From Alice Schroeder's The Snowball (2008), on Warren Buffett

Warren "Buffett was the one who enjoyed pleasing people... Whereas [Charlie] Munger wanted only respect, and didn't care who thought he was a son of a bitch." -- from Schroeder's The Snowball (2008) (hardcover, pp. 24)

"Life is like a snowball. The important thing is finding wet snow and a really long hill." 

"Spend less than you make" could, in fact, have been the Buffett family motto, if accompanied by its corollary, "Don't go into debt." (39) 

"School for the most part bored him... Warren's teachers found him stubborn, rude, and lazy. Some of the teachers gave him double black Xs, for extra bad." (82)

"Throughout his entire educational history he had shown little interest in formal schooling--as opposed to learning--and considered himself largely self-taught." (125)

"Warren particularly disliked buying houses, considering money spent on them as lying fallow, not earning its keep." (351) 

"Derivatives are like sex... It's not who we're sleeping with, it's who they're sleeping with that's the problem." (659)

"The purpose of life is to be loved by as many people as possible among those you want to have love you." (826) 

Warren Buffett on Sex

Warren Buffett on sex...yup, you read that right. See here for more.

On selling your business to Berkshire vs. private equity: You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever. Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.

A Puritan, he's not.

Warren Buffett and Bill Gates

CNBC and Columbia University recently held a townhall meeting with Warren Buffett and Bill Gates. I saw both of these men at a Berkshire Hathaway shareholder meeting. I remember Buffett lighting up a room with his energy, while Gates seemed nondescript. Here is the transcript from the meeting. Below is a portion from the transcript where the men describe what they admire about each other:

BUFFETT: Well, I would say what I really most admire about Bill is the view he has about what he should do with the wealth he's accumulated. I mean, as he said, he was very lucky. He was born in the right country, at the right time, with the right wiring and all of that sort of thing. In the end, he knows he's a beneficiary of a terrific society, and not everybody gets the long straws like he and I did. So he is -- and he has this view that every human life worldwide is the equivalent of every other human life, and he's backing it up not only with money, but backing it up with his time. And his wife, Melinda, is backing it up with her time. And they are really going to spend, you know, the last half of their lives or so using both money, talent, energy, imagination, all improving the lives of 6.5 billion people around the world. That's what I admire the most.

GATES: With Warren, there are a lot of things you could pick, you know, his integrity as an example for the world. His sense of humor. But I think I'd pick his desire to teach, his desire to teach things that are complex and put them in a simple form so that people can understand and get the benefit of all his experience, all his models of how the world works. He loves to teach. And he does it meeting with students. He does it in his annual newsletter. He does it when he's talking to me on the phone. It's a real gift that I admire incredibly.

Berkshire Shares to Split 50 to 1?

According to this article, Berkshire Hathaway shares might split, making them more accessible to the general public. Shareholders still have to approve the stock split, and the final vote tally might be close. Buffett started giving away his shares to the Bill and Melinda Gates Foundation, so it's unclear if any single person or group controls the outcome of the vote.

I bought my BRK.B shares so I could go to the annual meeting in Omaha, Nebraska. If shareholders approve the split, more people may attend the annual meeting. I'm not sure that's a great idea--when I attended in 2007, the meeting was extremely crowded. At the same time, Buffett is coming along in age, so perhaps he wants to give more people the chance to come see him.

Rich People, Free Links

Two great links:

1. Warren Buffett's financial advice:

http://www.billshrink.com/blog/lessons-wealth-warren-buffet

“Live your life as simply as possible.”

2. Worst financial gurus:

http://www.billshrink.com/blog/worst-financial-gurus

I really, really dislike the book, Rich Dad, Poor Dad. I am ecstatic that someone finally called out Kiyosaki.

Berkshire Hathaway's 2008 Annual Letter

Every year, Warren Buffett issues a fun, easy-to-read letter to his shareholders. Here are this year's highlights:

Cash is King: As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”

Government will get bigger without a firm hand: Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

The government's interference in credit markets is causing some disruptions: Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.

On bond insurers: By yearend 2007, the half dozen or so companies that had been the major players in this business had all fallen into big trouble. The cause of their problems was captured long ago by Mae West: “I was Snow White, but I drifted.” [Mae West, of course, was the rebel Hollywood sex symbol known for her wit.]

Public pensions are still a major concern: Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.

For more on this important topic, see my previous posts, here, here, here, here, and here.

On buying ConocoPhillips (COP) and the future of oil prices: I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. [Looks like investors who want to get a better deal than Mr. Buffett may want to consider buying COP.]

Just darn good writing and advice: Beware the investment activity that produces applause; the great moves are usually greeted by yawns.

On derivative contracts: Receivables and payables by the billions become concentrated in the hands of a few large dealers who are apt to be highly-leveraged in other ways as well. Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.

Questions at this year's annual meeting will be handled differently--various journalists will sort through the questions and pick which ones to ask: The journalists and their e-mail addresses are: Carol Loomis, of Fortune, who may be emailed at cloomis@fortunemail.com; Becky Quick, of CNBC, at BerkshireQuestions@cnbc.com, and Andrew Ross Sorkin, of The New York Times, at arsorkin@nytimes.com. From the questions submitted, each journalist will choose the dozen or so he or she decides are the most interesting and important. (In your e-mail, let the journalist know if you would like your name mentioned if your question is selected.)

Disclosure: I am bullish on ConocoPhillips (COP).

Tom Brokaw Interviews Warren Buffett

In case you missed it, here is the transcript of NBC's January 18, 2009 interview with Warren Buffett.

Every time I read what Warren says, I relax. America is lucky to have such an articulate, honorable spokesman. Excerpts from the interview are below.

Warren on public pensions:

[T]he pension plans of states and cities...have been decimated in the last year. And the costs from that, the lack of revenue they're going to face as the economy slows, means that you are going to see a parade of mayors and governors to Washington like you've never seen it. And they're gonna say, "If you can help out General Motors, and you can help out Citicorp, you can certainly help out, you know, this state or that state." So I think it's gonna make inauguration day look like nothing in terms of the public officials that come in here and say, "We need help." Their revenues are gonna be down. Their expenses, particularly including pension expenses, are going to be up. And you're going to have unbalanced budgets just all over the country with states and cities.

Warren on economic stimulus:

[E]very time you read about 523,000, or whatever, those people losing their jobs in December, those are 523,000 human tragedies. I mean, I can think of nothing worse than going home and saying, you know, to a family that, "I've lost my job and we've got mortgage payments and food to buy." And so we need to solve that one. And we will have consequences to the kind of deficits we're running up. And some of them will be unpleasant. But I would rather face those consequences than to face the consequences of doing nothing.

Warren on investing:

[Investors] have to look to the business, the asset itself. If you own an apartment house you wouldn't get a [price] quote on it every day. You'd just look at the rent, and what your taxes were and expenses were. And if they all came in line with what you expected when you bought it, you'd feel you'd made a satisfactory investment, and you'd never get a quote on it. So I don't look at quotes. Mostly-- I can't tell you what Berkshire Hathaway [BRK.A, BRK.B] is selling for today.

Warren on bailouts:

Well, that's [bank, auto bailouts] exactly what we did in 1933. I mean, in 1933, when Roosevelt came in, there was something called the Reconstruction Finance Corp, RFC. Actually, It got enacted under Hoover in '32. But Roosevelt appointed Jesse Jones in 1933. And they put preferred stocks into the banks. They concentrated on banks, but they went into other things. Incidentally, when [Jesse Jones] put that money in, he told 'em what the compensation rate was gonna be too. I mean, he was a tough tsar. And it helped take the United States out of a depression. I mean, the RFC was an important component. And I'm sure they got criticized at the start. And they said, "People, you're throwing money into the wrong things and all that." ...But you can't separate Wall Street, Main Street, side streets. We are connected. This is one big community. And you better have credit flowing.

I knew that Congress authorized loans in 1979 to prevent a Chrysler bankruptcy, and J.P. Morgan once bailed out the Treasury, but this is the first time I've heard about the RFC and Jesse Jones. I shouldn't be so surprised--as I wrote here, the more things change, the more they stay the same.

Warren Buffett on Geeks

Today's WSJ had another gem from Warren Buffett (front page). Regarding the computer programs that financial firms relied upon to evaluate so-called safe investments and derivatives, Warren delivered another classic line:

All I can say is, beware of geeks...bearing formulas.

Oh, the obviousness, especially post-LTCM.

Warren Buffett Says "Buy"

The Oracle of Omaha to the rescue? Warren Buffett has issued a "buy" signal:

http://www.nytimes.com/2008/10/17/opinion/17buffett.html

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

OCM: Other Countries' Money

Despite the failure of several financial institutions, the decline in worldwide stock markets, and unprecedented foreclosure activity, the average American still has no idea how much trouble we're in. America has become beholden to the international community’s willingness to lend us money. I haven’t seen anyone coin “OCM” as a phrase, but whenever you see someone using their credit card, mention OCM—Other Countries’ Money. OCM means realizing our money isn’t ours because of the massive deficits our government has incurred through its spending. Having a deficit means we are borrowing other countries’ money through the form of Treasury and bond sales. By running deficits and spending more than we make/collect, each cent we make no longer belongs to us—it belongs to our international creditors. As a result, we have lost financial control of our own country. If we had a surplus, for example, national healthcare would be a no-brainer. But after Iraq and the bailouts, we are now a nation of beggars. As the old saying goes, “beggars can’t be choosers.”

How did we get to this point? Less than a decade ago, we had a surplus. In 2001, President Bush inherited a 128 billion dollar surplus. Now, we have almost a half a trillion dollar deficit—and that’s just for the year 2009.

http://www.cnn.com/2008/POLITICS/07/28/2009.deficit/index.html

It gets worse. Overall, people agree we have a debt of at least 9 trillion dollars, although some entities, like the Peter G. Peterson Foundation, peg our national debt at an even higher number, 52.7 trillion dollars--see http://www.pgpf.org. The numbers have gotten so large, they seem almost imaginary, like Monopoly money, and that’s the danger—at a certain debt and spending level, the American dollar will lack credibility against the Euro, yen, and Swiss franc, not to mention gold. If the American dollar loses credibility, the entire worldwide financial system will be at risk. If that sounds too “Mad Max” for you, you just need to understand this key concept: we are debtors, and debtors don’t get to make the rules. When I hear people say they want to tie restrictions and regulations on AIG, Merrill Lynch, Fannie Mae, and Freddie Mac in exchange for taxpayer money, I cringe. It’s not “taxpayer” money, any more than the money given to you by your credit card company is “your” money. The money belongs mostly to the Japanese and Chinese, who have lent us trillions of dollars by buying up U.S. debt, bonds, and preferred shares. If we want them to continue financing our lifestyle—which they will do, because few other places contain citizens so willing to spend—they set the terms of the bailouts, not us. Thus, I have no interest whatsoever in what regulations and rules Americans believe should be passed prior to doling out the money to AIG et al. It’s not our money we’re giving to AIG et al—it’s the creditors’ money, and creditors make the rules because they hold the purse.

I am far more interested in what the Japanese and Chinese think about the bailouts. The fact that they are not demanding major restrictions is a pleasant surprise. Singapore and other sovereign wealth funds have lost billions of dollars loaning money to MGM Grand and other American companies. It’s a miracle they are not demanding more concessions or protection for loaning us money. The equivalent of what just happened—especially with Japan's Mitsubishi recently willing to buy up to 20 percent of Morgan Stanley—is like you and me going on a shopping spree, running up 1000 dollars in debt while unemployed, and coming close to declaring bankruptcy—only to have our credit card company reward us with a higher credit line and no punishment.

In large part, international investors are willing to forgive our transgressions because of the bailouts. The bailouts wiped out stockholders (held mainly by Americans and non-Asian investors) and preserved Fannie Mae’s and Freddie Mac’s bonds (held mainly by Asian and international investors). Thus, the bailouts were designed to convince our creditors America was a safe place to invest.

From March 2019

Only as a secondary effect might the government intervention, using taxpayer money, help American homeowners by increasing liquidity (“liquidity” being dependent on Japan and China continuing to put us in more debt by giving us more of their money). Government intervention worked—Asian markets recently swung back from double-digit declines, and liquidity is being restored to the worldwide economy. Some Americans have used this increased stability post-government-intervention to believe that deregulation itself was a bust or the cause of our financial collapse. Nothing could be further from the truth.

No rule or law could have saved us from ourselves and our greed. Remember that Warren Buffett himself called financial derivatives “weapons of financial mass destruction” in early 2003—over five years ago. See

http://news.bbc.co.uk/2/hi/business/2817995.stm

If someone with Mr. Buffett’s profile pointed out financial problems using language signifying the severity of a nuclear bomb and was unable to get anyone to take him seriously, what hope would a law have against this kind of indifference?

We had and have numerous laws to prevent financial and mortgage fraud. Laws against fraud exist in every state, and even if no express state statute exists, common law fraud can be pled in any county courthouse. Also, if you live in a company-friendly town, you can bypass your local state court judge and go to federal court under a 1968 federal law, the Truth in Lending Act (TILA). Thus, state and federal laws already exist to prevent financial fraud against consumers and homebuyers. Yet, no law could have prevented a bank from having lax standards for granting loans. Even if such a law existed, it may have forced a working class family to become permanent renters by requiring excessive upfront capital. In other words, laws don’t fix problems—they just arbitrarily create winners and losers. Furthermore, no law could have changed the common practice of mortgage brokers and real estate agents falsifying loan applications. Even if every D.A. in every county had dropped homicide cases in favor of prosecuting mortgage fraud, there would have been plenty of fraud to go around.

The problem wasn’t and isn’t a lack of regulation, but a lack of ethics and honesty. Unfortunately, there is no law that can curb the human appetite for greed when everyone is seemingly making money. Even a casual student of economics has heard of “tulip mania,” which took place in the year 1637. Back then, the price of a tulip contract sold for more than 20 times the annual income of a skilled craftsman; in other words, people were happy to exchange 41,600 hours of hard labor for a flower that you can now get for a buck at Home Depot. Financial bubbles happen, and then they pop. Unless a law can remove humanity’s attraction to getting rich, another bubble will occur, and more people who bought late in the game will be wiped out.

Overall, deregulation has helped the American consumer. Just twenty five years ago, the idea of an average college student being able to fly to Iceland and back was laughable. But the government deregulated airlines, and consumers have received low prices—just check out Southwest Airline’s deals. And that cell phone you have, with the cheap 1000 minutes a month? If the government hadn’t broken up Ma Bell in order to deregulate the telephone industry, you’d be paying twenty cents a minute because of regulations designed to help AT&T maintain a monopoly. The list goes on.

Deregulation is devastating only when unethical people are involved. For example, energy deregulation in California was working initially, until Enron decided to actively steal from Californians and intentionally increase the price of electricity through various shenanigans. The common factor in any bubble’s existence and inevitable collapse isn’t deregulation, but a lack of ethics. Stories from yesteryear indicate that local bankers knew more about their debtors than the local church. Whether apocryphal or not, the very idea that a banker today knows all of his debtors’ financial situations intimately is amusing—and that kind of ignorance should scare all of us.

It wasn’t just leverage that caused this financial collapse—it was the attenuated way in which various people could make money. For example, a mortgage broker could loan hundreds of thousands of dollars over the phone to an applicant or after meeting him for half an hour and filling out some forms. After this initial contact, the broker had no interest whatsoever in the applicant/debtor. The broker received a fee from the bank for giving it the loan, and the bank sold the loan it generated to other investors as part of a larger package. The story is old now, but deserves to be told, because too many people miss its crucial point: attenuation leads to irresponsibility.

The financial debacle had nothing to do with regulations, or lack thereof. It had to do with our society itself, and how year after year, cities get larger, neighbors rarely see each other, and no one can reasonably promulgate a set of core principles each and every American believes in. We have become so reliant on laws rather than personal trust that we've had to pass laws to protect people when they help others. Many states have passed laws protecting Good Samaritans from being sued for helping others if their assistance unintentionally results in further injury. In other words, in some states, if you help a woman on the street replace a tire, and her tire happens to blow up in the middle of the street through no fault of your own, you can be sued for negligence and lose your life’s savings as a result. When a law has to be passed to counteract other laws that discourage others from lending a helping hand, something is deeply wrong, and the absence of laws is clearly not the problem.

I wish I knew the solution to our modern economic problems. I am too pessimistic to decree an amorphous form of morality as the solution—morality is so vague and subjective, it can masquerade as homophobia, Jim Crow, anti-Mormonism, or anti-whatever-the-minority-is. But capitalism, we too often forget, relies on mutual trust. I trust that when I make a loan, it will be paid back. I trust that when I give you a dollar, the paper will be honored by the next establishment when I want to buy something. I trust that a mechanic won’t rip me off if I go to get my car fixed—and if I don’t trust any mechanics, that means I have to do it myself and not spend any money, which restricts the economy. As another writer once pointed out, currency has value because it flows, like a current. Value is created when money moves from person to person and is worth nothing standing still.

If I had to venture a guess about to increase trust and ethics, I’d try to fix two problems: one, a non-stop treadmill of working hours that takes people away from their loved ones and their friends, creating higher living expenses and less time for parents to teach their children anything; and two, a lack of corporate responsibility to long-term shareholders and customers. As more people change residences and products more often, corporations become disinclined to foster long-term relationships and instead chase the bottom line, knowing they might never see a particular customer or resident again.

How do we fix these problems in an era of increasing competition? That’s the trillion dollar question. Unfortunately, we won’t get an answer if we wrongly frame the debate in terms of what laws to pass and how to increase regulation. The debate should be about OCM and realizing we are debtors who have made our children beggars because of our fiscal irresponsibility. It’s a painful truth to admit, but admit it we must—the first step to overcoming addiction to OCM is admitting we have a problem.

© Matthew Mehdi Rafat

Update on 2/28/2009: more on local bankers, from Warren Brussee's The Great Depression of Debt:

In the past, local banks gave mortgages to area home buyers, and the banks kept those mortgages. That was a big source of the bank's income, so they were careful about who got those mortgages. Banks verified income, employment, and past payment history. And they did their best to make sure that people did not get over their heads on the amount of their mortgages because they realized the high costs of foreclosures even if homes could be sold at their current market prices. There even seemed to be a morality involved, and bankers were looked up to in their communities as conservative protectors of wealth. [page 40]

Update on 8/13/2010, from Niall Ferguson's The Ascent of Money, page 262, Penguin, 2008-9:

"Once there had been meaningful social ties between mortgage lenders and borrowers. Jimmy Stewart [in It's a Wonderful Life] knew both the depositors and the debtors. By contrast, in a securitized market (just like in space) no one can hear you scream--because the interest you pay on your mortgage is ultimately going to someone who has no idea you exist."

Update: if you want to make the above issues very simple, focus on leverage. Leverage continues to be the major catalyst of financial collapse, along with a lack of diversification. In 2004, the SEC exempted investment firms with a market capitalization of over $5 billion from the net capital rule. Thus, Goldman Sachs, Lehman, Bear Stearns, and Morgan Stanley were no longer governed by the 12 to 1 leverage limit. These investment firms promptly increased leverage dramatically, sometimes up to a 40 to 1 ratio. The stock market soon became a casino instead of an efficient place to start up or evaluate companies. Not surprisingly, several firms collapsed or had to change their corporate structure. The exact same thing happened before, in 1998, with the most famous hedge fund at the time, LTCM:

"At the end of August 1997 [prior to the its collapse in August 1998] the [LTCM] fund's capital was $6.7 billion, but the debt-financed assets on its balance sheet amounted to $126.4 billion, a ratio of assets to capital of 19 to 1...On Friday 21 August 1998, it lost 550 million--15 per cent of its entire capital, driving its leverage up to 42:1." (Niall Ferguson's The Ascent of Money, pages 324, 327, Penguin, 2008-9)

Bonus: "In 2007, the United States needed to borrow around $800 billion from the rest of the world; more than $4 billion every working day. China, by contrast, ran a current account surplus of $262 billion, equivalent to more than a quarter of the U.S. deficit." (Niall Ferguson's The Ascent of Money, page 355, Penguin, 2008-9)

Update and counterargument on 5/25/12, from The Atlantic Monthly (June 2012), by William Cohan ("How We Got the Crash Wrong"): 

"[T]he truth is that in recent decades, Wall Street firms have almost always been highly leveraged. For instance, according to a 1992 study by the U.S. General Accounting Office (now the Government Accountability Office), the average leverage ratio for the top 13 investment banks was 27-to-1 midway through 1991 (up from 18-to-1 in 1990). A subsequent GAO report, in 2009, noted that the big Wall Street investment banks had higher leverage in 1998 than in 2006. According to SEC filings, in 1998, the year before it went public, Goldman Sachs was leveraged at nearly 32-to-1, while in 2006 it was leveraged at 22-to-1. In 1998, Bear Stearns’s leverage was 35-to-1; in 2006, its leverage was 28-to-1. Similar patterns applied at Merrill Lynch and Lehman Brothers. To be sure, leverage has fluctuated over time: In the early 1970s, for instance, it was generally below 8-to-1. But in the 1950s, it sometimes exceeded 35-to-1. Of course, even a dollar of debt is too much if you are clueless about how to manage risk..." 

"The problem on Wall Street has never been about the absolute amount of leverage, but rather about whether financiers have the right incentives to properly manage the risks they are taking. During Wall Street’s heyday, when these firms were private partnerships and each partner’s entire net worth was on the line every day, shared risk ensured a modicum of prudence even though leverage was often higher than 30-to-1. Not surprisingly, that prudence gave way to pure greed when, starting in 1970 and continuing through 2006, one Wall Street partnership after another became a public corporation--and the partnership culture gave way to a bonus culture, in which employees felt free to take huge risks with other people’s money in order to generate revenue and big bonuses.  People are pretty simple: they do what they are rewarded for doing." More here. 

From Nader A, on 5/26/12: "Leverage is not new--applying it to complex derivatives is over the last 15 years is. The LTCM group used to arbitrage penny differences on equity and fixed income markets, but with leverage, they could profit in the millions, until everything turned (mostly because short term liquidity changed). Someone once said of LTCM, "You guys are picking up nickels in front of steamrollers," meaning they were scooping up small differences but with large amounts of leverage.The real changes in Wall Street are "Off the balance sheet obligations." Balance sheets, income statements and cash flows do a poor job showing what a company potentially owes, which could change drastically over time.  For example, Enron used Special Purposes Vehicles to stash debt from their balance sheets, but did not show their financial obligations when the SPVs soured. Lehman used repos to transfer debts before quarter ends. CDSes sold by banks started to increase in balance sheet obligations as debts widened. The problem in Wall Street today is that the current financial reporting does not reflect future obligations when "things change"; instead, it reflects current, optimistic, and biased asset values, which is okay until you have a "black swan" event.  The other thing about [complex] derivatives is that it obfuscates the problem. The recent JP Morgan trade that went bad was a derivative based on a derivative based on a derivative. Once you apply leverage to complex, multi-level derivatives, then the problems become systemic. So with respect to the sovereign debt problems in Europe, it's not as much the problem of Greece defaulting, as it is the banks holding the debt falling into insolvency and triggering a cascade of derivative swaps." 

Update on 6/3/12: from Sebastian Mallaby's 2010 book, More Money than God: "Capitalism works only when institutions are forced to absorb the consequences of the risks that they take on.  When banks can pocket the upside while spreading the cost of their failures, failure is almost certain." (pp 13, hardcover, Penguin Press)

Re: the difficulties regulating leverage: "In the wake of LTCM's failure, Greenspan and his fellow regulators could see that the real challenge was the leverage in the financial system writ large.  Ironically, this was what Soros had tried to explain to Congress in his testimony four years earlier. Sure enough, the culprits in the crisis of 2007– 2009 were leveraged off-balance-sheet vehicles owned by banks (known as conduits or structured investment vehicles, SIVs), leveraged broker-dealers, and a leveraged insurer. Hedge funds were not the villains.

If hedge funds were only part of the challenge, why didn't regulators clamp down on the wider universe of leveraged investors? Again, the answer echoes 1994: The regulators believed they lacked a good way of doing so. They could not simply announce a cap on leverage: The ratio of borrowing to capital was an almost meaningless number, since it failed to capture whether a portfolio was hedged and whether it was exposed to risks via derivatives positions. Regulators could not simply cap hedge funds’ value at risk, either: LTCM’s collapse had shown that this measure could be misleading. The frustrating truth was that the risks in a portfolio depended on constantly changing conditions: whether other players were mimicking its trades, how liquid markets were, whether banks and brokerages were suffering from compromised immune systems. The Fed’s Peter Fisher, who was at the center of the regulatory brainstorming following LTCM, could see the theoretical case for government controls on hedge funds and other leveraged players. But it seemed so unlikely that the government would get the details right that he never pushed for action." (pp. 245-246)

Update on 6/24/13: Michael Lewis warned about collateralized mortgage obligations back in November 1989: "The CMO stands for collateralized mortgage obligations, but bond salesmen call it 'toxic waste.'"  (originally published in November 1989 in Manhattan, Inc.; re-published in Michael Lewis' The Money Culture, paperback, W.W. Norton and Company, pp. 105 (1991))

Update on 11/0/14:"Although they are established to protect both the security of ownership and that of transactions, it is obvious that Western systems emphasize the latter.  Security is principally focused on producing trust in transactions so that people can more easily make their assets lead a parallel life as capital." -- Hernando de Soto, The Mystery of Capital (2000), paperback, pp. 62. 

Update on July 2017: "As a man who did business with other people's money, the banker had to be intensely respectable... 'The function of bankers is to be trusted, not to be liked.' 'Adventure is the life of commerce,' wrote Walter Bagehot, first editor of The Economist, 'but caution, I had almost said timidity, is the life of banking.'" -- from The Bankers: the Next Generation (1997), by Martin Mayer, hardcover, pp. 5.

"[A]s Charles Rice of Florida's Barnett Banks puts it, 'The Harvard Business School never graduated an MBA that can't be hornswoggled by the businessmen of the Florida panhandle.'" -- Id. at pp. 10. 

I.O.U.S.A.

Nothing particularly exciting going on these days in the world of economics. The market is going sideways, with not much to kickstart it. Here's an article on the release of an interesting film, I.O.U.S.A.

http://news.yahoo.com/s/ap/20080822/ap_en_mo/buffett_box_office

Some excerpts:

Peterson said the meager U.S. rate of savings today means that roughly 70 percent of the nation's debts are being bought by foreign investors, and that could create geopolitical and economic problems for the country.

[70%?! Seventy percent of our debt is owned by other countries? &^!$#!]

The U.S. government owed roughly $53 trillion more than it had at the end of the 2007 fiscal year

[53 trillion?! &^!$# &^!$#!]

Sometimes I dream we live in a perfect world, and the new President's Cabinet will include Pete Peterson, David Walker, and Richard Fisher. [crossing fingers]

Warren Buffett and Bill Gates Talk Economics

Warren Buffett and Bill Gates had an interesting conversation on economics--here's one excerpt:

[I]t just occurred to me that if you don’t trust the government to do a lot of things very well—and business will never trust them to do that; rich people will never trust them to do that—and if, on the other hand, the honor system doesn’t work particularly well in terms of how many people behave (and this idea just occurred to me ten seconds ago so it will take a lot of refining): what if you had three percent or something like that of the corporate income tax totally devoted to a fund that would be administered by some representatives of corporate America to be used in intelligent ways for the long-term benefit of society, This group—who think they can run things way better than government—could tackle education, health, etc. or other activities in which government has a large role. And it would have this forced funding of three percent of corporate profits or some sum like that.

As readers know, I am a huge fan of Warren Buffett. Enjoy the link:

http://creativecapitalism.typepad.com/creative_capitalism/2008/06/bill-gates-and.html

(Conversation took place on May 15, 2008)

CNBC "Stalks" Warren Buffett

In case you missed it, CNBC posted a page dedicated to Warren Buffett:

http://www.cnbc.com/id/19206666/

If the above link doesn't work or becomes outdated, google "CNBC Warren Buffett Watch."

Here are two transcripts relating to the 2008 Berkshire Meeting:

http://www.cnbc.com/id/24466954/

http://www.cnbc.com/id/24427682/

Warren Buffett's Letter to BRK Shareholders and Government Liabilities

Each year, Warren Buffett publishes a letter to Berkshire shareholders that is both informative and humorous. This year, Buffett discussed an issue that gets far too little press: pension plan liabilities and actual costs of future benefits, which are notoriously difficult to calculate:

"Whatever pension-cost surprises are in store for shareholders down the road, these jolts will be surpassed many times over by those experienced by taxpayers. Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement – sometimes to those in their low 40s – and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep."

I am happy to say I sounded the horn on this issue before Mr. Buffett, at least in print. On or around December 2007, The Metro published a letter from me discussing the government's pension plan liabilities. In the letter, I sound quite Ron-Paul-ish, probably more than I actually am, but I have revised the letter and included it below:

America was founded to ensure that private citizens had freedom. To that end, the Constitution provided for a limited federal government, recognizing that large, non-transparent governments and freedom are incompatible. Indeed, any government salary (or new law, for that matter) saps resources from private citizens that could be spent on innovation and other, more productive activities, while also increasing a government official’s power to exert influence and control over private lives. High government salaries are particularly problematic, because they are a form of fraud on the public, i.e. the taking of more funds than necessary from dispersed private citizens to support unionized government members. Here, our local government wanted to hide how much its members were making, which prevents the discovery of corruption and fraud in the form of higher-than-normal salaries. Yet, almost any county position could be filled with qualified individuals even if the county reduced its salaries significantly, recognizing that a pension and the possibility of lifetime medical benefits are more than enough to attract qualified workers. In fact, almost no one in the private sector receives pensions or lifetime medical benefits, and all the private companies that used to offer such benefits, such as General Motors and Ford, are changing their policies. There is a lesson there for private citizens, who may eventually be forced to pay higher taxes to support the unusually generous benefits the government keeps giving itself.

As an attorney, I have litigated against several government agencies and have been shocked at how power individual citizens have granted to unqualified government members. In one case, the DFEH brought an action in a separate tribunal set up exclusively for employment claims, in front of an unelected judge who used to work for the DFEH. The DFEH’s client was awarded no money in the case, but my client had to pay thousands of dollars in attorneys’ fees for a case that almost no one in the private sector would have touched. Yet, we are all paying for a tribunal (the FEHC) with the power to award 150,000 dollars against any small business or individual.

This government excess is not limited to legal tribunals. San Jose’s independent police auditor is having to fight to get a small measure of authority to review taser deaths caused by San Jose police. To get an idea of what happens when government workers are strongly unionized and do not have to fear discipline, read the case of Grassilli v. Barr (2006).

California's own government is so large, I was shocked the first time I saw a list of just the state agencies. Take a look at this link–it does not include city or county governments and yet shows a massive, sprawling government:

http://www.ca.gov/About/Government/agencyindex.html

Someone must pay for all of these employees and their pensions, sabbaticals, and health care. Teachers’ unions usually ask for more money, but the California State Teachers Retirement System is already worth around $125 billion.* It has around 750,000 members and is the third largest public retirement fund in the country. Yet, after health care, education reform remains crucial, and the CTA continues to ask for more money.

As a result of government salaries and benefits spiraling out of control, California’s bond ratings have gone from AAA to single A and are approaching status that is slightly above junk (see http://www.treasurer.ca.gov/ratings/current.asp). The high salaries and unusual benefits of local government workers are just one small part of major fiscal problems that will not get better on their own. The lack of transparency in local government salaries has been remedied somewhat, but many other issues remain. I pray that this country’s citizens will read its history and think harder about current Constitutional issues; otherwise, we will be seeing a great power slowly but inexorably degenerate into a bloated, inefficient police state.

*My figure placed the value of the CTA pension plan at $125 billion. It is actually $131.2 billion, according to the Wall Street Journal's February 28, 2008 article, "Dear Crunch," C1. But what is problematic is that the CTA pension plan is underfunded by 19.6 billion dollars, all of which eventually has to be paid by California taxpayers. This means that the current debt calls for paying retired California teachers 19.6 billion dollars, and the pension plan doesn't have that money now and is hoping to get it in the future (stock market gains, more dues, higher taxes, etc.). To get an overall picture of the financial liabilities we face, the WSJ states that we--that includes you, if you pay taxes in the U.S.--owe our government $440 billion dollars, all of which will be put into the pockets of government workers. In a sign that the purse is already appearing shallow, the WSJ said that the city of Vallejo, CA is considering filing for bankruptcy. Its local government granted itself so much in benefits and salaries that the police and fire department's "salaries and benefits account for 80% of budget costs." Again, if you look at my letter to The Metro, the unstated premise is that without oversight, government will enrich itself at the expense of private citizens, especially in the areas of police power. The City of Vallejo, with almost all the taxpayer revenue going to police/fire union members, proves my point. Yet, even recent front page news stories about how the San Francisco mayor's office increased the salaries of close associates, or how various government departments are paying so much in overtime that correctional guards regularly exceed 100,000 dollars per year in compensation, is not causing any alarm bells to go off (This in a country that now has 1% of its adult population behind bars and will probably need more correctional officers in the future). When front-page news does not shock the public into demanding reform, we need to re-examine how we grant benefits and salaries to government members, perhaps even having referendums or some opt-in voting measure to establish reasonable salaries and benefits. Otherwise, every government employee will be functioning in a pyramid scheme where actual future costs of benefits, especially health care, remain undisclosed and incalculable. Such a situation is not good for taxpayers or our government members. Government, like private industry, benefits when new and highly performing members are attracted to jobs and bring with them fresh ideas. At this rate, government agencies will not be able to hire new employees, and private citizens will not benefit from a fiscally-healthy, secure government.

One of the links in my letter led to bond ratings for all the states. As of today, it shows that California's bond rating is the second worst in the nation, leading to higher borrowing costs and difficulty with improving our infrastructure. Who has the worst bond rating? Louisiana, which was battered by Hurricane Katrina and is still feeling its effects economically. It should be shocking that the sixth or seventh largest economy in the world has the second worst bond rating in the U.S., above only a hurricane-ravaged state, but so far, there are no protests in the streets, no condemnation of government expenditures by citizens, and no cries of unjust takings from our grandchildren. Our founders would be stunned at our utter complacency, but perhaps also proud of the prosperity we have achieved in such a short time. With that in mind, it would be a shame if future generations were unable to see America's promise of prosperity because government members and unions were enriching themselves at our expense or refusing to accept pay cuts, even as tax revenue decreases.

Original letter here: http://www.metroactive.com/metro/12.26.07/letters-0752.html

Update on January 13, 2009: here's a great website on public pensions:

http://www.pensiontsunami.com/

Warren Buffett and Berkshire Hathaway's Meeting

My last two posts were about shareholder meetings and heroes. They provide the perfect segue into my hero, Warren Buffet, and my experience at the Berkshire Hathaway meeting in Omaha, Nebraska in 2007. I chose to attend the meeting for several reasons, primarily because I was not sure whether my future schedule would allow me to take several days off, and to a lesser extent, whether Mr. Buffett would still be around in the next few years. Also, I have never been to the Midwest, except for Chicago, so I was looking forward to this trip.

First, if you plan to go to the meeting, plan early. All the hotels were booked almost seven months in advance, and I was lucky to get a great deal on priceline.com for the Comfort Inn at the Zoo. The location is far from some of the events, such as Gorat's and Borsheim's, but I did not rent a car and relied on the kindness of strangers, including a chance meeting with a Reuters reporter, to get me to various places. (He was very friendly, an ex-lawyer, and seemed to lament the fact that Bloomberg had sent several more reporters with more resources.) As almost everyone there was friendly, I had no problem getting around, but I do suggest renting a car if you go. Omaha, NE is spread out because they have such a low population density and lots of open space. As a result of this land affluence, the city planners could afford to build with disregard to future growth, creating sprawl. Taxis are extremely expensive because of limited competition and also the numerous highways they have to enter to get from one place to another. So even though Point A and Point B are literally one mile away from each other, sometimes you have to take two highways to get there. For a city slicker like myself, used to being able to walk anywhere or take public transportation in Singapore, Boston, San Jose, and D.C., it was a shock to see so much land and so much sprawl.

Other than renting a car, my second tip is to bring a raincoat. Spontaneous thunderstorms are not uncommon in Omaha, and its location smack in the middle of the country creates interesting weather. One day, lightning was so bad, closing the blinds at night made no difference in terms of ambiance. (Apparently, you can tell how close a storm is by counting seconds between thunder and lightning, and had I known that at the time, it would have added to the "Friday the 13th" weather atmosphere.) I (mistakenly) brought plenty of warm clothing, but Omaha is humid in May. So bring a light raincoat and some jeans, and you will be all set.

The first day I arrived at Omaha's main airport, I was happy to be there. Numerous people were there from all over the world, and I chatted up people from South Africa to San Francisco. One tip is to take the Hilton Omaha shuttle from the airport because you will be much closer to the city center and your hotel. The Hilton Omaha employees were so nice, they allowed me to take the shuttle from their hotel to my hotel at the Comfort Inn. (The Midwestern kindness is no lie.) If you have a decent-sized budget, the newer Hilton Omaha is the best hotel. It is right next to the Convention Center where the meeting is held, and its shuttles will also take you to various Berkshire events, such as sale day at the Furniture Mart (which is massive and sells much more than just furniture, including cameras, laptops, etc.). Another Hilton is a few blocks away and has a great restaurant that serves wonderful steak. This brings me to the best tip about Omaha. Have steak, more steak, and when you're done, top it off with a porterhouse steak. Gorat's Steakhouse is the most famous restaurant in Omaha due to Mr. Buffett's frequent visits, but the Hilton restaurants serve some mighty fine steak also. The only other place I had better steak was Michael Jordan's Steakhouse at NY's Grand Central station, but that's another story. (Just imagine two college students looking at the menu and trying to decide how to eat and not take out a small loan--and the bathroom had an attendant, which I had never seen before. It was all worth it, by the way.) So again, order the steak.

When I landed in Omaha, NE, I realized that I did not have my pass. Each shareholder is entitled to four passes/tickets. For most shareholder meetings, simply bringing the proxy is sufficient. Not so for this event. Here, you have to send back a small document asking for a pass when you get the proxy in the mail. If you do not do this, you can go the Convention Center the Friday before the meeting and get a pass. (I found this out after almost suffering a heart attack on Thursday, the night before I was to board the plane and saw an unusually colored paper sticking out of the annual report.) Everything worked out, and the staff was very friendly. The key point is that if you are a shareholder, you can bring three guests (at least in 2007).

I am still giddy about the visit, and there is much more to tell, but I will save the stories for another day. I shook Warren Buffett's hand, which was my last goal on my list of things to do before I turned 30. Yup, I am still giddy.