What Warren Thinks...

[LaoPo]

Take your time reading......................... if you're interested of course:

April 14, 2008: 10:23 AM EDT

What Warren thinks...

With Wall Street in chaos, Fortune naturally went to Omaha looking for wisdom. Warren Buffett talks about the economy, the credit crisis, Bear Stearns, and more.

By Nicholas Varchaver,

Buffett says he 'got a call' about Bear Stearns, but bailing out the investment bank with only two days for due diligence, he says, 'took some guts that I didn't want to match.'

(Fortune Magazine) -- If Berkshire Hathaway's annual meeting, scheduled for May 3 this year, is known as the Woodstock of Capitalism, then perhaps this is the equivalent of Bob Dylan playing a private show in his own house: Some 15 times a year Berkshire CEO Warren Buffett invites a group of business students for an intensive day of learning. The students tour one or two of the company's businesses and then proceed to Berkshire (BRKA, Fortune 500) headquarters in downtown Omaha, where Buffett opens the floor to two hours of questions and answers. Later everyone repairs to one of his favorite restaurants, where he treats them to lunch and root beer floats. Finally, each student gets the chance to pose for a photo with Buffett.

In early April the megabillionaire hosted 150 students from the University of Pennsylvania's Wharton School (which Buffett attended) and offered Fortune the rare opportunity to sit in as he expounded on everything from the Bear Stearns (BSC, Fortune 500) bailout to the prognosis for the economy to whether he'd rather be CEO of GE (GE, Fortune 500) - or a paperboy. What follows are edited excerpts from his question-and-answer session with the students, his lunchtime chat with the Whartonites over chicken parmigiana at Piccolo Pete's, and an interview with Fortune in his office.

Buffett began by welcoming the students with an array of Coca-Cola products. ("Berkshire owns a little over 8% of Coke, so we get the profit on one out of 12 cans. I don't care whether you drink it, but just open the cans, if you will.") He then plunged into weightier matters:

Before we start in on questions, I would like to tell you about one thing going on recently. It may have some meaning to you if you're still being taught efficient-market theory, which was standard procedure 25 years ago. But we've had a recent illustration of why the theory is misguided. In the past seven or eight or nine weeks, Berkshire has built up a position in auction-rate securities [bonds whose interest rates are periodically reset at auction; for more, see box on page 74] of about $4 billion. And what we have seen there is really quite phenomenal. Every day we get bid lists. The fascinating thing is that on these bid lists, frequently the same credit will appear more than once.

Here's one from yesterday. We bid on this particular issue - this happens to be Citizens Insurance, which is a creature of the state of Florida. It was set up to take care of hurricane insurance, and it's backed by premium taxes, and if they have a big hurricane and the fund becomes inadequate, they raise the premium taxes. There's nothing wrong with the credit. So we bid on three different Citizens securities that day. We got one bid at an 11.33% interest rate. One that we didn't buy went for 9.87%, and one went for 6.0%. It's the same bond, the same time, the same dealer. And a big issue. This is not some little anomaly, as they like to say in academic circles every time they find something that disagrees with their theory.

So wild things happen in the markets. And the markets have not gotten more rational over the years. They've become more followed. But when people panic, when fear takes over, or when greed takes over, people react just as irrationally as they have in the past.

Do you think the U.S. financial markets are losing their competitive edge? And what's the right balance between confidence-inspiring standards and ...

... between regulation and the Wild West? Well, I don't think we're losing our edge. I mean, there are costs to Sarbanes-Oxley, some of which are wasted. But they're not huge relative to the $20 trillion in total market value. I think we've got fabulous capital markets in this country, and they get screwed up often enough to make them even more fabulous. I mean, you don't want a capital market that functions perfectly if you're in my business. People continue to do foolish things no matter what the regulation is, and they always will. There are significant limits to what regulation can accomplish. As a dramatic illustration, take two of the biggest accounting disasters in the past ten years: Freddie Mac and Fannie Mae. We're talking billions and billions of dollars of misstatements at both places.

Now, these are two incredibly important institutions. I mean, they accounted for over 40% of the mortgage flow a few years back. Right now I think they're up to 70%. They're quasi-governmental in nature. So the government set up an organization called OFHEO. I'm not sure what all the letters stand for. [Note to Warren: They stand for Office of Federal Housing Enterprise Oversight.] But if you go to OFHEO's website, you'll find that its purpose was to just watch over these two companies. OFHEO had 200 employees. Their job was simply to look at two companies and say, "Are these guys behaving like they're supposed to?" And of course what happened were two of the greatest accounting misstatements in history while these 200 people had their jobs. It's incredible. I mean, two for two!

It's very, very, very hard to regulate people. If I were appointed a new regulator - if you gave me 100 of the smartest people you can imagine to work for me, and every day I got the positions from the biggest institutions, all their derivative positions, all their stock positions and currency positions, I wouldn't be able to tell you how they were doing. It's very, very hard to regulate when you get into very complex instruments where you've got hundreds of counterparties. The counterparty behavior and risk was a big part of why the Treasury and the Fed felt that they had to move in over a weekend at Bear Stearns. And I think they were right to do it, incidentally. Nobody knew what would be unleashed when you had thousands of counterparties with, I read someplace, contracts with a $14 trillion notional value. Those people would have tried to unwind all those contracts if there had been a bankruptcy. What that would have done to the markets, what that would have done to other counterparties in turn - it gets very, very complicated. So regulating is an important part of the system. The efficacy of it is really tough.

At Piccolo Pete's, where he has dined with everyone from Microsoft's Bill Gates to the New York Yankees' Alex Rodriguez, Buffett sat at a table with 12 Whartonites and bantered over many topics.

How do you feel about the election?

Way before they both filed, I told Hillary that I would support her if she ran, and I told Barack I would support him if he ran. So I am now a political bigamist. But I feel either would be great. And actually, I feel that if a Republican wins, John McCain would be the one I would prefer. I think we've got three unusually good candidates this time.

They're all moderate in their approach.

Well, the one we don't know for sure about is Barack. On the other hand, he has the chance to be the most transformational too.

I know you had a paper route. Was that your first job?

Well, I worked for my grandfather, which was really tough, in the [family] grocery store. But if you gave me the choice of being CEO of General Electric or IBM or General Motors, you name it, or delivering papers, I would deliver papers. I would. I enjoyed doing that. I can think about what I want to think. I don't have to do anything I don't want to do. It might be wonderful to be head of GE, and Jeff Immelt is a friend of mine. And he's a great guy. But think of all the things he has to do whether he wants to do them or not.

How do you get your ideas?

I just read. I read all day. I mean, we put $500 million in PetroChina. All I did was read the annual report. [Editor's note: Berkshire purchased the shares five years ago and sold them in 2007 for $4 billion.]

What advice would you give to someone who is not a professional investor? Where should they put their money?

Well, if they're not going to be an active investor - and very few should try to do that - then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They're not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don't buy all at one time.

When Buffett said he was ready to pose for photographs, all 150 students stampeded out of the room within seconds and formed a massive line. For the next half hour, each one took his or her turn with Buffett, often in hammy poses (wrestling for his wallet was a favorite). Then, as he started to leave, a 77-year-old's version of A Hard Day's Night ensued, with a pack of 30 students trailing him to his gold Cadillac. Once free, he drove this Fortune writer back to his office and continued fielding questions.

How does the current turmoil stack up against past crises?

Well, that's hard to say. Every one has so many variables in it. But there's no question that this time there's extreme leveraging and in some cases the extreme prices of residential housing or buyouts. You've got $20 trillion of residential real estate and you've got $11 trillion of mortgages, and a lot of that does not have a problem, but a lot of it does. In 2006 you had $330 billion of cash taken out in mortgage refinancings in the United States. That's a hel_l of a lot - I mean, we talk about having $150 billion of stimulus now, but that was $330 billion of stimulus. And that's just from prime mortgages. That's not from subprime mortgages. So leveraging up was one hel_l of a stimulus for the economy.

If that was one hel_l of a stimulus, do you think the $150 billion government stimulus plan will make an impact?

Well, it's $150 billion more than we'd have otherwise. But it's not like we haven't had stimulus. And then the simultaneous, more or less, LBO boom, which was called private equity this time. The abuses keep coming back - and the terms got terrible and all that. You've got a banking system that's hung up with lots of that. You've got a mortgage industry that's deleveraging, and it's going to be painful.

The scenario you're describing suggests we're a long way from turning a corner.

I think so. I mean, it seems everybody says it'll be short and shallow, but it looks like it's just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don't invest a dime based on macro forecasts, so I don't think people should sell stocks because of that. I also don't think they should buy stocks because of that.

Your OFHEO example implies you're not too optimistic about regulation.

Finance has gotten so complex, with so much interdependency. I argued with Alan Greenspan some about this at [Washington Post chairman] Don Graham's dinner. He would say that you've spread risk throughout the world by all these instruments, and now you didn't have it all concentrated in your banks. But what you've done is you've interconnected the solvency of institutions to a degree that probably nobody anticipated. And it's very hard to evaluate. If Bear Stearns had not had a derivatives book, my guess is the Fed wouldn't have had to do what it did.

Do you find it striking that banks keep looking into their investments and not knowing what they have?

I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. Now if you're going to understand that CDO, you've got 50-times-300 pages to read, it's 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you're now up to 750,000 pages to read to understand one security. I mean, it can't be done. When you start buying tranches of other instruments, nobody knows what the hel_l they're doing. It's ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. hel_l, they're all subject to the same thing. I mean, it may be a little different whether they're in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior - it isn't super-senior or anything. It's a bunch of juniors all put together. And the juniors all correlate.

If big financial institutions don't seem to know what's in their portfolios, how will investors ever know when it's safe?

They can't, they can't. They've got to, in effect, try to read the DNA of the people running the companies. But I say that in any large financial organization, the CEO has to be the chief risk officer. I'm the chief risk officer at Berkshire. I think I know my limits in terms of how much I can sort of process. And the worst thing you can have is models and spreadsheets. I mean, at Salomon, they had all these models, and you know, they fell apart.

What should we say to investors now?

The answer is you don't want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that (a) if you knew what was going to happen in the economy, you still wouldn't necessarily know what was going to happen in the stock market. And ( they can't pick stocks that are better than average. Stocks are a good thing to own over time. There's only two things you can do wrong: You can buy the wrong ones, and you can buy or sell them at the wrong time. And the truth is you never need to sell them, basically. But they could buy a cross section of American industry, and if a cross section of American industry doesn't work, certainly trying to pick the little beauties here and there isn't going to work either. Then they just have to worry about getting greedy. You know, I always say you should get greedy when others are fearful and fearful when others are greedy. But that's too much to expect. Of course, you shouldn't get greedy when others get greedy and fearful when others get fearful. At a minimum, try to stay away from that.

By your rule, now seems like a good time to be greedy. People are pretty fearful.

You're right. They are going in that direction. That's why stocks are cheaper. Stocks are a better buy today than they were a year ago. Or three years ago.

But you're still bullish about the U.S. for the long term?

The American economy is going to do fine. But it won't do fine every year and every week and every month. I mean, if you don't believe that, forget about buying stocks anyway. But it stands to reason. I mean, we get more productive every year, you know. It's a positive-sum game, long term. And the only way an investor can get killed is by high fees or by trying to outsmart the market.

Source: Fortune/CNNMoney

LaoPo

[BEENTHEREDONETHAT]

Good one LaoPo very interesting reading.

Thanks for that!

[bartender100]

Warrens too old now, if you are still listening to him, forget it. Much younger guru's t to follow these days.

[LivinLOS]

Warrens too old now, if you are still listening to him, forget it. Much younger guru's t to follow these days.

Yeah with exactly the historical perspective and wisdom that statement implies..

[LaoPo]

Warrens too old now, if you are still listening to him, forget it. Much younger guru's t to follow these days.

Names please; if you say that....names please ?

LaoPo

[AFKAFSinLOS]

What should we say to investors now?

... Stocks are a good thing to own over time. There's only two things you can do wrong: You can buy the wrong ones, and you can buy or sell them at the wrong time. And the truth is you never need to sell them, basically. ...You know, I always say you should get greedy when others are fearful and fearful when others are greedy. ...

By your rule, now seems like a good time to be greedy. People are pretty fearful.

You're right. They are going in that direction. That's why stocks are cheaper. Stocks are a better buy today than they were a year ago. Or three years ago.

..

LaoPo

Something a little different so thanks Lao Po. Probably an interesting speech to listen to if you're a young student, listening to a famous guru. Reading it tho' didn't seem to highlight much new, and I guess it loses some gloss reading it instead of listening.

The old adage of owning stocks over time is something people need to bear in mind at the moment. Particularly those who may have panic sold recently, by being fearful when everyone else is fearful.

For me the best part comments that we're heading in a direction to be greedy. I believe that as well, but always nice to have someone more knowledgeable than yourself underline your current thinking

[LaoPo]

...People continue to do foolish things no matter what the regulation is, and they always will. There are significant limits to what regulation can accomplish. As a dramatic illustration, take two of the biggest accounting disasters in the past ten years: Freddie Mac and Fannie Mae. We're talking billions and billions of dollars of misstatements at both places.

Now, these are two incredibly important institutions. I mean, they accounted for over 40% of the mortgage flow a few years back. Right now I think they're up to 70%. They're quasi-governmental in nature. So the government set up an organization called OFHEO. I'm not sure what all the letters stand for. [Note to Warren: They stand for Office of Federal Housing Enterprise Oversight.] But if you go to OFHEO's website, you'll find that its purpose was to just watch over these two companies. OFHEO had 200 employees. Their job was simply to look at two companies and say, "Are these guys behaving like they're supposed to?" And of course what happened were two of the greatest accounting misstatements in history while these 200 people had their jobs. It's incredible. I mean, two for two!

Buffett knew more when he said this, I suppose.....

Regulators settle with ex-Fannie execs in scandal.............................. :D ''settle" ???

Fri Apr 18, 2008 3:23pm EDT

NEW YORK (Reuters) - Federal regulators announced a settlement on Friday with three former executives of Fannie Mae regarding their alleged roles in a 2004 multibillion-dollar accounting scandal.

The Office of Federal Housing Enterprise Oversight, or OFHEO, said the former executives of the largest U.S. home funding company agreed to fines and penalties.

OFHEO's 2006 charges against former Chairman and Chief executive Officer Franklin Raines, former Chief Financial Officer J. Timothy Howard and former Controller Leanne Spencer included earnings mismanagement, failure to ensure adequate internal controls and the release of misleading financial reports.

"OFHEO's mission is to ensure that the Enterprises operate in a safe and sound manner," said OFHEO Director James Lockhart said in a press release. "That cannot occur without corporate management providing prudent and responsible leadership and setting the appropriate ethical and overall 'tone at the top'."

The three former executives agreed to various payments, which OFHEO estimated to total $24.7 million for Raines, $6.4 million for Howard and $275,000 for Spencer.

Sources familiar with the cases downplayed the total costs to the former executives, saying required payments to the U.S. government would be covered by insurance and surrendered stock options are currently without value.

OFHEO said Raines will pay $2 million to the government under the agreement, donate proceeds from the sale of Fannie Mae stock valued at $1.8 million and surrender claims related to stock options valued at $15.6 million when issued.

Those options were issued with strike prices between $77 and $81, but the company's stock now trades under $29, effectively making the options worthless, a source familiar with the case said.

http://www.reuters.com/article/ousiv/idUSN1835681920080418

Note: absolutely unclear to me why they didn't put those chaps in jail....

LaoPo

[LaoPo]

Buffett, Seeking Deals, Meets With Business Owners in Frankfurt

By Josh P. Hamilton

May 19 (Bloomberg) -- Billionaire Warren Buffett meets today with business owners in Frankfurt as he looks outside the U.S. for acquisitions to spur profit growth at his $200 billion Berkshire Hathaway Inc.

The world's wealthiest person, starting a four-city European tour in Germany's financial capital, is seeking to form relationships that may lead to purchases by his Omaha, Nebraska- based investment and holding company.

``If you have a great business, it's best to not sell it,'' Buffett told reporters at the Berkshire annual meeting in Omaha earlier this month. ``But when the time comes, whether for taxes or siblings, we want to be the first ones they think of.''

Berkshire has $35 billion in cash and Buffett, 77, has been looking for places to put it. He's invested in China, Israel and the U.K., complaining that there's a dearth of U.S. investment opportunities for a company as large as Berkshire.

Buffett's trip includes meetings in Lausanne tomorrow and Madrid on May 21, finishing in Milan on May 22. The visit was arranged by Eitan Wertheimer, president of Israel's Iscar Metalworking Cos. -- acquired by Berkshire in 2006 in Buffett's first non-U.S. purchase -- and Angelo Moratti of the family-run Italian energy company Saras SpA.

Buffett owns about a third of Berkshire, which he built over four decades from a failing maker of men's suit linings into a company with businesses that range from candy-making to insurance and a $72.6 billion stock portfolio.

Not a Meddler

He's known for buying well-run, privately held companies with high barriers to would-be rivals, cutting deals on a handshake and not meddling in management. In exchange, he typically pays less than companies could receive in an auction.

Germany is fertile ground for Buffett's investment style because about three-quarters of companies there are family-run. Many were founded as the nation rebuilt after World War II and are now grappling with succession issues as their founders age.

``Many families go through certain stages of strategic decision-making and they need to know their options,'' said Iscar's Wertheimer, 56, whose company was founded in 1951 by his father. ``From Warren you get much more than money. You're part of something that's unique.''

Expectations for a weak U.S. currency add to the allure of earnings in other denominations. Since at least 2002, Buffett has made investments with the assumption the dollar will decline, first with direct bets against the currency, and then with the Iscar purchase. The euro fetched less than a dollar when Buffett first enlisted Moratti in 2001 to advise him on potential European purchases. It closed Friday at $1.5577.

$2 Billion IOU's

``The U.S. is going to continue to follow policies that make the dollar weaker,'' Buffett said at the annual meeting. Americans' preference for foreign goods causes the country to send about $2 billion in ``IOUs'' and assets abroad every day, pressuring the dollar, he said.

After paying $4 billion for 80 percent of Iscar, which makes cutting tools for manufacturers in plants around the world, Buffett said he hoped the deal would raise Berkshire's international profile and help him find new candidates in ``the bigger economies.''

An investor who says he buys companies ``for life,'' Buffett looks at businesses he understands and in which he can project performance during the next one or two decades. To familiarize himself with Europe's business culture and issues, Buffett has met Moratti, the Italian energy executive, in Omaha at least four times a year since 2001, Moratti said in an interview last month.

Buffett has a devoted following, particularly in the U.S. About 31,000 shareholders and groupies from every continent except Antarctica filled Omaha's Qwest arena to overflowing earlier this month to hear Buffett answer questions for hours on topics ranging from the economy to his businesses and philosophy of life and marriage.

During the meeting, Buffett said a subsidiary was ``probably close'' to a ``mid-size'' U.K. acquisition.

---Bloomberg

LaoPo

[LaoPo]

Buffett vs. Bernanke: The inflation showdown

The billionaire investor says inflation is 'exploding,' but the Fed believes commodity price shocks should subside.

By Colin Barr, senior writer June 26, 2008: 8:08 AM EDT

NEW YORK (Fortune) -- Even Warren Buffett is wrong some of the time. Federal Reserve chairman Ben Bernanke is hoping this is one of them.

Buffett, the billionaire investor behind Berkshire Hathaway (BRKA, Fortune 500), fingered "exploding" inflation Wednesday as the biggest risk to the economy. "I think inflation is really picking up," Buffett said on CNBC. "It's huge right now, whether it's steel or oil," he continued. "We see it everywhere."

Indeed, the prices of gasoline and milk have shot past $4 a gallon, and Dow Chemical (DOW, Fortune 500) has announced twice in the past month that it's raising prices to offset soaring commodity costs.

Yet Bernanke's Fed signaled Wednesday that, after nine months of interest rate cuts and expansive lending to the financial sector, it isn't eager to reverse course and push rates higher to try to tamp down rising prices.

Why? Because the Fed remains skeptical that high commodity prices will ripple through the economy, leading to broad price hikes and big wage increases.

"The committee expects inflation to moderate later this year and next year," the Federal Open Market Committee said in holding the fed funds rate steady at 2%, though it did note that "uncertainty" remains high and suggested inflation concerns could rise.

Depends on what you mean by 'inflation'

In part, the Fed's decision turns on a distinction economists make between inflation and "relative-price changes." The former is a general loss of purchasing power that's caused, or at least exacerbated by, overly lax monetary policy (such as keeping interest rates too low for too long). The latter are price hikes driven primarily by fundamental shifts in supply and demand.

If demand for commodities is spiking because of strong worldwide growth, the thinking goes, prices should rise accordingly, until consumers react by reducing consumption - a process that isn't apt to be influenced by interest rate changes.

The Fed is betting that rising prices won't feed through to higher general inflation expectations unless workers start demanding raises and companies start raising prices.

But wages haven't been rising sharply, and declining unionization means workers have less bargaining power than they did during the inflationary 1970s, economists say. And while some processors of commodities, like Dow, are charging more, their customers in turn have generally been unable to pass along those costs to consumers.

So even as some members of the Fed's policymaking body, such as Dallas Fed President Richard Fisher, warn of the need to take quick action against inflation - Fisher dissented for the third straight meeting in Wednesday's vote, this time advocating a rate increase - committee members' inflation forecast for 2010 has risen only slightly since October, despite surging oil prices.

"Oil prices have ratcheted up over the past nine years and the dollar has depreciated for more than six years. Nevertheless, as long as a central bank is not creating an excessive amount of money, these relative price pressures ought to be transitory," Sandra Pianalto, president of the Federal Reserve Bank of Cleveland and a voting member this year of the Federal Open Market Committee, explained in a speech last month.

"As consumers spend more money for higher-priced petroleum and agricultural goods," she continued, "they eventually have less money to spend on other goods and services. Other relative prices must then fall."

Wait and see

To be sure, there are other factors at work in the Fed's move to the sidelines. Bernanke & Co. wants to measure the stimulative effect of the rate cuts it's already made. The rate cuts of the past nine months - the Fed has slashed its overnight bank lending rate by 3.25 percentage points since September - will take time to impact the economy. If possible, the Fed wants to wait before making another move on rates.

And while fears of a marketwide meltdown seem to have eased, a weak housing market, rising unemployment and increasing loan losses at banks mean the risk of a sharp economic pullback remains substantial.

"In an environment of dislocated funding markets, a rate cut would not produce a recovery but a rate hike could trigger a recession," writes Tullett Prebon economist Lena Komileva.

Indeed, while inflation is the buzzword right now, the surge in fuel costs is hurting growth in some key industries. Airlines such as United Airlines, a unit of UAL (UAUA, Fortune 500), and Continental (CAL, Fortune 500) have set plans to eliminate thousands of jobs in response to soaring fuel costs.

Automakers Ford (F, Fortune 500) and General Motors (GM, Fortune 500) have slashed their production schedules as well, as consumers stopped buying the fuel-guzzling sport utility vehicles that were once a huge source of profits for Detroit. The loss of high-paying pilot and autoworker jobs will only add to existing weak wage and job trends.

None of this makes the recent price shocks easier to bear, of course. But for policymakers, if not for media darlings such as Buffett, the distinction is an important one. "While sometimes devastating," Pianalto said in her speech last month in Paris, "these global relative-price pressures are not the same thing as inflation."

---Fortune-CNNMoney

LaoPo