In 2006, there were signs that this had become a highly leveraged Ponzi economy and that housing was at the pinnacle of this leverage. The temperature of the U.S. housing market was always best read here in Orange County [Calif]. But one day that August, as I was going across the street for my daily yoga exercise, it occurred to me that we needed to get a feel for the rest of the country.
We had 40 credit analysts covering companies like IBM (IBM) and General Motors (GM). I thought: Why not take 10 of these people and turn them into pretend real estate buyers? Instead of sending them to Armonk to interview the treasurer of IBM, let's send them to places like Detroit, Miami, or Vegas to pretend to be in the market to buy a house. They didn't have a bankroll, and they obviously weren't going to buy a house. Nonetheless, I gave each of them a territory and told them to go there two or three times a month until June 2008. They were told to be serious buyers, to get serious information.
There was no pushback, but I wondered whether it was kosher. I wasn't necessarily proud of the obvious deception. But this little bit of trickery alerted us to what was really going on: the liar loans and the extravagant lending practices. We got much better real-time information, and we learned homes were being bought without a down payment or without documents to prove income. The extent of the lending malpractice—to use a nice word—was shocking, and it caused us to stay out of the subprime market.
Timing is everything, though. It wasn't easy for quite a while: There was a stretch of nine to 12 months pre-Lehman where we were underperforming, and there was a lot of internal questioning and debate. Maybe we should jump in the pool with everyone else. Every investor has an alarm clock. I wish I could get up at 6 every morning and time things just right. I probably get up at 4:30. There's a cost to that hour and a half, where you sit around the table and acknowledge your competitors are having your lunch. But it's better than getting up too late.