legendary investor Seth Klarman and his firm, Baupost Group, are out with their 2010 year-end letter. Courtesy of VII, below is an excerpt from their letter. We’re going to warn you that it is very long, but a must-read:
“Two problems are upon us at once: short-term stimulus that is unaffordable over the long run and runaway entitlements that must be reined in. But restoring fiscal sanity will be bad for the economy and financial markets. What Treasury official or politician would want the cash spigot turned off before a recovery is certain? Recipients of government handouts – a large percentage of the population – would grumble at the termination of policies that offer them outsized benefits. So prepare for a chorus of “but not yet.” One already sees this in editorials and commentaries, such as the ones saying it’s time to close down bankrupt Fannie Mae and Freddie Mac, but not yet, because doing so would harm the still-weak housing market. There will never be a good time to end housing support programs, reverse quantitative easing policies, end fiscal stimulus, or reduce massive budget deficits – because doing so will restrict growth and depress share prices. Nor will there be a good time to cut entitlement programs or to solve Social Security or Medicare underfunding. All will agree the stimulus cannot go on forever, that excessive entitlements must be reined in, “but not yet.”
The financial collapse of 2008 highlighted our national predicament. The sudden decline in consumer activity that followed the plunges in the housing and stock markets represented a reasonable – indeed a desirable – response to overindebtedness. Yet the federal government saw this well-advised retrenchment as cataclysmic, because the national economy had grown dependent on our living beyond our means. The imagination of our financial leaders remains so shallow that their response to a crisis caused by overleverage and excess has been to recreate, as nearly as possible, the conditions that fomented it, as if the events of 2008 were a rogue wave of financial woe that can never recur. It is only in Fantasyland that the solution to vastly excessive debt is more debt and the answer to overconsumption is less saving and more spending. Worse still, we have yet to see a serious assessment by policymakers of the causes of the 2008 financial market and economic collapses so that we might take action to ward off a repeat performance. The government’s knee-jerk response to contraction was to prop up economic activity by any and every means possible; the hole in consumer activity had to be materially repaired on the government tab.