Margin of Safety- Klarman

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JZ: What metrics did you look at that told you the time was right to deploy capital?

SK: With most stocks down 40%, it wasn’t economically too different form a depression.
We assumed a depression was going to happen, and looked for what would still work out.
One example was captive auto finance companies whose bonds
were trading at $0.40. We specifically liked Ford Motor Credit since they seemed to
be the best run. And we said, ok, you have 5% of loans defaulting. What happens if
this doubles, or quadruples, or goes up 8x? We decided that at a 20% default rate
the bonds would be worth par, and at 40% default, they’d be worth $0.60. So we
thought we were pretty safe buying since we didn’t think defaults would go anywhere
near that high. In 07/08 there wasn’t an erosion in auto loans, people just expected
there to be one. Autos didn’t have over building and multiple investment cars like
homes had. So we looked for depression protection.

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