Smart Guys (and gals) can be Wrong Too

The Wall Street Journal reported this week that fund management company Legg Mason reported a quarterly loss of more than $250 million, due in large part to the credit crisis. “Legg’s flagship Legg Mason Value Trust mutual fund, managed by Bill Miller, was down 19.7% in the quarter ended March 31, its worst quarter ever relative to its peers. Mr. Miller had big misses in stocks like Bear Stearns.”

My first thought was, “it’s nice to know that the guy is human!” Before this misstep, Miller had outperformed the S&P 500 for about 900 years in a row (I think it was actually 15). So yes, even the smartest guys and gals in the business can be wrong sometimes. In fact, in the business of managing money, we should expect it and stop trying to think that any one person is the investment guru of all time.

I was thinking about this after fielding a radio show question about some of the beaten down financial service companies and their exposure to the subprime and housing messes. The caller wondered, “How could those guys have been so wrong?” The answer is that these large companies are populated with human beings, who are pushed and pulled by the same emotions that do in all mortals who confront money issues: fear and greed.

A recently-published book about the credit crisis is worth picking up if you want to better understand how experts in a myriad of financial fields fell prey to the excesses of the housing and credit boom. In “The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash,” Charles R. Morris points out what every student of markets know: in every bubble there is a seed of a good idea. But as more people catch on, the idea goes to excess.

Lending cheap money to willing borrowers who purchase assets that rise makes sense. Morris writes “When money is free, and lending is costless and riskless, the rational lender will keep on lending until there is no one left to lend to…You logged in the loans, collected your fees and sold them off to yield-hungry investors. The investors were ‘insured.’ Your fees were real money. The loans might even be paid off.” The strategy works, until it doesn’t. At that point, the smart guys and gals are just like anyone else who gets caught up in a boom and bust. They must absorb the losses, lick their wounds and move on.