In Memory of Sam Zell
Sepulcrum Saltator (translation: The Grave Dancer)
In the 1980’s, I heard the lesson first-hand from the legendary Sam Zell, the Chicago based billionaire and real estate mogul. Sam was one of many mentors and partners over the past forty years. Along with John Klopp, now head of Global Real Assets for Morgan Stanley, Sam, John and I went on to co-found Capital Trust in the 1990’s which was subsequently acquired becoming Blackstone Mortgage REIT (BXMT).
Sam had written an article in the Real Estate Review in 1986 called “Modern Sardine Management.” I am sure there are many versions of the trading sardine story, but Sam told it this way in the article:
Mr. A had a can of sardines. He sold them to Mr. B for $1. Mr. B Sold them to Mr. C for $2. Mr. C sold them to Mr. D for $3. Mr. D opened them and found they were rotten. He complained to Mr. C that he wanted his money back. Mr. C said, “No, you don’t understand. There are eating sardines and there are trading sardines. These were trading sardines.”
Legendary value investor Seth Klarman of Baupost also uses the trading sardines metaphor in his 1991 very rare, out-of-print book Margin of Safety. While they are slightly different tellings, the message of both versions about speculation is clear: there is price and then there is value. Sometimes the two are the same but more often than many people think the two are not the same.
One only need to look back at the 2008 financial crisis to realize that when markets are gripped by financial crisis, which occur with a surprising degree of regularity every 5-10 years or so, the value and price of assets become disconnected. A dozen years ago, the Great Recession was initially triggered by real economics losses from poorly underwritten or fraudulent securitized pools of subprime residential mortgages. Who can forget the NINJA loan (no income, no job or assets)? As the financial markets seized up, the prices of mortgage securities collapsed. Severe misalignment– among brokers, mortgage bankers, investment banks, the rating agencies, regulators and the borrowers– was the real culprit.
But the contagion quickly spread from $300 billion in non-performing residential subprime mortgage loans to the broader commercial real estate CMBS whose underlying assets were frequently 100% performing. Notwithstanding that the loans continued to perform throughout the crisis, prices for CMBS also collapsed as liquidity dried up, margin calls were made as the securities were marked to market. While the value of the underlying collateral was fine, the prices of securities experienced enormous distress as everyone was heading for the hills and/or hiding under their beds. The spreads on BB securities that had traded at 275-325 bp over suddenly shot up to 1200bp. Some securities became “no bid” as all trading came to a halt. Extraordinary measures by the Fed and the U.S. Treasury injected unprecedented liquidity into the market (TARP, TALF, QEI, QEII etc.) saved the day or perhaps just kicked the can down the road. When markets seize to function, all hell breaks loose. History has shown that with sufficient liquidity and the lender of last standing by market meltdowns can usually stabilized in 18-24 months.
For markets to function in an orderly manner a degree of speculative investment is needed. But the knowledge and expertise necessary to speculate successfully on a regular basis is best left to the professionals. That doesn’t mean you should never invest based on an intuition or gut feeling that something looks too cheap to pass up. But you should have to discipline to takes profits and losses if the the investment is in your trading portfolio. But learn to tell the difference: when to invest for the long-term and when to trade for the short-term.
The moral of the story is that a trader knows the price of everything and, all too often, the value of nothing; one needs to learn the difference.
Caviar emptor… or is it caveat emperor? Perhaps both?
Will miss you Sam. Thanks for the lessons, your friendship and one helluva ride!