ShareIn a prior post I excerpted portions of a CNBC interview with Warren Buffett in which he provided strong support for Treasury Secretary Hank Paulson’s plan to buy distressed securities from Wall Street firms.
On October 1, 2008, Warren Buffett was interviewed by Charlie Rose. The central points Mr. Buffett made were:
The economy, not just Wall Street, is at severe risk: “The patient that’s on the floor with the cardiac arrest is not Wall Street. It’s the American economy.”
There is a profound lack of confidence that has caused the credit markets to seize up: “You don’t want 300 million Americans putting their money under the mattress. This economy doesn’t work well without the lubrication of credit and trust. And that’s been lost. It’s a huge problem. What you have is you have the major institutions of the world all wanting to deleverage. They want to take down their assets and liabilities. What seemed so easy to borrow against a year ago now looks like rat poison to them. … it’s the deleveraging that’s going on right now that has caused the credit crisis.”
Deleveraging is necessary because everyone got fooled by the real estate bubble: “… the biggest single cause was we had an incredible residential real estate bubble. … 300 million Americans, their lending institutions, their government, their media, all believed that house prices were going to go up consistently. And that got billed into a $20 trillion residential home market. Lending was done based on it, and everybody did a lot of foolish things. And people really behaved in a fraudulent way or something, we’ll go back and find the culprits later on. But that really isn’t the problem we have. I mean that’s where it came from, though. We leveraged up and if you have a 20 percent fall in value of a $20 trillion asset, that’s $4 trillion. And when $4 trillion lands — losses land in the wrong part of this economy, it can gum up the whole place.”
People should have known better but in some way’s it’s unavoidable with markets: “People should always know better. … I mean people — people don’t get — they don’t get smarter about things that get as basic as greed and you can’t stand to see your neighbor getting rich. You know you’re smarter than he is, and he’s doing these things, you know, and he’s getting rich, and your spouse is getting unhappy with you because you aren’t doing — pretty soon you start doing it. And so you get what I call the natural progression, the three I’s: the innovators, the imitators, and the idiots. And that’s what happens. Everybody just kind of goes along. And you look kind of silly if you disagree.”
When all the private institutions need to delever, at the same time, the government is the only institution that can act: “There is only one institution in the world that can leverage up in a way that’s all a countervailing force to that, and that’s the United States Treasury.”
Time is of the essence: “I mean, if Pearl Harbor came along, you could have said the planning was wrong by the military ahead of time or maybe the battleships shouldn’t have all been in the harbor and all that kind of thing. … I mean, the job is Pearl Harbor. And you better not spends weeks and weeks and weeks trying to assign blame or deciding on a complete plan for fighting the whole war, you know, and letting a committee decide where the battleships should go and all of that. You better spring into action with the best people you have. … it’s very important that the determination of the US Congress to do what is is needed be made evident this week and by the actions of most of the members.”
The Secretary of the Treasury and the head of the FDIC have been fantastic: “I don’t think you can have a better secretary of the Treasury than Hank Paulson … he knows markets, he knows corporations’ work, he knows money, and he’s got the interests of the country at heart. And so, you’ve got the right — you’ve got a wonderful person with Sheila Bair, most of the viewers have never heard of Sheila Bair. Sheila Bair, in the last two weeks, has taken eight percent of the deposits in the United States and seamlessly moved those over to sound institutions which in turn have gotten more capital, ended up, it’s been a magnificent job.”Maybe we should see the Treasury Secretaries of Obama and McCain debate: “I would say it’s more important who the treasury secretary is than who the vice president is. If you want to have a debate here, I’d like a debate between potential treasury secretaries than the vice presidential debate.”
These government officials should be given tremendous resources and flexibility in how they implement the fix, but there should be oversight to make sure purchasing distressed securities is done at market prices: “Well, they need plenty of money and they really need plenty of flexibility to carry out this plan. They also need in my view to very much tie it to market prices. … I would hand something pretty close to a blank check to a fellow like Hank Paulson … trying to invest through 535 people is a tough job … I think the oversight is great, and I think that oversight ought to be devoted almost entirely to the question is this being done at market you know. … I think you’ll have plenty of scrutiny as how the money’s invested.”
$700 billion worth of purchases may be enough, if used to purchase distressed securities at market prices: “700 billion is a lot of money. And it will buy a lot of distressed property. And if you buy them at the right price, you may be buying two trillion of face value. The one thing you don’t want to do — [unintelligible] paid for it what you’re paying it from or what his carrying value is, you got to buy it at market. And one way to do that is if some institution wants to sell you a billion dollars worth of mortgages, they might have to sell 100 million in the market, and then you’ll buy the other 900 million on the same terms.”The US government can borrow money very cheaply, and buy mortgages at fear driven low prices, which should allow it to make a profit from the rescue, if it buys at the market price: “The U.S. Treasury has got borrowing costs like nobody else has. They can borrow basically unlimited amounts. They can stay there for years and years. These assets will be worth more money over time. So when Merrill Lynch sells a bunch of mortgage-related assets at 22 cents on the dollar like they did a month or so ago, the buyer goes — is going to make money, and he’s going to make a lot more money if it happens to be an institution like the U.S. government which has very, very cheap borrowing costs. … When the Federal government buys the mortgages, they’re not spending it, they’re investing it. Now, they’re investing it in distress type assets but they’re buying them at distress prices if they buy them at market. It’s the kind of stuff I love to do. I just don’t have 700 million. Maybe we could go in it together. … But like I say, we are not spending money. I mean, if we buy these assets intelligently, the United States Treasury will make money. I mean, it’s borrowing money. It’s just a few percent a year. And these assets are better than that.”
The rescue plan should make distressed securities liquid (provide cash for securities) and eventually capital should be provided for some undercapitalized companies: “… there are two things needed in the system, the one that’s needed overwhelmingly is liquidity. I mean, when people are trying to sell, there has to be somebody there to buy. And they don’t have to buy at a fancy prices, but to buy. And then there’s also a capital problem with some of the institutions. We have provided capital here with a couple of institutions recently. The Federal government did that in the ‘30s for the RFC and I think there could well be a proper role for government in that. … But I don’t think trying to combine that with what’s going through now, I think what is needed now is liquidity.”
Unlike the Resolution Trust Company mechanism which resolved the Savings and Loan crisis by orderly liquidating their assets, in the present crisis there is an opportunity to buy distressed securities that may rise in value: “Yeah, well Resolution Trust Company was set up to liquidate a bunch of assets that the government had inherited because the savings and loans went broke. So the savings and loans went broke, the government stepped in, paid off depositors, and now they’re left with this mass of assets to sell. We’re not talking about selling here, we’re talking about buying intelligently. They were selling what they got handed to them by a bunch of savings and loan operators that had in many cases had done some very dumb thing. But their job was to liquidate it. And they liquidated. This is an entirely different proposition.”
The goal is to re-establish confidence: “Confidence in markets and in institutions, it’s a lot like oxygen. When you have it, you don’t even think about it. Indispensable. You can go years without thinking about it. When it’s gone for five minutes, it’s the only thing you think about.”
Derivatives have allowed for funny accounting and allowed otherwise sound companies to create tremendous risks for themselves: “AIG would be doing fine today. It was one of the ten largest companies in the United States in terms of market value, over 200 billion, the most respected insurer and everything in the world. If they never heard of the word derivatives, they’d be doing fine. They’d be going to work in the morning and they would have no troubles. But they — they — it was very easy to do, because it’s very tempting to write numbers on little pieces of paper and you can report the profit you want to, and there is no limit on it. I mean there is no capital requirements to it or anything of the sort. And basically, I said there were possibly financial weapons of mass destruction, and they had them. They destroyed AIG. They certainly contributed to the destruction of Bear Sterns and Lehman. Although Lehman had other problems, too.”
Leverage is very dangerous: “You just pay for everything, you do smart things, you eventually get very rich. If you do smart things and use leverage and do one wrong thing along the way, it could wipe you out, because anything times zero is zero.”Beware of geeks with clever computer models: “I mean they had all these types from Wall Street, you know, and they had advanced degrees, and they look very alert, and they came with these — they came with these things that said gamma and alpha and sigma and all that. And all I can say is beware of geeks, you know, bearing formulas.”
The American economy is still a marvel, and is going to recover: “I mean we had a seven for one improvement in the average American standard of living in the 20th century. Now, we had the great depression, we had two world wars, we had the flu epidemic. You know, we had oil shock. You know, we had all these terrible things happen. But something about the American system unleashed more of a potential to human beings over that hundred years so that we had a seven for one improvement in — there’s never been any — I mean, you have centuries where if you’ve got a 1 percent improvement, then it’s something. So we’ve got a great system. And we’ve got more productive capacity now than we ever have. The American worker is more productive than he’s ever been. We’ve got more people to do it. We’ve got all the ingredients for a sensational future. It’s just that right now the athlete’s on the floor. … This country is going to be living better ten years from now than it is now.”
Markets are fantastic, but prone to excesses: “… as long as you have markets, you’ll have excesses. … the human animal really doesn’t get a lot smarter. Now, you can you know you can have institutions that put curbs on that in various ways, and actually what the banks, you know, they have various capital ratios and that sort of thing, but the banks got around them, I mean, they set up SIVs [structured investment vehicles] and that sort of thing just to get more leverage.”
Accounting for securities should mark them to market: “… I believe in mark to market. I think that accounting in 1974 Charlie, it was either 1974 or ’75, we owned a bunch of common stocks at Berkshire Hathaway. I told our shareholders what the market was. And we used that. I said I think these things are worth a lot more than market. And I think we’re going to make a lot of money out of it. But this is what they’re worth today. And I don’t think anybody gets hurt by telling the truth on that sort of thing. … once you start putting phony figures into financial statements, you get in a lot of trouble.”
The rise of the non American world is fine: “I want our pie to grow all the people, but if some other guy’s pie is growing a little faster, that’s terrific. It will be good for us in the long run, and I mean there are, you know, six and a half billion people in this world. And it’s great for 300 million to keep enjoying more and more property, but I think it’s terrific if, you know, the remainder do. And I think if they can learn something from us in terms of our system, and I think they have, they are learning more about how to unleash the potential of their citizenry to turn out more goods and services that their citizens want or that we want, I think that’s terrific. And that’s — you know, I think it’s much better to live in the world where those around you, particularly when some of them have nuclear bombs, I think it’s much better to live in a world where their lives are getting better also.”The fact that Americans consume more than they produce will slowly transfer ownership to foreigners, but it’s a slow problem: “As long as we consume more than we produce, and we trade away little pieces of the country daily, they’re going to own something. Now, they can’t run from American assets. I mean every day the rest of the world is going to have about two billion more of American assets than we have, as long as they sell us these goods. … But we’ve actually been pretty good on exports. I mean we are exporting 12% of our GDP now roughly. That was five percent many years ago, a much smaller GDP. So the rest of the world really likes our stuff pretty well. It’s just we buy so damn much of what they produce. … But our country’s productivity grows enough so we actually can do that, and we’ll still be better off.”
Greater inflation and unemployment is likely: “… we’re likely to have more inflation in the future as a consequence of the things we do to fight the present situation. … You’re going to see more people unemployed.”
Taxes shouldn’t treat income from capital more favorably than income from labor: “I think it’s terrible for people in effect to say that income from investment should be taxed at a much lower rate than income from labor. … everybody likes to talk about how the top one percent pays this percent in income, but the income tax, we’ll say 1.3 trillion. The payroll taxes are over 900 billion. That 900 billion, that doesn’t come from me. I pay it on the first hundred thousand or something like that. But that comes from the people in my office.”
The entire interview is worth watching or reading.
Update, 10/9/08: In September of 2005 I was asked by a friend whether we were in a real estate bubble. It’s interesting to look back at my reply, “On buying land (aka, how to tell if we are in a real estate bubble)”, which I published on September 21, 2005. I’m pleased that I foresaw the risks that the structure of the real estate industry was creating and that I saw the increasing risks home buyers were making. On the other hand, I did not take sufficient time to look at the balance sheets of banks to see how decreasing real estate prices would hurt them. I thought at the time the investment banks would not be dumb enough to hold the risk themselves. Perhaps this is why Warren Buffett refers to the immense advantage that having had a longer experience in the market has given him over time. I’ve since tried to bolster my own knowledge by reading extensively on prior panics and manias. And always looking at the balance sheet.
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