Warren Buffett can Breathe a Sigh of Relief

Whitney Tilson, lead manager of the Tilson Focus Fund, says "Buffett hasn't lost it".

David Einhorn on Lehman Last Year

Via Seeking Alpha again, Amit Chokshi's notes on David Einhorn's presentation on his Lehman (NYSE: LEH) short idea at last November's Value Investing Congress in New York:

Value at Risk (“VaR”) is not appropriate for measuring risk:

• Einhorn compared investment bank VaRs to actual results for recent quarters, which showed that actual results were off by multiples of VaR estimates in some cases.
• Risk managers should focus on the tails of bell curves and also be prepared for fat tail risk - 5-10 sigma events are not uncommon¹.

FAS 159: Profit from One’s Demise

• Fair value accounting standard that allows asset and liabilities to both be marked at fair value.
• This accounting mechanism allows for income to be recognized as liabilities are marked down to fair value.
• FAS 159 is acceptable for market risk but not for idiosyncratic risk.
• The Street is comfortable with FAS 159 but does not seem to grasp all aspects of the ruling.

Lehman Brothers (LEH) – short idea

• Looks vulnerable due to lack of transparency regarding writedowns
• Could be following its “playbook” from 1998 liquidity crisis

LEH had mortgage exposure but took no writedowns

The market recovered and LEH pulled through

Could that happen now?

• LEH stock has held up because of “good” quarters

2008 EPS estimates remain unchanged at $7.75 which would follow a record year in 2007

Sellside believes the chance of a writedown at LEH is minimal

LEH 10-Q reveals no significant loss on Level III investments which Einhorn is skeptical of

• In 2006, fixed income accounted for 48% of LEH income while securitizations accounted for 15% of income.
• LEH should be much more exposed to losses than what has currently been reported.

LEH either recognizes larger losses (which will be a negative surprise) or LEH will likely under-earn competitors that have taken larger losses and cleaned up their balance sheets relative to LEH.

Lehman was trading at about $60 per share last November when Einhorn gave this presentation. Today it closed at $7.25 per share.



¹Not to be picayune about it, but if I remember my statistics correctly, by definition, 5- and 10-sigma events are of course uncommon, and also by definition, bell curves (normal distributions) don't have fat tails. I think Einhorn's point (simplified, apparently, for his audience) was that in finance returns usually do not follow normal distributions; their distribution curves have fat tails, indicating that extreme events are far more likely to occur than they would under a normal distribution. This is true, and has been, as far as I know, widely accepted for some time.