Iron Capital Insights

  • Iron Capital Insights
  • September 23, 2015
  • Chuck Osborne


“I will not lie, cheat or steal and I will discourage others from such actions.” That is the honor code at my alma mater Culver Military Academy. There are similar codes at other schools, and while the language varies slightly, the message is the same:  I not only will act with honor myself but also will insist that those around me do the same. These codes are usually enforced by student-run honor councils that have the ability to punish severely, including dismissal. One can be punished not only for lying, cheating or stealing, but also for not sufficiently discouraging such action, i.e. witnessing an honor violation and not reporting it.

It is interesting that these codes almost always trace back to the military. The Latin word “integritas” is what Roman legionnaries would shout while being inspected. It means wholeness, completeness and entirety. The legionnaire was signaling to his commander that he was whole and ready for battle. It is from this word that we get “integrity.”

I don’t know if they have an honor code at Volkswagen, but if they do, some heads are going to roll. For those who missed it, Volkswagen somehow rigged the software in some of their diesel vehicles to pass U.S. emissions inspections. How does this happen? I have no insider knowledge of this situation; in fact Iron Capital owned Volkswagen in some client portfolios until this came to light. I drive one of their products as do several friends and relatives. However, having spent my career working in and researching large corporations I can submit a very likely hypothesis: This revelation most likely came as a complete shock to senior management. That does not make them innocent, but the conspiracy theorists who are undoubtedly out there are as usual dead wrong. The CEO and board of directors likely did not meet in secret and decide to break the law because they were so greedy that they really want the stock price to completely collapse. What likely happened was some middle-level engineer was told, “Fix this,” and since he couldn’t figure out how to build an affordable vehicle that complies with EPA standards, he cheated. His bosses are likely more guilty of not being curious enough about how things actually get done. They all are likely guilty of caring more about pleasing the boss than living with integrity.

Of course lost in this story will be any question of why U.S. emission standards for diesel engines are so much more restrictive than the restrictions in Europe? Could that have anything to do with the lack of diesels made by the U.S. auto industry? Why was this not discovered by EPA inspectors? We will likely never know. One of the great tragedies of the aftermath of the financial crisis is that there is no accountability given to regulators and policy makers. Greed was and is a convenient and believable villain, which has the benefit of also being factual – there are greedy people in the world – but it is not complete, and therefore lacks integritas.

Just about every asset pricing bubble that has ever popped has taken place after a prolonged period of time with lower than normal interest rates. Yet rates sit at zero seven years after the crisis is over. I have not been critical of the Federal Reserve in the past, but last Thursday’s decision was a poor one. Of course the biggest benefactors of low interest rates are the world’s largest debtors – governments. Could it be that the Fed has the same lack of courage as the engineer at Volkswagen? Could it be that they are just too scared to tell the truth? Sorry, we cannot profitably make a diesel engine that meets EPA standards at the price point demanded for such small cars in America. Sorry, we cannot keep borrowing money for free. Integrity is tougher than it looks.

Towards the end of the Roman Empire the tradition of pounding the chest and shouting integritas was replaced. They changed integritas to, “Hail Caesar!” Seemed like a small thing. That is the trouble with honor codes; it is the second part that gives them strength – using the power of peer pressure for good. It is much easier to just try and please one’s boss.

Alas, we cannot control what goes on around us, we can only react. While integrity may seem like a quaint notion in our modern world, it is this love of truth – the whole truth – which drives prudent investment decisions: the desire to not be satisfied with surface answers, for investment opportunities exist precisely where actual truth differs from perceived truth. That is what we strive to find every day.

Chuck Osborne, CFA
Managing Director