Warren Buffett Interview With FCIC (May 26, 2010)
Financial Crisis Inquiry Commission
FCIC formed to write a report on Financial Crisis
- Buffett purchased Dunn & BradStreet in 1999 which later spun off Moody’s (Buffett has not made any purchases in Moody’s since then)
- Single most important factor in evaluating a business is pricing power
- Moody’s has/had a duopoly – other competitor could come in and cut prices in half and it wouldn’t change Moody’s business.
- Cause of crises was 50% reality and 50% psychology - imbedded in belief that housing price couldn’t go down.
o People buy into a sound premise. People later forget the original sound premise and focus on prices.
o Bubble occurred b/c housing was easiest asset class to borrow against and peoples largest asset.
o This crises will be remembered along with South Sea Bubble.
o Thinks every aspect of society, including rating agencies, contributed to crisis.
- He was wrong in not selling Moody’s before Financial Crisis
- Ben Graham made an observation 50 years ago. People can get in more trouble in investing with a sound premise then a false premise.
o There was a premise that common stocks will always perform better then bonds.
o Book in 1924 by Edgar Lawrence Smith of study of common stocks vs bonds. His idea was that bonds would outperform in deflation and stocks outperform during inflation. He found that actually common stocks always outperformed. This was because there is a retained earnings factor, when dividend yield on stocks was the same as bonds and with retained earnings factor, stocks outperformed. This became idea for 1929 bubble.
o However, this was the case only when stocks and bonds had same yield that they would outperform going forward. What happened was people heard this and everyone got into stocks driving prices up and yields down, so bond yields actually became higher. Original premise was forgotten and price action took over.
- Housing was the same idea – premise was that houses will become worth more over time b/c dollar becomes worth less i.e. house bought 40 years ago worth more today. So it was a sound premise to buy a house that may cost more next year, and you can finance it. Soon price action takes over and premise gets twisted.
- When original premise is forgotten, price action takes over peoples minds. B/C housing was single largest asset class, $22 trillion, it was understandable to the public, thus created a bubble like we’ve never seen.
- 1999 Bubble: When your neighbor is buying internet stocks and getting rich your wife starts saying , why is he making all this money your smarter then he is, this leads to day trading, etc… and price action taking over in internet stocks.
- Buffett sold all his holdings in 2000 of Fannie Mae and Freddie Mac
o He was concerned with management at both firms. Management said they could increase EPS in low double-digit range. This meant to Buffett that there would be trouble b/c no one can proclaim this. This meant management may something in operations or accounting that could be unsound to meat this expectation.
o FMae/FMac made an investment in Philip Morris bonds. They are dealing with essentially gov guaranteed credit. The company is serving gov and investors. Using their power to make money not related to corporate mission. They were “arbitraging the government credit.” Buffet found one cockroach and new there were more. This concerned him about what else these companies could be doing that he didn’t know about.
- The reason stock markets do well is they have a 3-day settlement period. Derivatives have a very long settlement period – this is very hard to predict the behavior of someone else, for example 100 years from now. As derivatives became more and more pervasive and more dramatic they increased risk. Let people engage in massive mischief. This along with minimum money put up and maximum leverage.
- Investing vs speculation. Difference is the intent of a person engaging in transaction. Investment operation is where you look at the asset itself to lay out some money now and get more money back later. Look at what it will produce. Committing funds now to get more funds later through the operation of the asset. Speculation - focused on the price action of the stock. You are counting on for example, an increase in quarterly earnings or a div. increase etc, but you are not looking at the performance of the asset. The real questions is, do you care where the market will go? If you care if the stock market is open tomorrow then you care about the price action.
o Gambling propensity with people is huge. People fly thousands of miles to a desert to do things that are mathematically against them.
o Gambling is encouraged by the state with lotteries that have terrible odds. This is why bells and whistles go off in casinos so people can see winners around them and feel that they too can be winners.
- “I have a model in my mind when making investments”, Buffett
- “Anybody investing in something that is opaque should run away, whether that is common stocks or inventions.” - Buffett
- What caused the bubble to really blow up was incentives. Incentive structure was also messed up during Internet bubble. i.e. someone said 20,000 eye balls equals $100,000.
- Once leveraged was loosened it allow the Internet and housing bubble to expand, not as much in Internet bubble though.
- Once you start lending money to ppl where the hope to get money back is if you sell the asset instead of where the asset is used to service the loan, you have a problem. Once you think the asset will go up, you don’t have to look at anything else. This is was happened in Housing Bubble.
- “Owning a home is a way to be short the dollar.” “If a couple can afford it and not pay silly prices in terms of replacement value, I would say buy it. But I wouldn’t say buy 3 more or buy it with 50% leverage.” - Buffett
- “ The vast majority of [Berkshire] short term money is in T-bonds. Not any other better option. We don’t know what will happen tomorrow. In 1914 the government closed stock market for many months.” – Buffett
- “If troubles are brewing the government should error on the side of overkill.” Buffett referring to government injecting money into the system.
- Currently, Europe is in a different situation than the US. Only the government could save us in the USA. We were only trying to save ourselves, for example we weren’t trying to also save Mexico. Europe has a system where a group of ppl will have to help another group. A group will have to put up a lot of money to help another group who haven’t behaved the way they should have.
- The problem develops because ppl thought currencies were all equal with Euro in different countries. PPL realized that really Euroes in each country really aren’t the same. No one has to buy a Greek bond for example, ppl will buy US bonds tomorrow because we have a US bank that is in sync with the country. No one in Greece has the power to do this, like US does.
- It was asked if Warren has any books he recommends about the Crisis. Buffett recommends a book that doesn’t exist - he would write his own story starting with Ken Lewis answering the phone to save Merrill. The book would go from there forward.
- He likes Sorkin’s book on the Crises. (This is the “Too Big To Fail” Book)
