We’ve seen a lot of houses now. There was the house with the goat out back--we stood around in 110 degree heat looking at all the weird crap that was piled up outside the door in which wasps were nesting while the listing agent hunted for a way inside. It used to be a feed store. The ceilings were all about 5 feet high.

The house where someone had bashed in the front wall to make a couple of picture windows. Strange things had happened there—pieces of abandoned art, odd cabinetry that looked like some high schooler’s project for shop, and then, in the back, a perfect little room with a beehive fireplace like the maid’s quarters in a Mexican hacienda. The tiny kitchen was dominated by a 1950s six-burner, two-oven stove, very rare. Restored, worth maybe ten grand. The guest house could’ve been a rustic cabin in a Raymond Chandler novel. Something had died outside the front door and hadn’t been properly buried.

Most recently, we looked at a house where the owner was having a yard sale in absentia, leaving signs atop piles of glass bricks and old clothes. A bowflex and one of those cross-country skiing machines didn’t seem to be for sale. Mr. Carruthers commented that cross-country skiing machines are stupid anyway. We put an offer in on that one. We won’t be the new owners of the Crazy Tenant House, as we found out earlier this week, though the pot plants may still be available…

Roy lurches up off the bed and grinds some coffee—it’s Nicaraguan cup of excellence that he roasted himself, filling the house with a peculiarly dense smoke that required us to walk around waving sheets in an attempt to clear the air. He fires up the James Bond espresso maker and pulls a shot.

“Wow, massive crema!” he exclaims, not for the first time. Knocking back his espresso, he wonders if real estate is really the right investment right now. As our nation's pole star Sarah Palin has recently asserted, we might be heading for another Great Depression. Should we start a café instead? Leave the country? Berkshire Hathaway has backed away from insuring bank deposits, a subtle move that is scarier than all the headlines put together. Even so, as Buffett suggests, “be greedy when others are fearful and fearful when others are greedy.” Maybe now’s the time to take a good long look at the stock market.

Roy Reads: When Genius Failed

“I had some dreams, they were clouds in my coffee…”

When Genius Failed: The Rise and Fall of Long-Term Capital Management
Roger Lowenstein (New York: Random House, 2000)

A while back I was watching a pithy speech on YouTube given by Warren Buffett to a group of MBA students at University of Florida. Among its many gems was a brief description of the hedge fund Long-Term Capital Management and the decisions that led to their downfall in the late 90’s. Basically, in order “to make money they didn’t have and didn’t need they risked what they did have and did need.” OK, so what if I want to make money I don’t have and do need? Is the inverse true? Obverse? I needed to know more. So when I read an article by Roger Lowenstein in the New York Times and he seemed to know what he was talking about, I thought his book about LTCM might be worth checking out—of the library of course. What’s not to like about free?

Consider for a moment the average financial professional. We may ask: Has he


or she


won a Nobel prize? Is this person turning away new money because she has too much to invest already? Does he even own a clean suit and have a firm handshake? No on all accounts? Well, maybe that’s ok. Read on.

Now, I grant you that the idea of turning over a fortune to highly intelligent professionals so that I can roam the earth without a care in the world is appealing. And it may just be sour grapes (I don’t yet have a fortune to turn over) that makes me so skeptical of money managers, but the more I heard about LTCM, the more my skepticism grew.

LTCM started life as a great story that went something like this: “We’re smart, we have a plan and we know what we’re doing—trust us.” They were quite convincing because a) they were smart—the group consisted of two Nobel prize winners, professors from Harvard and MIT, a central banker and several industry heavyweights; b) they had a plan, literally a Nobel-prize-winning plan; and c) they had ample past success, not to mention rolodexes filled with the names of friends and colleagues at the highest levels of finance. Hell, yes, you could trust them. Where’s my checkbook? Investors fell all over themselves to get onboard. And these weren’t mom and pop investors—only the savviest insiders and richest institutions and individuals were allowed in. Banks trusted them too. There was such fierce competition to loan the group money that their borrowing costs were negligible. This was a good thing, because the bets they were making paid pennies on the dollar. It was as if they were playing dollar slot machines and expecting $1.03 payoffs. Luckily for them, they could use a friendly bank’s dollar and keep the pennies for themselves—and do it millions of times per day. Brings to mind the Saturday Night Live skit about being in the business of making change. “Some ask us how we can make money doing this. The answer: volume.”

LTCM made so much money in its first few years of business that it had to force its investors to take back billions of dollars so that the owners’ shares wouldn’t be diluted. Talk about a good business to be in. The partners in LTCM (and most hedge funds operating today) collected 2% of the money people had given them to invest and kept 25% of the profits every year. That’s what I call a plan.

However, the plan the group used to invest everyone’s money was a bit different. It relied on the belief that financial markets were becoming big enough and efficient enough that they could be described mathematically. With these mathematical models, the group would make predictions. Not predictions in the sense that one could know when and by how much prices would change—even LTCM thought that couldn’t be done consistently—but that prices would change within certain limits. It was like the mixing of cream into coffee. At any given point in the cup, things may look chaotic, but the overall change from black and white to beige can be modeled and explained. LTCM’s model and explanation, taken from physics and applied to markets, called the Black-Scholes model was just getting popular in the ‘90s, and it actually is a good description of market behavior most of the time. That’s how LTCM was able to quadruple its money in 4 years with basically no deviation from its expectations. The problem, as it usually does, came when the theory didn’t hold true. The markets ceased acting like cream in coffee and more like a panicked crowd. The cream jumped out of the coffee, and LTCM went belly up within months.

One take home lesson: If Long-Term Capital Management wasn’t smart enough to predict short-term market behavior, nobody is smart enough to predict short-term market behavior. A better plan doesn’t require such predictions. So does that mean our average money manager might be worth hiring after all? I’ll get back to you on that one.

At our rap session in Mr. Carruthers’ office today, we talked about the fact that we were calling him “Mr. Carruthers.” Mr. Carruthers said that he imagined someone named Mr. Carruthers as a hunched old guy wearing a brown blazer who remembers back when nice houses were going for $50,000. He remembers when this town was just a train stop on the way to somewhere else.

We also got the address for a property in the same general area as the Crazy Tenant House. The area used to be part of a ranch, and it turned out the road wasn’t paved. Baby Biv was getting ready to scream. This property was next to pens that held a flock of chickens and a couple of longhorn sheep. The neighboring house seemed to have sprawled out of bounds. It looked like a high school with a big Ag program. The place we went to see must have been someone’s guest house. Real estate’s booming—split off the lot, slap on a couple of extra rooms using cheap siding and, inside, a style that should be known as Home Depot Bubble Generic. Then the market pops. The house looked distinctly uncomfortable, like we were the mailman, and we’d caught it slouching around half-naked.

If we could pick this place up for 150k, hire an architect--but the owner probably owes 230k on it.

Today we looked at a house with several young pot plants growing in a ceramic planter in the carport. It was in a really good neighborhood, and the asking price was low. The former tenant had trashed the place. He’d thought he was renting to own, but the house went into foreclosure. The guy poured concrete in the drains, ripped out toilets, disappeared the kitchen drawers. Created a cement waterfall from the hot tub to the pool. He left ashtrays full of cigarette butts, the title to a car in someone else’s name. He left letters from two firms of attorneys, a fog machine, tax documents from 1997, and an 8-foot marlin. There was clear evidence that a bird had lived here, including a number of small eggs lying about on the kitchen counter, along with a half-eaten jar of salsa and a Domino’s pizza box.

As we stood in the living room our real estate agent, whom we’ll call Mr. Carruthers, commented that his brother used to raise birds when he was like 13 or 14. He was making thousands of dollars a month in high school. People would get birds and then realize that they make a huge mess, and want to get rid of them. So the brother would buy used birds cheap, Mr. Carruthers said, and then “flip them.” And I was like, He was flipping birds! Yeah—flipping birds! There was a big nasty pile under the place where the bird must have been, and a lot of hair collected on a cheap old sleeping bag in a corner.

The floors were tile picked up at a discount, maybe remnants. Popcorn ceilings with angry holes punched in them. As we surveyed the wreckage of the house, we thought to ourselves, “This is one sweet pony.” The place had a Wow Factor of 0. But the things that were wrong with it would be easy and fairly cheap to fix—lots of cleaning, some new appliances, flooring—and once that was done, we’d have about $100k in equity.

We went immediately to Mr. Carruthers’ office and, after much hemming and hawing--we wanted the property but we didn’t want to leave money on the table--we put in an offer at fifteen grand below asking. The bank that owns it would only accept cash, and we needed to provide proof of funds. Done. Unfortunately, Mr. Carruthers learned that there were three offers on the place already. “I put our chances at 30%,” said Roy.

The next day Mr. Carruthers called to let us know that the bank had pulled the property off the market. They won’t tell us anything for a month as they deal with the tenant’s personal left-behind stuff. Did he hire a lawyer and get through to the bank? Who knows.

Bottom line: This is our first time dealing with a bank-owned property, and while the price is right, sitting in limbo limbo limbo leaves much to be desired. Still, we can’t help imagining having a cocktail party in the newly redone living room, lights of the city winking below us—that is, until we flip that bird and make some cash.