bluntlysaid

Quotable quotes from Mr. Buffet’s 2009 letter to the shareholders (my comments are in paranthesis)—-

By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

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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.”

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The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear. (I AGREE!!!!!)

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Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat. (To every single Republican and Dem-Hater who was agains the stimulus package and thought “doing nothing is an option” TAKE THAT!!!!! You are wrong. As unsavory as government intervention is we must admit that it was necessary. Period.)

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Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead. (I love it)

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As predicted in last year’s report, the exceptional underwriting profits that our insurance businesses realized in 2007 were not repeated in 2008 (Note: Buffet became very concerned about his insurance business in 2005 when Katrina hit. His insurance firm had to pay out  a lot of claims. They were prepared to do so and were fine, but he noted that the firm would be in trouble if it global warming had the effect of making a Katrina like disaster more common). Nevertheless, the insurance group delivered an underwriting gain for the sixth consecutive year. This means that our $58.5 billion of insurance “float” – money that doesn’t belong to us but that we hold and invest for our own benefit – cost us less than zero. In fact, we were paid $2.8 billion to hold our float during 2008. Charlie and I find this enjoyable. (hehehe)

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That’s the good news. But there’s another less pleasant reality: During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt. I will tell you more about these later. Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action. (The sign of a good manager is one who recognizes mistakes once they happen. The sign of a great manager is one who recognizes flawed behavior….bias and escalation seem to be his two bigest flaws, but recognizing their presence in his thinking is the first step of obliterating there impact in the future.)

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At that time, much of the industry employed sales practices that were atrocious. Writing about the period somewhat later, I described it as involving “borrowers who shouldn’t have borrowed being financed by lenders who shouldn’t have lent.” To begin with, the need for meaningful down payments was frequently ignored. Sometimes fakery was involved. (“That certainly looks like a $2,000 cat to me” says the salesman who will receive a $3,000 commission if the loan goes through.) Moreover, impossible-to-meet monthly payments were being agreed to by borrowers who signed up because they had nothing to lose. The resulting mortgages were usually packaged (“securitized”) and sold by Wall Street firms to unsuspecting investors. This chain of folly had to end badly, and it did. (Sounds like my Credit Crisis for Dummies post!)

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Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser. (HERE HERE!)  The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified. Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition. (OKAY, I haven’t really revealed what I used to do before business school but lets just say that a huge portion of my job was trying to convince decision makers that played a significant role in the housing market that our goal shouldn’t just be “generate new home loans” but “to mitigate risk, and keep more people in their homes.” I COMPLETELY agree with Buffet here.  Now everyone can or should own a home. Everyone has the right to shelter, but that doesn’t always mean white-picket-fence shelter. A rental apartment or manufactured home must suffice in some cases. What the government and country must do is provide affordable housing options that allows people to have a roof over their head that they can actually pay for on a monthly basis.)

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Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is nowfar 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. (This concerns me because it means that strong companies that should survive may not if they do not have enough cash stockpiled to pull them through the credit crunch.  If my scenario plays out then our economy will be left with weak, zombie like companies that crutch on the government. This is not good. This is like Japan in the 90s and everyone knows what happened to Japan—-an entire lost decade of growth.)

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Derivatives are dangerous. They have dramatically increased the leverage and risks in our financial system. They have made it almost impossible for investors to understand and analyze our largest commercial banks and investment banks. They allowed Fannie Mae and Freddie Mac to engage in massive misstatements of earnings for years. So indecipherable were Freddie and Fannie that their federal regulator, OFHEO, whose more than 100 employees had no job except the oversight of these two institutions, totally missed their cooking of the books. (LOL! It’s true. I was just in a finance group meeting and we were doing a case on derivatives. The boys in the group were going ga-ga over the terminology. It’s as if engineering a derivative is the equivalence of owning a giant phalice….he who makes the biggest, most obscure, most complicated derivatives trade is the biggest.  They are dangerous.)

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Now, for those MBAs looking for a summer internship or fulltime offer—-take a look at these companies for inspirtation, they are all owned by Mr. Warren Buffet himself:

American Express Company . . . . . . . . . . . . . . . . . . . . 13.1% ownership

The Coca-Cola Company . . . . . . . . . . . . . . . . . . . . . . . 8.6%

ConocoPhillips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.7%

Johnson & Johnson . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1%

Kraft Foods Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.9%

POSCO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2%

The Procter & Gamble Company . . . . . . . . . . . . . . . . . 3.1%

Sanofi-Aventis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.7%

Swiss Re . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2%

Tesco plc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.9%

U.S. Bancorp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3%

Wal-Mart Stores, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . 0.5%

The Washington Post Company . . . . . . . . . . . . . . . . . . 18.4%

Wells Fargo & Company . . . . . . . . . . . . . . . . . . . . . . . 7.2%

The Oracle

 Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas. (LOLOL!!!)

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The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

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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. (OH NO!)