at Kitty Hawk, North Carolina on December 17, 1903

Throughout human existence, people have looked to the sky and dreamed of breaking free of the earth and soaring upward toward the heavens. This dream was firmly within the realm of science fiction for millennia until the dawn of the twentieth century when the Wright Brothers changed the world by proving that it is possible for humans to pilot a heavier-than-air powered aircraft. The full implications of human flight were not fully grasped for some time and skeptics abounded. Yet within a span of a few decades, airplanes had become vital tools that changed the world.

Fast forward fifty-seven years to the spring of 1961. At the Baikonur Cosmodrome in southern Kazakhstan, Yuri Gagarin climbed into the Vostok 1 capsule and was blasted into space in the first manned space flight in history. Less than 21,000 days had passed between the triumph of the Wright Brothers in North Carolina and this early success of the Soviet Union’s space program. To put this into context, slightly more than 21,000 days have passed between Garagin’s historic spaceflight and the date of this article.

If taking flight seemed like an impossible fantasy prior to the twentieth century, traveling from the earth to another celestial body was even more far-fetched. In 1865, Jules Verne wrote his futuristic novel From Earth to the Moon. The plot involves a plan to send three astronauts to the moon in a capsule launched from a giant cannon. Jules Verne lived long enough to know about the first human flight but never knew that man would walk on the surface of the moon in the twentieth century. Apollo 11 was launched on July 16, 1969 with three astronauts aboard. Two of the astronauts, Neil Armstrong and Buzz Aldrin, would walk on the surface of the moon four days later on July 20, 1969 while Michael Collins remained in lunar orbit.

The story of the moon landing is inextricably linked to the brief presidency of John F. Kennedy. It is through the lens of President Kennedy’s leadership that Douglas Brinkley tells the story of this epic achievement in American Moonshot: John F. Kennedy and the Great Space Race. The book does not purport to be a study of the technical accomplishments that led to the moon landing and readers who are looking for much detail on the science of space exploration will be disappointed. The book is more suited for those who are fascinated by the leadership of President Kennedy and the story of the team of scientists who made the moon landing happen. Perhaps more importantly, the reader comes away with a sense of the level of commitment and effort that will likely be required to send humans to Mars and beyond during the twenty-first century.

The race to the moon cannot be viewed outside the context of the dawn of the nuclear age at the end of World War II and the Cold War between the United States and the Soviet Union that began almost immediately after the Nazis were defeated. Nazi scientists, led by Wernher von Braun, had developed revolutionary capabilities in rocketry that the Germans used toward the end of the war to attack targets in France and the United Kingdom. The German V-2 program provided the means to launch conventional weapons from hundreds of miles away and foreshadowed the possibilities of inter-continental ballistic missiles tipped with nuclear warheads. The race to master long range missiles and to gain a nuclear advantage dominated the rivalry between the superpowers in the late 1940s and 1950s.

The story of Wernher von Braun and Operation Paperclip might be unfamiliar for many readers. Once the fate of the Nazi regime became obvious in early 1945, von Braun and his team of scientists were ordered to evacuate the German rocket facilities at Peenemünde in a retreat from the rapidly advancing Soviet army. Eventually, von Braun and his team evacuated to the Bavarian Alps where he decided that his best option was to surrender to the United States Army. In a breathtaking turn of events, the U.S. Army ended up capturing not only the personnel on von Braun’s team but also fourteen tons of blueprints and design drawings from Nazi facilities and enough parts to manufacture one hundred V-2 rockets. These materials would otherwise have fallen into the hands of the Soviet Union within days.

By late 1945, the United States had achieved one of the greatest technology grabs in history with the capture of 119 German Rocket scientists who were cleared of war crimes and brought to America under Operation Paperclip. The benefits were tremendous:

According to the U.S. federal government’s own estimate, at the close of the war, America had been eight years behind the Germans in rocket capability. With the arrival on American soil of von Braun and the other Peenemünde engineers, that gap vanished all at once.

In the late 1940s, The United States was not only the world’s only nuclear power but also possessed rocket technology that far surpassed anything that the Soviets had. Had von Braun’s team and the materials been captured by the Soviet Union, the course of history would have been changed dramatically. Yet, the moral dimensions of exonerating von Braun and his team of war crimes cannot be easily ignored.

Although von Braun always maintained that he was a scientist fascinated by space travel who had no choice but to apply his skills to weapons of war under Hitler, the book provides ample evidence that von Braun was fully aware of atrocities taking place all around him. He had joined the Nazi party and became an SS officer, enjoying the privileges that came with his position during the war. In 1943, Germany established Mittlewerk, an underground facility used to produce thousands of V-2 rockets. Mittlewerk employed slave labor from the Dora camp of the notorious Buchenwald concentration camp:

Conditions at Mittlewerk and Dora as 1944 began were nothing short of a living hell: there was no fresh air, little water or food, vermin and lice, plumbing that consisted of open barrels, and grueling work without end — slave laborers were tortured and beaten if caught working at less than a double-time clip. These physical strains were combined with the oppressive knowledge that illness or injury might mean instant execution by their Nazi overseers.

Corpses were piled up on a daily basis for cremation as more than twenty thousand slave laborers died of disease, torture, beatings, and malnutrition. Von Braun was a colonel in the SS and regularly visited Mittlewerk during this period. There is little doubt that he was at least aware of these crimes, if not fully complicit in their execution. Yet, after the war, the United States government protected von Braun:

When the Dora-Mittelbau war crimes trial ensued in 1947 at Dachau, the U.S. Army Ordnance Corps made it clear that the von Braun team (the Peenemünders) had eluded any charges. Unscathed by the Dachau trial, in the fall of 1948, von Braun’s team began contemplating the development of Earth-orbiting satellites.

It is easy today to cast moral judgements on the men who made the decision to utilize von Braun’s skills rather than subject him to deserved punishment for his war crimes. However, it also cannot be denied that von Braun’s genius and passion for his craft greatly accelerated American capabilities during the 1950s and 1960s, both in the race to achieve an advantage over the Soviets in intercontinental ballistic missile technology and in the space race. Although President Eisenhower never fully trusted von Braun due to his Nazi past, John F. Kennedy had no such reservations after meeting von Braun in 1953. Kennedy preferred to attribute von Braun’s wartime actions as being swept up in German nationalism during the 1930s and 1940s. Once he took office, President Kennedy enthusiastically utilized von Braun’s unique skill set to advance the moonshot.

Douglas Brinkley’s book is a captivating story of achievement and the possibilities that come with strong presidential leadership. John F. Kennedy’s optimism and belief in American greatness led him to set challenges for the country that seemed outrageous at the time and were mocked by his political opponents. Kennedy knew that the winner of the race to the moon would gain enormous political benefits in the eyes of the world, especially the many countries that were weighing the advantages of aligning with the United States or the Soviet Union in an increasingly bi-polar world. The need to achieve that goal was paramount in his thinking, and outweighed any moral qualms he might have had regarding the personnel used to achieve it.

At the end of the book, the author renders his personal opinion regarding Wernher von Braun:

It is my personal opinion, based on all that I’ve read, that Wernher von Braun was culpable for war crimes associated with the German Third Reich, using slave labor to build his V-2s during World War II. Too many studies of von Braun try to sugarcoat his questionable Nazi past. While von Braun should be studied and honored within the guided corridors of engineering and space exploration, he should not be treated as a sustainable twentieth-century American hero.

As Americans celebrate the fiftieth anniversary of the moon landing next month, it is doubtful that many mainstream media accounts of the story will even mention the critical role of Wernher von Braun. Like so many aspects of history, this story is one of imperfect human beings who nonetheless achieved remarkable things. After the war, von Braun became a born-again Christian, and by all accounts embraced his American citizenship and poured all of his efforts into helping the United States win the space race. However, he never faced up to his crimes during the war before his death in 1977 and continued to deny any culpability.

One of the great aspects of reading widely is that one never knows where books will take you. I expected to read an account of the events leading up to the moon landing, which the author certainly delivered. I did not expect to read a book that involved at least as much contemplation of World War II and Nazi atrocities. Ultimately, the book is stronger for its thorough coverage of both aspects of this story, and for pulling no punches when it comes to the complicated life of Wernher von Braun.

Warren Buffett Moves the Goalposts!

Warren Buffett released his 2018 annual letter to Berkshire Hathaway shareholders last weekend which, of course, prompted investors and journalists to set aside their normal Saturday morning activities to analyze the Oracle’s words in great detail. Since the mid 1980s, Mr. Buffett has opened the letter with a statement regarding Berkshire’s change in book value per share. Longtime readers immediately noticed that this convention was missing from the 2018 letter. Readers quickly learned that this omission was not an oversight but driven by fundamental changes in how Mr. Buffett views book value at Berkshire:

Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so. First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner. Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years. Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.

In future tabulations of our financial results, we expect to focus on Berkshire’s market price. Markets can be extremely capricious: Just look at the 54-year history laid out on page 2. Over time, however, Berkshire’s stock price will provide the best measure of business performance.

Warren Buffett’s 2018 Letter to Shareholders

Those who have followed Berkshire Hathaway for many years will understand that abandoning book value as a performance metric is a very big deal. Mr. Buffett has long viewed percentage changes in book value per share over time to be a very rough proxy for changes in intrinsic value. Although he has been stating that book value understates intrinsic value for decades, the rate of change in book value was thought to be a relevant metric until now. In fact, Berkshire’s stock repurchase program was limited to only permit repurchases below 120 percent of book value until the policy was changed in July 2018.

Is the Change Logical?

Mr. Buffett points out that a growing portion of Berkshire’s value is attributable to operating businesses rather than marketable securities. Marketable securities are carried at market value on Berkshire’s books. In a hypothetical scenario where all of Berkshire’s assets consist of marketable securities, book value would represent the current market value of what Berkshire owns and would be an excellent proxy for Berkshire’s intrinsic value. However, the value of operating businesses are carried on Berkshire’s books at the original purchase price subject to being marked down if the goodwill paid for the business at the time of acquisition becomes impaired. No matter how much economic goodwill is added to an operating business, it is never marked up on Berkshire’s books. As a result, over time, successful acquisitions, such as Berkshire’s 2010 purchase of BNSF, will tend to increase the gap between book value and intrinsic value.

The situation related to repurchases is even more interesting and, perhaps, not intuitive to most observers of the company. Repurchases of stock above book value have the effect of reducing book value per share. Let’s examine why.

When a company repurchases stock, both assets and shareholders’ equity on the balance sheet declines. When Berkshire repurchased $1.346 billion of stock during 2018, that amount is directly deducted from the company’s cash balance. Shareholders’ equity also declines by $1.346 billion reflected in the treasury stock account. In exchange for the $1.346 billion, Berkshire retired 1,217 A shares and 4,729,147 B shares. Since each A share is economically equivalent to 1500 B shares, Berkshire repurchased 4,370 A share equivalents, which means that the average price paid was slightly more than $308,009 per share.

At December 31, 2018, Berkshire’s shareholders’ equity was $348.703 billion and there were 1,640,929 A equivalent shares outstanding, indicating that book value per A share was $212,503. Now, consider an alternative scenario where Berkshire did not repurchase any shares in 2018. Under this scenario, shareholders’ equity would be $1.346 billion higher at $350.049 billion and there would be an additional 4,370 A equivalent shares outstanding for a total of 1,645,299 A shares, and book value per A share would have been $212,757.

The result: If Berkshire had not repurchased any stock in 2018, book value per A share would have been $254 higher at the end of the year!

Did Warren Buffett suddenly lose his mind and purposely do something to destroy $254 of value per share? If you believe that Berkshire Hathaway is only worth book value, then value was indeed destroyed because Mr. Buffett paid a premium to book value to retire those shares. That premium is the reason that book value per share declined. However, if Berkshire’s intrinsic value is higher than the price paid for repurchases, then the intrinsic value of remaining shares actually increased even though book value decreased. The result is a wider gap between intrinsic value and book value for the remaining shares.

Based on his 2018 letter to shareholders, Mr. Buffett believes that Berkshire will be a significant repurchaser of its own shares in the years to come. The math above demonstrates that significant repurchases will, over time, increasingly distort book value. Management might be adding value for shareholders by repurchasing stock below intrinsic value, but above book value. But book value per share will decline as a result.

In 2018, Mr. Buffett promoted Ajit Jain and Greg Abel to Vice Chairman positions and it is likely that one of these men will be the next CEO of Berkshire Hathaway. Continuing to use changes in book value as a rough proxy for changes in intrinsic value would create incentives for the future CEO to NOT repurchase any stock even if shares are available below intrinsic value (but above book value). The result could be a sub-optimal situation where managers decide to pay dividends instead of repurchasing stock. This would create negative tax consequences for shareholders. Although both Mr. Jain and Mr. Abel are excellent executives, it is a bad practice to use a metric to measure performance that will be negatively impacted by value-adding moves such as repurchases of stock below intrinsic value. This is likely the main reason for Mr. Buffett’s abandonment of book value. The rate of change in book value is now very unlikely to be used as a performance metric for compensation of Berkshire’s next CEO.

The “Gotcha” Moment!

Mr. Buffett has long argued against the practice of changing the goalposts after the game has started. In other words, changing the metrics by which management is judged should be looked upon with great skepticism. However, it is not logical to say that the goalposts should never be changed regardless of changes in circumstances. The important question is whether the change is logically defensible.

Some observers have implied that Mr. Buffett’s abandonment of book value signals an abrupt shift designed to obscure the fact that book value only progressed by a modest amount in 2018 and has slowed significantly since Berkshire’s earlier decades. However, these observers probably have not carefully studied the 42 years of letters to shareholders available on Berkshire’s website. In fact, Mr. Buffett has been warning about the limitations of book value for well over three decades. The following excerpt from the 1983 letter to shareholders is a typical example:

We report our progress in terms of book value because in our case (though not, by any means, in all cases) it is a conservative but reasonably adequate proxy for growth in intrinsic business value – the measurement that really counts. Book value’s virtue as a score-keeping measure is that it is easy to calculate and doesn’t involve the subjective (but important) judgments employed in calculation of intrinsic business value. It is important to understand, however, that the two terms – book value and intrinsic business value – have very different meanings.

Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.

An analogy will suggest the difference. Assume you spend identical amounts putting each of two children through college. The book value (measured by financial input) of each child’s education would be the same. But the present value of the future payoff (the intrinsic business value) might vary enormously – from zero to many times the cost of the education. So, also, do businesses having equal financial input end up with wide variations in value.

Warren Buffett’s 1983 Letter to Shareholders

Those of us who have read all of Mr. Buffett’s letters know that the distinction between book value and intrinsic value has always been something he has made an effort to explain. Over the past few decades, and especially since the turn of the century, Berkshire has transformed from a company dominated by marketable securities to one dominated by operating companies. As Mr. Buffett’s letters explain, the intrinsic value of these operating businesses today have next to no relationship with the historical amount they are carried on Berkshire’s books.

As long as Berkshire was not a large repurchaser of its own shares, the concept of book value retained some utility because the rate of change in book value in any given year could serve as a rough proxy of changes in intrinsic value. However, the possibility of large repurchases in the coming years will make the utility of book value increasingly suspect. If one runs the same numbers as shown above for 2018 but assumes $13 billion of repurchases instead of $1.3 billion, the distortion in book value per share for the year will become more noticeable. It is very possible that Berkshire will deploy tens of billions of dollars toward repurchases over the next several years. Book value will become distorted and retaining its use would not only potentially mislead investors but create bad incentives for future CEOs to shun value adding repurchases. The change is justified and probably overdue.

A note on the impact of dividends on book value

Alert readers will note that if Berkshire had paid out the $1.346 billion in dividends to shareholders rather than repurchase 4,370 A shares in 2018, book value would have been even lower at the end of the year. The cash outflow on the asset side of the balance sheet would have been offset by an equal reduction to retained earnings. Each of the 1,645,299 A share equivalents would have received about $818 in dividends and book value would have been about $211,939 at the end of 2018. Would shareholders have been better off with $818 in their pockets (pre-tax) and a share with book value of $211,939? They would only be better off if Berkshire had overpaid for the shares it repurchased. As long as the repurchases are made below intrinsic value, continuing shareholders are better off than if Berkshire pays out an equivalent amount as dividends.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

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