While I was in New York City a few weeks back, I had a book handed to me by my cousin Vinit Sethi. It was a newly released book, penned by David Einhorn, the founder of Greenlight Capital, where Vinit is also a partner. It was quite a read. Fooling Some of the People All of the Time: A Long Short Story is one of those books that I wouldn’t have picked up wandering through a bookstore or surfing online. On the surface, it’s a book about a peculiar publicly traded company, Allied Capital, and Greenlight’s (Einhorn’s hedge fund) short position on Allied’s stock. Allied is primarily a high risk financing company that maintains a portfolio of investments, many of which are secured (guaranteed) by the federal government. Allied has had a long history of returning solid returns for its investors, a trend that seemed to be on track when Greenlight began it’s short sell strategy. Below that surface emerges a story of financial shenanigans, and criminal deeds, that reads like a banker’s version of a John Grisham novel. Einhorn reveals not only the smoke and mirrors accounting methods of Allied (and it’s auditors), but also exposes a level of incompetence by federal agencies and regulators that should make all taxpayers’ blood boil. The book serves as much an indictment of Allied’s management team as it does of the Small Business Administration, one of the primary ‘victims’ of Allied’s fancy financial footwork. Towards the end of Einhorn’s tale, I couldn’t help to think of the scene from an old Seinfeld episode where Kramer destroys Jerry’s stereo, ships it insured through the Post Office, and then tries to collect the insurance claim on the basis of a damaged shipment:
Jerry : So we’re going to make the Post Office pay for my new stereo?
Kramer : It’s just a write off for them.
Jerry : How is it a write off?
Kramer : They just write it off.
Jerry : Write it off what?
Kramer : Jerry all these big companies they write off everything
Jerry : You don’t even know what a write off is.
Kramer : Do you?
Jerry : No. I don’t.
Kramer : But they do and they are the ones writing it off.
Jerry : I wish I just had the last twenty seconds of my life back.
Unfortunately, in both Kramer’s insurance caper and Allied’s financial manipulations, the ‘write offs’ are on our backs, the taxpayers. I wonder if Einhorn had the same quizzical look as Jerry did after Kramer’s explanation when he engaged Allied.
Hedge funds get slammed everyday by media, management teams and shareholders for taking questionable short positions, and then tying to ‘talk down’ the stock to lock in profits. There is tremendous pressure on public officials and federal agencies to ‘regulate’ hedge fund activity. I’m sure that is the case in many instances, but the drama that unfolds in Einhorn’s book is remarkable for both how brazen Allied’s actions were and how maddeningly incompetent the federal government was when Greenlight exposed the fraud. Instead of enforcing the laws against Allied, Einhorn (and Greenlight) became the target of federal ire.
To be sure, Einhorn didn’t expose the fraud, or write the book, out of a simple search for the truth (although his portion of any profits are headed to charity), he repeatedly called Allied’s bluff because of the profit potential Greenlight could deliver to it’s partners and investors. And, apparently the focus on Allied has proven profitable.
In recent days Einhorn has again raised questions about the financial reporting of a public company. This time it is Lehman Brothers. The result has been a very public battle which even led to headline grabbing attention. Both instances, the Allied story chronicled in the book and the Lehman story unfolding as I write this, reveal Greenlight’s sharp analysis of financials in exposing irregularities that put those companies on the defensive. As you might expect, that’s not always the case. As Einhorn himself admits, he’s not always right. One example that his critics point to is Einhorn’s activities related to the collapse of sub-prime mortgage lender New Century Financial. I don’t know the details of how and why Einhorn ended up on New Century’s board, but given Greenlight’s tenacity in unraveling financial puzzles, it’s perplexing that Einhorn apparently didn’t see the shaky foundation on which the mortgage market of the last decade was built. I spent some time about four years ago looking at the processes of the mortgage business and was astounded by how weak the entire system was. It didn’t take long to figure out that the mortgage Ponzy scheme would unravel. I’m surprised that Greenlight didn’t see the same problems, given their analytical successes with Allied.
Like I said at the beginning of this post, I wouldn’t have picked this book up by myself, but having read it, I would wholeheartedly encourage you to read it as well.
Disclosure: While I am related to Vinit, we typically do not discuss investment ideas and most definitely not Greenlight short positions. We mostly talk sports when we get together. 🙂
UPDATE: It looks like Einhorn’s pressure on Lehman has led to the ouster of some senior Lehman management earlier today.