Steak N Shake (SNS), run by activist investor Sardar Biglari, who took over Steak N Shake, Western Sizzlin, has just filed a 13D in Fremont Michigan Insuracorp, showing 9.9% ownership.

Sardar has a successful history of activist investing, not only in the companies he now controls, but also in his fight with Friendly's Ice Cream.

In The Unintended Effects of Bad Policy (May 18th), I wrote that:

[L]ow interest rates often have the opposite of their intended effect. Extremely low interest rates can vacuum liquidity out of nations. Japan has been referred to as a nation where loose monetary policy was like "pushing on a string." There was no push. It was a pull. Liquidity was sucked out of the country as the Yen became the world's carry trade currency of choice. Borrowing in a currency is the opposite of investment. It is liquidity-draining to the carry trade currency nation. For all of the talk about using monetary policy to dampen the business cycle, no result could be more damaging or procyclical.

In The Unintended Effects of Bad Policy (May 18th), I wrote that:

[L]ow interest rates often have the opposite of their intended effect. Extremely low interest rates can vacuum liquidity out of nations. Japan has been referred to as a nation where loose monetary policy was like "pushing on a string." There was no push. It was a pull. Liquidity was sucked out of the country as the Yen became the world's carry trade currency of choice. Borrowing in a currency is the opposite of investment. It is liquidity-draining to the carry trade currency nation. For all of the talk about using monetary policy to dampen the business cycle, no result could be more damaging or procyclical.

In The Unintended Effects of Bad Policy (May 18th), I wrote that:

"[L]ow interest rates often have the opposite of their intended effect. Extremely low interest rates can vacuum liquidity out of nations. Japan has been referred to as a nation where loose monetary policy was like "pushing on a string." There was no push. It was a pull. Liquidity was sucked out of the country as the Yen became the world's carry trade currency of choice. Borrowing in a currency is the opposite of investment. It is liquidity-draining to the carry trade currency nation. For all of the talk about about using monetary policy to dampen the business cycle, no result could be more damaging or procyclical."

This past year, many of us have asked ourselves how corporations could practice such lax risk control. Often, in order to understand a board's effectiveness at risk control, it is wise to examine a board's makeup and the structure of incentives between board members. While corporate strategy is often complex, board members' incentives are often quite obvious after a thorough analysis of footnotes in company filings, such as 10-Ks and Proxy Statements.

Indeed, while many boards meet stock exchange and legal standards of independence, that does not mean that they are free from management influence.

The key to financial stability and reform at major banks is simple. The President, through his force of stature, could go to the nation's most successful and conservative banks, such as Hudson City Bancorp (HCBK) and request that some of these banks' executives and loan officers be placed in leadership positions at problem financial institutions. Of course, the incompetent executives they replace would have to be fired.

Most well run banks would naturally view losing talented executives as a raiding of their ranks, and rightly, as a penalty, rather than a reward, for their excellent performance. The government could issue to these well-run banks modest amounts of stock options in problem banks where their former executives have been placed as partial recompense for the loss of talented executives and the strengthening of competitors.

Californians are insane. They just voted down their best hope of avoiding insolvency. When you're in a sinking boat, stop blowing holes in it. So now the U.S. government should take care of them when they decide to spend more than they have? People in states which balance their budgets prudently should subsidize those who do not?

Does democracy mean that the thrifty should subsidize the profligate? Perhaps Californians will not have any incentive to pay their bills unless bonds are secured and creditors can start seizing state government land. In such scenario, tax increases and spending cuts might commence rather quickly.

There is a reason why credit spreads widen. It is to more adequately compensate savers for taking risk. Adequate compensation for risk forestalls panic by providing an incentive to those with liquidity to supply it. In contrast, extremely loose monetary policy is procyclical and drains liquidity from economies. How can extremely low interest rates and quantitative "easing" create such a counter-intuitive result?

Widening banks' net interest margin by dropping rates to near zero at the low end of the curve will temporarily create accounting profits at banks. However, as inflation takes hold, this seeming "quick fix" will decimate the real economic value of financial institutions' mortgage portfolios and any bonds with a duration of over 10 years. Even with a full suspension of mark-to-market, the real economic book value of many insurance companies and banks may be catastrophically eroded (Buffett observed this years ago with insurance firms during stagflation). This could have the effect of removing liquidity from the system at precisely the point our economy needs it.

"The aggregate happiness of the society, which is best promoted by the practice of a virtuous policy, is, or ought to be, the end of all government..." (George Washington)

"Only a virtuous people are capable of freedom. As nations become more corrupt and vicious, they have more need of masters." (Benjamin Franklin)

It is highly important for management and directors to view core business issues from a variety of angles. Hopefully, these questions will stimulate constructive solutions to serious business issues that face Fremont (FMMH.OB). Of course, evidence of effective solutions will be concrete action which quantitatively improves results.

The Problem

Sometimes, the managements of public companies disappoint us. I have been engaged in a long term relational/activist investment in Fremont Michigan Insuracorp (FMMH.OB) and have gotten to know management, including CEO Richard Dunning, CFO Kevin Kaastra, COO Kent Shantz, EVP David Mangin, VP Kurt Dettmer, and VP Bill Hall in meetings, phone conversations, emails, and at an annual meeting one year. I think Fremont's employees are hard working and honest. However, I have become disappointed by basic issues of corporate governance. Recently, I nominated myself to Fremont's Board of Directors, and the company refused to recognize my nomination. Their outside counsel, Paul Yared, wrote that they could find no record that I am a shareholder. I sent in documentary evidence from Interactive Brokers, but Paul Yared would not budge. Ignoring my documentary evidence, he said Fremont could find no record of me or my broker on the Nobo list. He would not respond to phone calls from my lawyer and correspondence explaining that most shares at any company are held under the name of Cede & Co. My lawyers and I wanted to give management the benefit of the doubt, despite my many meetings with them as a shareholder, and assume that they were confused, rather than throwing up roadblocks to my nomination.

What am I to think when their outside counsel does not even have the courtesy to return my lawyer's phone calls?

The recent debate over whether issuers or investors should pay ratings agencies totally misses the point. Both models create incentives for potential distortions of ratings behavior.

As many have pointed out, when issuers pay, there is a clear incentive to make the initial rating higher than it otherwise might be. No one would debate that.

In the latest quarter reported, Fremont Michigan Insuracorp (FMMH.OB) decreased its expense ratio from 38.4% to 30.8%. That is a great performance, and if the company can keep dropping the expense ratio to 25% and lower, it will be in the running to make the business a true "low cost leader" on the expense front. This progress is a great testament to COO Kent Shantz, CFO Kevin Kaastra and EVP David Mangin’s hard work on the expense front.

Starting today, the company also needs to raise rates! Along with low expenses, it should be the company's prime focus. Fremont Vice-President Skip Massucci handles all pricing for the company, and he has done a first-class job. It is born out in the numbers.

It might be extremely profitable for Fremont Michigan Insuracorp (FMMH.OB) to moderately reduce its level of reinsurance in certain of its lines. While this might make underwriting results more volatile on a quarterly basis, it would very likely reduce the combined ratio of the company on a longer term basis and significantly increase underwriting profits. This approach would make sense, since it would increase the company's longer term intrinsic value, rather than the current approach, which I believe might reflect a shorter term focus that views public shareholders as unable to tolerate more volatile quarterly numbers. However, long term Fremont investors deserve the lowest combined ratio possible, rather than a higher combined ratio number which is smoother and less volatile quarter to quarter due to a relatively higher, suboptimal level of reinsurance.

From Berkshire's 1995 Chairman's Letter:

I've been in an activist campaign to push Fremont Michigan Insuracorp (FMMH.OB) to lower its expense ratio and make other reforms to lower the company's business risk and increase its intrinsic value.

To the company's credit, the expense ratio has come down significantly over the past year. However, I still highly disagree with certain of Fremont's actions, such as a new plan that would allow certain independent agents to purchase shares at a discount to market value.

What would an optimum government policy for helping the financial crisis look like? On each side of the political spectrum, we can all agree that it should be transparent, targeted, provide patient capital to the financial markets, help with deleveraging, and minimize government payouts.

The number one thing the government would need to do is create market incentives for investors to provide patient capital to the debt market. Otherwise, most investors may keep their wallets zipped.

In my last article on Fremont (FMMH.OB), I wrote that "The proof of the pudding in terms of management's serious about shareholder interests will be if we see significant progress on the expense ratio front next quarter and beyond and a move to expand to other states." This latest quarter, Fremont has had another remarkable improvement in its expense ratio.

The company reported earnings Monday, and their underwriting results were outstanding at a combined ratio of 87.1. The combined ratio and the expense ratio both improved substantially from previous quarters, leading to a significant increase in diluted EPS.

Charlie Munger, the Vice-Chairman of Berkshire Hathaway (BRK.A), has often pointed out that it is most instructive to not only study success, but also failure. Ironically, a balance sheet is often a direct reflection of the executives' values and the social mores of their environment. The soul of a company can often be found, not only in its financial statements, but in its location. From what soil does it grow?

Berkshire Hathaway is profoundly Midwestern in its ethos and its financial structure. In short, keep the debt level reasonable, write business at prudent rates, and make shrewd investments. AIG (AIG) is very New York I-bank-esque: overleveraged, greedy, and vacuous. One firm owned Coke (KO) stock, the other subprime mortgages. Of course, the shareholders of Berkshire sleep well at night, while the shareholders of AIG paid a high price for their lack of discernment.

There is an old-fashioned way that companies used to win business—by taking it from someone else. Yesterday, the U.S. government penalized a variety of insurers and other financial institutions who behaved with intelligence, shrewdness, and honor towards their shareholders and customers.

By 'doing the right thing' (a passé concept in Washington?), these companies rightfully deserve to win customers from a company whose balance sheet resembled more a highly leveraged hedge fund than a well-run insurer. To those who would argue that derivative counterparties would have been "unfairly" penalized by AIG's (AIG) collapse, let us be clear—we are not talking about innocents, we are talking about highly sophisticated (but clearly not very bright) players in the derivatives markets.