David Einhorn of Greenlight Capital wrote a book called Fooling Some of the People All the Time, John Wiley & Sons , 2008. Mr. Einhorn runs a hedge fund called Greenlight Capital and it has longs – expects stocks to go up and shorts expects stocks to go down. In theory, everyone should look how to make money going short or buying puts,  in reality most of us focus on the upside. In part, investment companies make money bringing shares to market for their future growth. The issues Mr. Einhorn writes about in his book do not go away which makes the book an excellent read.

Greenlight Capital along with others did a great deal of research about how a company called Allied Capital was valuing its investments. Allied Capital was (no longer exists) in the business of making loans to small businesses (which is a great thing) and a US agency would return 75% of the loans if the company failed. In theory, it was taking a 25% risk. There were a number of issues – the government agency sets up a program expecting lenders to lend money to small business because often they can not receive loans from the local banks (high risk), the agency expects the contractor in this case Allied to be honest and ethical and has limited capacity to determine if they are. In all likelihood Allied started as honest and ethical, but Mr. Einhorn and others determine they were not. Mr. Einhorn determined Allied had many examples of approving loans and keeping the value of the loan at 100% even though the small business was in bankruptcy and not paying the loan. Under normal circumstances – when a company does not pay the value of the loan falls to less than 100%. When the company is in bankruptcy the bonds are worth cents on the dollar. The effect of not writing down the debt was to make Allied’s balance sheet look good and allowed them Allied to pay dividends or a regular income. As long as the income was paid, many choose to believe Allied’s story. When the income was cut, the end of Allied was near.

The book is written from Mr. Einhorn’s perspective which means Allied Capital for many years had a different story. Part of their story was Greenlight Capital was only interested in the company because it sold short, otherwise made money when the stock fell. Their story was the good people of Allied were trying to help the US economy grow by investing in small businesses. To be against Allied was to be against small businesses.That is a powerful argument. In all companies there is likelihood of some fraud, but how much? is it rotten to the core? Does the government, if it believed in Greenlight Capital arguments, remove Allied from the preferred list of small business loans? The answer was for many years no. (in part because the preferred list did not track fraud, but how well the paperwork was done) (what is measured is what will be received).

Linking to dividend paying stocks – how does your company value its assets? When does the company write down and off its assets which no longer produce income?

There are more questions than answers, till next time – to raising questions.