Partners can be beneficial - sometimes

By DAVID MOON, Moon Capital Management, LLC
September 14, 2008

When Barack Obama and John McCain selected their running mates, they knew the importance of a partner. People are known, judged, influenced, inspired and limited by the company they keep.

This also includes businesses. Just ask Fannie Mae or Freddie Mac.

When you take on the federal government as your partner, it's like getting into bed with the Mafia, except usually (but not always) without the possible threat of going to jail. You get access to wonderful resources, including money, power and, if needed, guys with guns.

But you can never go back across that line.

It can work to your benefit, sometimes for years. When the tobacco companies reached a master settlement with the attorneys general from 46 states in 1998, many investors thought the annual cost would spell financial doom for the cigarette manufacturers. Instead, Philip Morris and RJ Reynolds took on 46 new partners ' the states ­­' each of which then had a financial interest in protecting the profitability of the tobacco industry.

So far, that's worked out wonderfully for the tobacco companies, their shareholders, and the states.

The symbiotic relationship between the government-sponsored housing enterprises (Fannie Mae and Freddie Mac) and the federal government likewise worked wonderfully for years. From 1982 to 2003, the earnings of Fannie Mae increased almost 1,000 percent.

When the housing market went into decline and the enormously leveraged balance sheets of these mortgage giants went under scrutiny, all sorts of people became nervous.

Had the companies been treated like any other bank, they would not have been taken over by the feds last week. At the end of its most recent quarter, Freddie Mac had less than half the level of nonperforming assets (relative to total assets) as First Horizon, the parent company of First Tennessee Bank.

Of course, had Freddie been treated like any other bank, it would have never been leveraged with more than five times as much debt as First Horizon.

Politics allowed these creatures to grow out of hand. And politics ended the party.

This trap caught some mighty successful money managers. The Growth Fund of America, the Washington Mutual Investors Fund and the Investment Company of America, three of the market's largest and most popular mutual funds, are among the four largest mutual fund owners of Fannie Mae. Bill Miller, whose Legg Mason Value Trust beat the S&P 500 for 15 straight years, owned more than eight percent of Freddie Mac at the end of June.

And in the interest of full disclosure, I also owned Freddie Mac.

Having the government as your business partner is a lot like a redheaded woman. Most redheads are either quite attractive or they are' well, let's just say that their strengths lie in areas other than physical attractiveness. There aren't many average-looking redheads. The same is true with a government-business relationship. It is usually either very, very attractive, or something at the other end of the spectrum.

And sometimes it can change from one to the other.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

Add me to your commentary distribution list.

MCM website