Ordinarily, the arrival of Warren Buffett’s annual report to Berkshire Hathaway shareholders is one of the most invigorating highlights of my year. Buffett is not just a great investor; he is a fine prose artist and one of the leading philosophers of capitalism. Insights explode like firecrackers in the pages of his annual letter to shareholders, and with the advent of the Internet, we can now all benefit from the wisdom once shared with a small circle of early adopters. These letters are now scrutinized as closely and passionately as the Septuagint.
In 2009, the sparkle is still there. Perhaps Buffett is merely stating the obvious when he explains that the mortgage business should never have gotten out of the habit of demanding down payments from buyers, in order to encourage them not to walk away from deals in the event of a sudden downturn in housing prices. But if it’s obvious, how did things ever go so wrong in the housing markets? And why do the New New Dealers continue to deny that government-facilitated overgenerous lending — with the aim of dragooning millions of marginal earners into some of America’s most expensive homes — was what lit the fuse?
Unsurprisingly, Buffett is also brilliant at providing the historical context so rarely heard from the young cuties on the financial talk shows. “In the 20th century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21.5% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years.” Capitalism, the Oracle of Omaha promises, will prevail. “Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived.” (Hmm, has the old man been reading Fogel? Greg Clark?) “Though the path has not been smooth, our economic system has worked extraordinarily well over time.”
This is champagne-flavoured optimism at its finest. But more than in most years, one is aware that Buffett’s letter is an exercise, not only in teaching and accounting, but in selling the Warren Buffett brand. After a 12-month period in which shares in his company lost 19% of their value, even the Oracle can start to sound a little like that old hypocrite Polonius.
Even before the Dow Jones began its shocking collapse, market-watchers had noticed that Buffett’s rhetoric about derivative contracts as “weapons of mass destruction” didn’t square well with his actual portfolio. Now the chickens have come home to roost: “Derivatives are dangerous,” Buffett says in 2008, shortly before going on to explain why Berkshire is a party to no fewer than 251 derivatives contracts. “I believe each contract we own was mispriced at inception, sometimes dramatically so,” he says by way of excusing himself. In a time of economic grouchiness, one notices that as an explanation, this is little better than putting one’s hands together to make a whoopee-cushion noise. One party in a contract always thinks the other has “mispriced” the good or service being exchanged. I had understood Buffett’s endless attacks on derivatives to be founded on the premise that pricing them correctly is impossible in principle.
One notices other slightly hucksterish tendencies that might have gone overlooked in the good times. Buffett makes a big deal of endorsing mark-to-market accounting, but uses “book value” in stating the worth of many of his investments, including some of those derivatives. His big leap into insuring tax-exempt municipal and state bonds is outlined in the manner of an old-time mesmerist hypnotizing a maiden lady. Buffett loves the insurance business, in all its forms, because it’s characterized by “float” — the temporary costless use of free money from premiums — but he admits that if those bond-issuing institutions ever start defaulting, a cascade is likely to follow, and the quantitative models are pure shinola in such circumstances.
As for his grovelling over having bought a huge chunk of ConocoPhillips near the top of the oil market (“the terrible timing of my purchase has cost Berkshire several billion dollars”), Buffett has won accolades for displaying a lack of CEO ego, but doesn’t explain, or even demonstrate any understanding of, why his consultative process for deciding on new investments failed in that case. Same with the two Irish banks he has had to write down to 11% of their purchase price: Again, he says merely that “they appeared cheap to me.”
Berkshire Hathaway Annual Letter to Shareholders 2008 - Read the latest Berkshire Letter
Daily Forex Updates - Daily Forex data, commentary & tools to help make trading Forex easy
Share Investor Blog - Stockmarket & Business commentary
Share Investor New Zealand Business News- Get more business news
Shareinvestorforum.com - Discuss this topic further
Recommended Amazon Reading
Pilgrimage to Warren Buffett's Omaha: A Hedge Fund Manager's Dispatches from Inside the Berkshire Hathaway Annual Meeting by Jeff Matthews
Buy new: $16.47 / Used from: $9.41
Usually ships in 24 hours
Kindle 2: Amazon's New Wireless Reading Device (Latest Generation)