Bill Miller of Legg Mason Value and the "collateral-driven" banking crisis of 2007-2009

I had the privilege to hear from legendary fund manager Bill Miller last week at the Ritz Carlton, where Legg Mason held an investment forum. Bill Miller's Legg Mason Value fund is most famous for having beaten the S&P500 for 15 consecutive years. Unfortunately, Bill has been in the news more recently in 2008 for his then-disastrous bets on financial institutions (some may recall the comparisons made with Bill Gross of Pimco, who placed bets on the debt of Freddie Mac and Fannie Mae, while Miller held the stocks. The government's bailout immensely benefited the debt holders of these enterprises, while shareholders took massive hits).

While he "returned to form" with an outperformance of the S&P 500 in 2009, his explanation of how he incorrectly read the recent financial crisis was far more poignant for some in the audience (like myself). He talked about how the 2007-2009 banking crisis was a "collateral-based" problem, while the 1987 crash was precipitated by a "liquidity" problem. He bought financial stocks when the Fed first injected liquidity in 2007, a grave mistake as the crisis was collateral-driven, which meant that the assets backing the deposits held by banks were actually turning sour, resuling in bank capital continuing to shrink until the prices of the colletaral (sub-prime, mortgage backed securities etc.) were actually propped up to prevent further falls. This only occurred in early 2009, which was the perfect time to be buying bank stocks.