Friday, 17 October 2008

Should we trust Warren Buffett?

So, it would seem that the one person both Barack Obama and John McCain would like to be Treasury Secretary is Warren Buffett, the Sage of Omaha. Warren Buffett is the CEO of Berkshire Hathaway, the outrageously successful insurance company that has appreciated in value at an outrageous rate of 21.4% a year since 1965. To put the power of that compounding appreciation in perspective, the stock was $4 in 1965, and is now worth $120,000, having fallen 20% during the financial crisis from its high of $150,000. If my father had bought me ten shares when I was born, it would be worth a million dollars today! This is an astounding record of achievement by any measure, and has earned Buffett the admiration of conservatives and liberals alike, though conservatives were devastated when Buffett endorsed Obama.

Would Buffett make a good Treasury Secretary?  Undoubtedly yes.  His insight into the markets, and his grounding in the real world make him an ideal choice.  Buffett famously decided to give away the bulk of his wealth to the Bill and Melinda Gates Foundation, rather than leave his children idly rich.  He is all too aware of the Third Generation syndrome, which leads to trainwrecks like George Bush, Paris Hilton, and the like.  

Buffett has made his fortune buying value-priced companies, and holding on to them.  He never bought into the tech bubble of the 90's, preferring stalwart investments that yield dividends and moderate growth. I can't imagine another person on Earth that understands the world economy like him.

Would he want the job? His biographer, Alice Schroeder, says no.  He doesn't like meetings, and would hate the job.  I am not so sure.  At age 78, what better way to cap off an incredible career than saving the world?  The financial system teeters on the edge of oblivion, and Buffett stands up to shape the new economy in his own image.  It is a play for immortality if I have ever heard one.  Buffett himself refused to comment on it, but I believe he would take the job if it was offered, assuming he was guaranteed a free hand in making sweeping changes.

However, should we really trust him? In the midst of this speculation following the 2nd Presidential Debate, when both candidates named him first on their short lists, Buffett has written an Op-Ed for the New York Times, in which he advises everybody to invest in stocks now:

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. 

His explanation is persuasive.  It is the timeless contrarian argument:
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
So, Buffett shares that his personal wealth is now 100% in US equities, and he warns people who are hunkering down in cash (like me), that we will miss the boat before the signals are clear for a recovery.  He gives historical examples from the Great Depression and WWII to show that people brave enough to invest after the crash make out like bandits:
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
So, given this airtight logic, why would I doubt him?  Because he has a conflict of interest.  First of all, his beloved BRK-A stock has dropped $30,000 since December. Berkshire Hathaway is basically a giant holding company, and the tide brings down all ships.  For the sake of his investors, and his own holdings, he wants it to get back on track.  However, this is in everybody's interests, so that's OK, right?  So far so good.

It becomes a bit more tricky given his $5 Billion investment in Goldman Sachs. One of the two surviving investment banks, Goldman Sachs wields incredible power around the world, but especially in the US.  Clinton's Treasury Secretary, Robert Rubin, was Goldman Sachs President, as was Henry Paulson.  Josh Bolton, Bush's Chief of Staff, is a Goldman veteran.  The 35 year old now running the $700 Billion bailout was one of Paulson's proteges at Goldman Sachs.  The bank profited mightily from this bailout, as well as the Mexican bailout in 1994. 

Worse than this opportunism are the allegations that Goldman Sachs is partially responsible for the current meltdown, and prolonged the Great Depression by encouraging the failed policies of Herbert Hoover. Naked short selling and speculation by Goldman hedge funds in the derivatives market could have started the dominos falling in the current crisis.  Goldman Sachs stands to make billions more when the economy recovers, and they stand alone with JP Morgan as the pre-eminent investment banks.

Now, taking off my tinfoil hat for a moment, I must say that I don't really buy into this assessment of Buffett's motives.  The man has more money than he could ever spend, and he has never shown much interest in spending it anyway. He clearly has no plans to leave it to his kids either, so nepotism is out as well.  We could hypothesize that he wants to increase his estate to benefit his philanthropic enterprises, but that is a stretch.   Perhaps he really believes what he is saying...

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