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Phillips: I believe we have some questions. We will take one here, please.
Audience Member 1: Bruce, you recently took a position in Cisco. Care to comment on what you see in Cisco at these levels?
Berkowitz: I think it's too soon for me to comment on Cisco, other than that: I always ask my partner Charlie [Fernandez] what products or companies are critical to the functioning of the United States. And we believe that Cisco is one of those companies. We did it with WorldCom before, in the bankruptcy we knew that the government could not get rid of WorldCom because they were only one of two players that had the advanced telecommunications needed by our defense forces, Treasury, credit card processing banks, and Cisco's equipment is absolutely essential to the running of the country--especially at very high speed. Whether it's the bank processing, credit card processing, defense, and of course, we're running out of IP addresses, and we have to go to the new IP 6, which is going to cause a huge changeover for everybody. But I'm afraid that's all I have to say on Cisco right now.
Phillips: You mentioned, Charlie, and I should point out that Charlie Fernandez is here in the audience today, and has joined us. He works as someone you bounce ideas off of, sort of like Charlie Munger to Warren Buffett …
Berkowitz: I did learn from Warren Buffett that everybody needs a Charlie.
Phillips: The importance of being earnest; you did a worldwide search for the smartest person named Charlie you could find. So, welcome Charlie.
Do we have another question? Yes. Thank you very much for waving. Right in the middle.
Audience Member 2: You talked about Bank of America and you also own a lot of MBIA, can they both do well? Because it seems the best case for MBIA is they win their lawsuits against Bank of America. How do they both do really well?
Berkowitz: Yes, there is a bit of schizophrenia in that investment. So, Bank of America on one side of the fence, MBIA on the other. MBIA and Bank of America are suing each other over the representations and warranties of residential securitizations. MBIA guaranteed the securitizations of the old Countrywide and some of Merrill Lynch, and MBIA is claiming that the representations and warranties were false. So, how can I own both? There's going to be a winner, and there's going to be a loser.
The thinking there is--the win for MBIA is going to be very large relative to MBIA's size. Any loss for Bank of America is not going to be very large whatsoever. And it's just in everybody's interest--not just MBIA, [but also] Bank of America, Morgan Stanley and everybody out there, Credit Suisse, Deutsche Bank--to get the U.S. economy going. We've got to stop all of this, just settle up, and move forward and remove all these uncertainties.
I don't know whether it's going to happen in two months or 20 months, but it should happen soon. So, MBIA is going to win, in my opinion, on reps and warranties. Bank of America has already settled with Assured Guaranty for $1.5 billion-plus. MBIA was bigger in the business. So, it's a legal arbitrage.
MBIA is a good product. Everyone says municipal bond insurance is dead. Well, I don't think it's dead for the $6 billion-plus the municipal bond owners that receive guarantees from MBIA. They've kept their word on every single guarantee.
Bank of America inherited a mess. They know what they need to do. It just has to be done in a reasonable way, and it will get done. It's going to be a little nip to Bank of America. It's going to be a big win for MBIA.
Audience Member 3: Bruce, within the last year, year and a half, you started investing in China. That's a change for Fairholme. Could you talk a little bit about why you did that and why you think that Fairholme may have an edge in picking investments in China?
Berkowitz: Sure. We have two investments that are associated with China. The first being AIA, which doesn't have that much business in China but does do business in China, but it's Asian-based, run by Mark Tucker--an absolutely brilliant executive in the life insurance business.
Just backing up a little bit, China, other parts of the Far East, remind me of what the United States was about in the 1950s. Now, you may ask, I was born in 1958, how I would know this? But---
Phillips: The late '50s?
Berkowitz: The late '50s. There is a dynamic, growing middle class, and that middle class needs to know, like we used to need to know, that the next generation is going to do better than the previous generation, that your children are going to do better than you did, and that life insurance takes care of that need, and it's very underutilized in Asia. So, AIA has great growth on doing it; the guy who runs it, his team, fabulous. AIG needed to sell [AIA], and because we were the largest shareholder of AIG at the time, we were able to buy a big chunk of AIA, and we did, and that was our first investment ever in that part of the world.
From that and a few other events, then we bought into a company called China Pacific Insurance Group, which is a life insurer and a property and casualty company. And they are 100% focused on China. We recently had the chairman of the company and 14 of his lieutenants come to Miami to visit us, and it was just amazing.
The insurance industry, the regulations are more conservative than the United States. They don't have unlimited risks, liability risks; all of their products, believe it or not, they know the development of the liability; in one year they know 98% of the development, two years, it's done.
It's all pretty much on a claims-made basis, very conservative, and it's a bit of a virtuous circle there where people want the product, they are learning about the product, and then the premiums are then used to help build the infrastructure of the country, some of which is government guaranteed, cost-plus, or to help develop the bond markets of China, which is still in its infancy and also maybe for one or two IPOs.
So, AIA, which I view more as a U.S. company, is great and that led to China Pacific Insurance Group, and that's pretty much been that for us. We hope we can do more, but we're going to take our time. But both companies are quite unique.
Phillips: Our wranglers are circling around, just flag someone down, if you've got a question you'd like to ask. If not, I'll ask a string of increasingly more boring questions to prompt you to join the discussion. We have one right here.
Audience Member 4: Bruce, do you worry about the regulation coming on the banks and what about them being forced to buy government debt?
Berkowitz. The short answer is, no, but I worry I wish it happened already. We passed a few laws, we passed a law before we knew it was written in the laws, and to some extent, the current executives are being punished for previous executives, and the prescription we're doing today was for yesterday.
But that being said, I turn around and say, what can kill a company? Everyone is so worried that higher capital standards will kill them and only being able to charge $0.12 or $0.14 per transaction on a debit card will kill them. And then, there will be other fees, but the bottom line is, again, I don't think allowing banks to earn a 1% return on assets is egregious or a 10% return on equity. And if you do that, and if you have some of these companies selling at half of their book value, I don't see how you get hurt. But eventually also the pendulum will swing in the other direction again. We'll overreact as we do to catastrophes in the capitalist system, and then we'll eventually get to the right medium. And sadly we will probably eventually go too far to the other side. I think it's the nature of our ecosystem.
Audience Member 5: You run such a concentrated portfolio. I'm just wondering, is there magic to the number of holdings that you may have at one time, and how many companies are you watching that you don't actually invest in today?
Berkowitz: Given the nature of companies and the complexity of companies today, I really don't know how you can get your hands around dozens and dozens of companies. So, we tend to focus, so we can spend thousands and thousands of hours on individual companies.
But as you find more companies, I really don't understand the concept of picking your 50th best company, when you can buy more of your first- or second-best company. Once you get past about 30 companies, you're pretty much nearing an index anyway. So what's the point? That's about it.
Audience Member 6: Bruce, thanks for coming. You've had some personnel changes in the last year or two. Could you kind of address that, because, the idea flow, and you got Charlie there, but is there anything we need to be aware of or concerned about?
Berkowitz: No. We have an anti-growth call to creative destruction. I put myself in the shoes of the shareholders and I make decisions as to what's best for the firm's shareholders; that's it.
People come, people go. Time will tell, but Fairholme about three years ago shifted from what I would call a more philosophical model where portfolio managers that never ran businesses but studied the traditional portfolio management system, SEC reports, quite good, studied the grades, fine.
But I wanted to develop operating people. I want people at the firm who know what it's like to run a company with 1,000 people, to have to restructure, to have legal issues or accounting issues. People that have rolled up their sleeves and have been involved in the very messy business of business. And I think the better you are at business, the better you will be at investing, and that's the reason why I shook the tree a few years ago. I wanted operating people. And what got us to a billion would not have gotten us to $10 billion, and what got us to $20 billion we could not have used that got us to $10 billion. And moving forward we'll require something else, and we have to be aware of it, and we have to constantly change for the benefit of our shareholders, and it's as simple as that.
Audience Member 7: Bruce, could you comment on the macroeconomic issues that concern you and whether you think Washington can get their act together to actually effect the proper change necessary for just returning to more historical GDP levels.
Then depending upon your answer to that question, how will that impact your concentration in the financials, because if you don't have a positive outlook as to the ability for Congress to get their act together, then how will we actually be able to dig out of this mess?
Berkowitz: Well, I do have a positive outlook that it will happen. The question is when? I think Winston Churchill had it right. It seems that we do every alternative possible and the last alternative we finally pick is the right one, and we do really well under extreme stress. I thought the government did very in late '08, '09. We've took out full-page ads in the Wall Street Journal, New York Times, Washington Post complimenting the United States Treasury for the decisive action that they took.
But I would hope that we would be moving a little further; we haven't, but we will. It's inevitable; it has to be, because it gets a little worse, then all of a sudden people get moving. I've noticed the change in the past few weeks where I think people are noticing that especially with an election coming up next year.
In terms of the macroeconomic environment, I'm horrible at it. All I could tell you is interest rates are low, so I figure eventually they will go up, and if they go down, there's not much more they can go down. Will that be good for the banks? Yes. Will it be good for the insurance companies? Yes. Will it be good for financial services? Absolutely. It's very hard to make a return on float these days. So interest rates will eventually go up, and we will start penalizing conservative savers, and we'll get to a more normal environment. Other than that, I think the country is just going to continue being a great country.
Phillips: Bruce, it's been a big week for you. You've had a birthday, an anniversary. I know you're little under the weather with the laryngitis. Thank you so much for joining us today.
Berkowitz: Thank you.