Buffett

David Sokol, (now former) executive at Warren Buffett's Berkshire Hathaway, recently disclosed that

• he bought 2,300 shares of Lubrizol on December 13, the day he told Citi to arrange a meetting between Lubrizol and Berkshire for a potential acquisition.
• Supposedly the first overture was rejected by Buffett.
• By Jan 7, Sokol had bought 96,400 shares of Lubrizol.
• Soon after, Berkshire bought Lubrizol, and David S. made off with $3 million as per today's valuation.

Sokol, supposedly, "is a rich man already" and is therefore, just stupid. Which, after Rajat Gupta and Raj Rajarathnam and Ramalinga Raju, A Raja and so on, is hardly surprising. Clinically, I mean. When you're rich, your brain has this glaze of "I'm successful so I'm right" which impairs the functionality of the "What the fuck is wrong with you?" part of your cerebrum. Every once in a while the impairment is so severe that even after the drama these very people defend their actions as if there was nothing wrong in the first place. After Goldman Sachs, Citigroup, the entire US political system, Greece, Portugal, Ireland and everyone else, the idea is to vehemently deny any wrongdoing first. Regardless of how much of a turd it makes you look like.

Sokol has, in line with the above affliction, denied allegations of "front running" - or, buying shares before a large transaction takes place, where you can influence that transaction. Long time readers will remember that SEBI in India banned HDFC Mutual Fund AVP Nilesh Kapadia for such front-running, but Sokol seems to be getting away okay. On the defense that he didn't know Buffett would buy. Or, that he didn't have the ability to influence Buffett on the purchase.

Buffett has also endorsed Sokol's view that he didn't do anything illegal. But Buffett is known for talking his book, so that's no big deal either. Since Sokol had admitted to Buffett earlier that he owned the shares, and Buffett didn't protest, any rants against Sokol would be counterproductive.

Now I often own shares before I write about them in this blog. I mention that as a disclosure. I don't need to, you know. We don't have rules that require me to. I could be technically legally correct in not telling you I own shares, or even lying that I DON'T own the shares. I could be a sleazeball of that magnitude and be absolutely, completely, legally fine. But it stinks, no?

The point is - while legal, it was a sticky wicket to be on, in terms of perception.

Yes, I will get the standard ten people who stand up for Buffett and say boss do you know he donates all of his wealth, even though the place he donates to, Gates foundation, gives just 5% of the wealth it owns while investing the rest in companies that constantly kills the very people they're trying to save. Or that he's right because he's Buffett and I'm not. But then, one acquires a certain thick hide when writing anyway.

Berkshire shares have fallen since, but I doubt that'll stick. Barry Ritholtz has a different take - he suggests that Sokol was okay until BRK decided to buy Lubrizol - post that, he should have transferred them to BRK.

(Photo credit: mikebaudio at flickr)

You might think that when Warrent Buffet says "Rule One: Never Lose Money. Rule Two: Never Forget Rule One." it means that he makes money on every trade. He doesn't. At least, not when it came to BoA:

Warren Buffett’s Berkshire Hathaway Inc. sold its stake in Bank of America Corp., ending an investment that spanned three and a half years in which the lender’s stock lost more than two-thirds of its value.

Buffett’s firm had no shares in the Charlotte, North Carolina-based bank at the end of 2010, compared with 5 million shares three months earlier, Berkshire said late yesterday in a regulatory filing that lists the company’s U.S. stockholdings.

Berkshire, where Buffett serves as chief executive officer and head of investments, entered the Bank of America stake with the purchase of 8.7 million shares in the second quarter of 2007.

This is why you shouldn't follow what people say, follow what they do. Buffett probably never meant hold on till you make money on everything - he's lost money in US Airways and a number of other purchases earlier. I'm sure he didn't intend to lose money (who does?) but it doesn't mean he'll follow this rule forever. I wrote about this in Losses and Endowments:

Warren Buffet has two rules: 1) Do not lose money and 2) Don't forget rule #1. It would be entirely stupid to believe he doesn't lose money. Rules, after all, are meant to be broken, especially when your choice is to break it and lose money, or to stand by it and lose even more money.

Some might think I'm just taking Buffett's trip - but I'm not. He's done exactly like he should have - cut his losses and walked when it seemed it would just get worse.

There are people who mail in Buffett-isms as if they were written in stone. I'm just saying that it's perfectly okay to violate those rules; the thinking behind investments has to be to avoid losses on average. That is, you come out winning if you make more on your winners and lose less on your losers.

A better meta rule, perhaps, and I'm not the first one to say this - is 1) Have great sounding rules and 2) know when to break them.

Felix Salmon’s article on Buffett talks a fair lot on how important is what Buffett DOESN’T say as much as what he does. Buffett, in his annual letter said that his stock, Clayton Homes, which makes and finances mobile homes at 9% because “very few factory-built homes qualify for agency [Fannie/Freddie] insured mortgages”; Felix thinks that’s rather rich:

Wow, sounds like a great business! Rather than see its financing profits competed away in a commoditized mortgage market, Clayton essentially has a monopoly on providing financing on its homes, and can lend out money at rates much higher than prevailing mortgage rates.

But weirdly, Buffett seems to be unhappy about this:

Berkshire can’t borrow at a rate approaching that available to government agencies. This handicap will limit sales, hurting both Clayton and a multitude of worthy families who long for a low-cost home.

Really, Warren? I’d like to see some numbers on this, because I always thought that the great thing about being Berkshire Hathaway, even without a triple-A credit rating, was that you could borrow at a rate approaching that available to government agencies. What’s the spread on Berkshire debt over agency debt? When Berkshire recently borrowed $8 billion, it paid between 2bp and 43bp over Libor on the floating-rate bonds, and between 63bp and 93bp over Treasuries on the fixed-rate bonds. In comparison, agency debt recently narrowed all the way to 66bp over Treasuries, albeit at longer maturities.

In any case, I’d say that the funding advantage that agencies have over Berkshire will be no more than about 50bp, while the financing rates that Clayton’s buyers are paying to Berkshire are, by Buffett’s estimation, about 375bp more than those offered by Frannie. And remember here that Buffett is adamant that Clayton’s buyers are good credit risks, and that “Clayton’s delinquencies and defaults remain reasonable and will not cause us significant problems”.

See, when Buffett said it, it sounded like oh God, these agencies, they won’t buy the mortgages on our mobile homes, so darn, we have to finance our customers and charge them 9%. Poor consumers could have got 5.25% but we have to lend to them at 9%. What he left unsaid was: Boss, I get money at the same rate or 50 bps above what Fannie/Freddie get, and I lend it out at 3.75% higher, and I believe my customers have low risk profiles. Feel sorry enough for me?

Clayton made about 300 million dollars on it’s financing arm. I don’t know how much it made on the actual housing sales (net of cost of construction) but I’m sure losing the 300m to the dirty rotten agencies doesn’t appeal to him as much as he hurts by their policies of not financing his customers.

This is usually a great read:

Berkshire Hathaway Annual Report

Barry Ritholtz is really pissed off.

Due to an unexpected outbreak of rationality (and perhaps embarrassment), the Treasury department has rejected requests of Goldman Sachs and Berkshire Hathaway to purchase Tax Credits from Fannie Mae.

This paper transaction would have provided precisely zero value to the taxpayers, and allowed these firms to add to the piles of bailout monies already received by avoiding billions of dollars in taxes otherwise legally owed. It would have been a license to steal.

The sheer arrogance, the colossal gall involved boggles the mind.

And while we expect this sort of behavior from the Vampire Squid — they take pride at Goldman in not just being whores, but in being the highest paid callgirls in town — it is stunning to see such behavior from the usually politically astute Oracle Tentacles of Omaha. For Warren Buffett’s Berkshire Hathaway to team up with Goldman Sachs (which he now owns a healthy chunk of) is a bit of a revelation: We have been spun by his genteel manner, his aw shucks down-home-isms, his off Wall Street, less bloodthirsty approach to investing, into somehow believing he was different.

We have been duped.

We should not have been. Buffett has been the biggest shareholder in Moody’s — a collection of filthy whores and pederasts who were one of the main contributors to the economic collapse — should have raised serious questions as to his judgment in our minds. That he sat by silently as they did their worst, sodomizing the nations credit system for fun and profit was a powerful indictment of Buffett as someone far different than his public persona. In retrospect, as Moody’s was helping to destroy America’s financial system, his merely spouting off aphorisms about about Financial WMDs now looks too cute by half.

Those of you who used to respect Warren Buffett might consider moving him off your increasingly short list of participants in the marketplace who behave ethically. This crude attempt to steal billions — coming on the heels of the bullshit about “Investing in America” by buying Railroads — is a shock to me; perhaps that is a testament to my naivete.

Perhaps the Oracle of Omaha has been infected by a new flu variant, the H1N1 GS mutation. It is usually non fatal to the host, but destroys its reputation . . .

This is probably the toughest stance I've seen Barry taking; but it is disgusting that people are taking the system for a royal ride. Goldman is considered scum anyhow, so their doing this isn't all that surprising. But Buffet? He does well with straight talk, but the walk isn't quite that straight, it seems.

Barry also references a Rolfe Winkler post I'd spoken about and got some tough comments on. It's becoming more evident now that Buffett, for all his talk, isn't quite the saint he's made out to be.

Berkshire made a healthy profit this quarter, though that's a mark-to-market game; the real businesses seem to show slack and he's trying to keep it lean there.

If the anger against these people trying to game the system doesn't blow up, we'll see the Buffetts and Goldmans make even more money at the cost of a lonely taxpayer. But the anger's just starting to show - probably a year more of this craziness will be needed before someone gets really ticked off. It's starting to appear slowly - Elizabeth Warren, Chairman of the Congressional Oversight Panel, is appalled that "financial institutions could think that they could take taxpayer money and then turn around and act like it's business as usual. I don't understand how they can't see that the world has changed in a fundamental way, that it is not business as usual when you take taxpayer dollars.".

It's disconcerting that the lessons of this crisis are all screwed up, and that people are still taking advantage of the now explicit taxpayer backstop. We're learning to lie [let's not mark to market], to fabricate positive news out of the most negative [US Unemployment at 17%? Dress it up as better than something else] and to cow down to threats that banking failures will crush everyone. If there ever was a time that thieves can look back and remember fondly, this is it.

Rolfe Winkler on Buffett's Betrayal:

Today, Buffett remains famous for investing The Right Way. He even has a television cartoon in the works, which will groom the next generation of acolytes.

But it turns out much of the story is fiction. A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money. The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee.

Apart from that there are the hidden ways the Fed is providing liquidity to the banks, which they refused to reveal even after Bloomberg sued. The latest seems to be a way to make primary dealers (many banks are these) a conduit to pass treasury bond sales through. The Fed isn't allowed to buy bonds directly, and this article (Chris Martenson) says the treasury sells bonds to the PDs, and the Fed buys them back within a week. (Our RBI does buy back securities but they tend to buy different securities than the ones they recently sold)

But that's off the point. The "Betrayal", says Winkler, is that the bailout rescued Buffett; and now he complains, in his annual letter, that Berkshire is losing out to the cheap funding available to the banks now.

He may have a point. And the book he mentions - "Buffett" by Roger Lowenstein - is well worth the read. Lowenstein portrays Buffett in an unbiased way - which seems anathema to most Buffett fans, for whom he's either loved or loved some more. Buffett has his faults, he talks his book, he keeps silent when his money is involved (Moody's for one, one of the rating agencies that should be taken out and shot) and he does a lot different than he talks. I'm a fan of arguments, not of arguers - so while there's some sense in listening to some of what he says, Buffett is not quite the god he's made out to be. In my world, there are no heroes.

Warren Buffet's Annual Report is here. Always fun to read, and interesting titbits emerge.

This has been the worst absolute year for Berkshire Hathaway since 1965, a 9.6% decline in per-share Book Value. The stock, meanwhile, sits in at $74,000 - about half its high about a year back.

Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans). Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment – derived from savings and not from other borrowing – seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments.

Interesting. The word "primary residence" is important here - as speculators were more likely to have overleveraged on their second or even third homes. They usually form a small percentage, but in the age of easy money, everyone is a speculator except those who aren't counted because they're so damn stupid. (not anymore, but they did look stupid then. And they're not counted today either, because they're the smart minority. Who pay for the stupid.)

After homeowners fall behind and can't meet their monthly payments, what if the mortgage owner called and said "Listen, I'll cut you a little slack. Let me modify your mortgage so I take a little value off, and give you a lower interest rate, so you can make the monthly figure"?

Turns out the answer to that question isn't an emphatic yes. (In that link, FDIC had a program to help modify IndyMac loans that were delinquent for 60 days or more. 50K qualified, 15K were mailed mod offers, and after two months, only 3,500 said ok - a figure we don't know is much higher or much lower than the mod-rate without this "program". This line is important:

if you apply the program to borrowers who are, as a class, more likely to be able to afford their mortgages anyway, you do get more successful modifications. But something tells me that's not quite what we all had in mind.

That is perhaps what Buffett had in mind though, as he says:

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.

on Bond Insurance, that Berkshire writes:

A universe of tax-exempts fully covered by insurance would be certain to have a somewhat different loss experience from a group of uninsured, but otherwise similar bonds, the only question being how different.

To understand why, let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds – virtually all uninsured – were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York’s citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.

Now, imagine that all of the city’s bonds had instead been insured by Berkshire. Would similar belttightening, tax increases, labor concessions, etc. have been forthcoming? Of course not. At a minimum, Berkshire would have been asked to “share” in the required sacrifices. And, considering our deep pockets, the required contribution would most certainly have been substantial.

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.

When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop “solutions” less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?

Insuring tax-exempts, therefore, has the look today of a dangerous business – one with similarities, in fact, to the insuring of natural catastrophes. In both cases, a string of loss-free years can be followed by a devastating experience that more than wipes out all earlier profits. We will try, therefore, to proceed carefully in this business, eschewing many classes of bonds that other monolines regularly embrace.

There are well written comments on Derivatives, the idea behind Freddie Mac and Fannie Mae, how a huge regulator was created just for their oversight and how they managed to confuse the hell out of the regulators. Apart from that, Buffett defends the US Government-supported buyout of Bear Stearns by JP Morgan; and that derivatives are best done when you're too big to fail - as indeed, Berkshire seems to have become too.

It's written second level bond insurance - if the monolines fail, Berkshire will be reasonably crippled, it seems. It has a $37 billion dollar put write, for which they have recognised a $5 billion mark to market loss ($10 bn MTM less the 4.9 billion premium received). And that was when the index was at 900 - it's at 700 now, and europe looks in worse shape. Buffett reiterates that he has to post no collateral for the European put option, and that it's unlikely to go to zero. I give you Japan - 20 years, and 66% loss and staying there. Even 50% of the 37 billion is a good big figure. As for the collateral - what if regulation changes to force collateral for every contract, otherwise it's illegal?

(Just like saying a houseowner should be 10% down - a contract should be marked with collateral)

But overall, a fascinating annual report. I think Berkshire will lose a lot of money this year. And a truckload of stock value has already gone, and more likely to go. But they will survive, even without government support. That's more than I can say of nearly everyone else their size.

Buffett's saga continues. The shares of BRK-A were down, at the bottom a couple days back, to nearly 50% of their highs of $150K.

His derivatives bet (Buffett Crosses Over To The Other Side) has come back to haunt him. Berkshire Hathaway's profits fell 77% in the last quarter, on lower income. That was a given, since he's exposed largely to housing (interiors, pre-fab), consumer excess spending (netjets) and finance (Moodys, Amex).

But the biggest problem in the income,not yet truly recognised, is the $37 billion derivative bet. Buffett, as most of us know, wrote puts on the S&P and other indices, with an exposure of $37 billion, last November. He got $4 bn in premiums. These are about 40% down today, and the net loss, marked to market, is $14 bn I would imagine.

Buffett doesn't have to put any collateral (or mark-to-market margin) because he's rated AAA. Even if downgraded, Buffett won't have to put up too much collateral:

A credit rating downgrade would likely not be material. Berkshire would have to post "nominal" additional collateral on derivatives of "far below 1 percent of assets" if Berkshire lost its "triple-A" ratings, Buffett's assistant, Jackie Wilson, said. It was posting no such collateral as of Sept 30, when Berkshire assets totaled $281.7 billion.

A theory doing the rounds (round one and two) is that people who bought the puts are spooked that Berkshire is now a credit risk. One says that ah, even if the rating goes down, Mr. Buffett gets away with very little collateral. This therefore is driving up the cost of Berkshire CDS - insurance in case of a Berkshire default - to nearly 5%, of 500 basis points.

Another says that Buffett's $5bn Goldman investment was primarily a way to provide extra collateral through the broker of these puts; I doubt that, since that would be too sweet a deal. (equity and collateral? Uhem)

Buffett himself believes US unemployment will go higher than 8%. (My personal belief is that it could go to 15%, totally random, number picking from free air) In that case, all the negative news will drive the stock lower, CDS higher, and in general create collateral needs out of nowhere.

Is this kind of fear unjustified? Is Buffett truly untouchable - and therefore, people are being idiots? Market prices are irrational a lot of the time, and unreasonably low in bad times. Yet, in a market that is driven by trust, we are seeing a serious lack of trust. And that has taken businesses down - Bear and Lehman - for good reason, that they were overexposed, and the revelation brought them down. Buffett is exposed, much more than is usually comfortable, and the news is likely to take the stock value much lower.

It may not go to zero though - there is enough cash on their balance sheet to cover the damage, and even if the S&P halves from here, they have enough assets to pay back the whole exposure by selling them (and will leave money behind). But we are not a rational market, and we will underpay. I doubt this is the end - watch for another 50-60% drop, more bad news, more revelations. (The SEC has asked for info. People will be watching like hawks)