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Geoff Gannon February 11, 2009

Suggested Link: Charlie Munger Op-Ed

Warren Buffett’s business partner, Charlie Munger, writes an op-ed in the today’s Washington Post.

Read “How We Can Restore Confidence” 
by Charlie Munger.…

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Geoff Gannon February 10, 2009

On the President’s Address

President Obama spoke about the economy last night. I am not a political commentator, so I may not be able to correctly score the politics of the fight.

The President began by painting gloomy word pictures of a Depression – without actually using the “D” word:

“…They can’t pay their bills and they’ve stopped spending money. And because they’ve stopped spending money, more businesses have been forced to lay off more workers. Local TV stations have started running public service announcements that tell people where to find food banks, even as the food banks don’t have enough to meet the demand… As we speak, similar scenes are playing out in cities and towns across the country. Last Monday, more than 1,000 men and women stood in line for 35 firefighter jobs in Miami.”


Although the President said – correctly I think – that most economists agree a stimulus is necessary, agreeing a stimulus is necessary and agreeing it is sufficient are two different things. Economists don’t agree a stimulus is sufficient. Nor did most of them think very highly of a New Deal redux like this one until more proven measures – like monetary stimulus – were already depleted.

What economists do agree on is that the economy is very bad and that the number of tools that have been tried before and not yet tried this time around is very low. In technical terms, they are advocating a kitchen sink approach.

Seventy years of social science have given government a whole new toolbox with which to approach the same problems (of 1929) and despite the change in process the outcome has remained the same.

Eventually, this will make for an interesting case study. The idea that the Great Depression was a unique and unrepeatable event will be challenged. The idea that lessons learned in retrospect can be applied in the future has been seriously compromised. It is not clear that in an ever-changing system like an economy, theory could keep pace with reality. Prescriptive economics may not work. But prescriptions have to be made nonetheless.


The President made some errors last night. He gave in to partisan temptations and reminded Republicans of their previously profligate ways.

An excellent point – if he was aiming for honesty – but honesty is rarely the best policy. Utility is.

He needs to pass bills – not win elections – and maybe his little reminders helped Democratic chances at the ballot box, but he hurt the country’s chances of getting the bills it needs passed. It was an understandable but idiotic mistake. It wasn’t just partisan politics, it was poor tactics.

The President is a lot weaker than he appears. Constitutionally, his legislative powers are – well – non-existent. A President is not a Prime Minister.

The man himself is popular. His policies are not. His party’s majorities are large, but not large enough to pass bills in the Senate – even without any Democratic defections. And there will be defections. …

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Geoff Gannon February 10, 2009

On the Geithner Plan

Yesterday, the stock market tanked as Treasury Secretary Geithner outlined his financial stability plan. Blogger Felix Salmon noticed the mirror image:

“I like the symmetry here. On November 21, when Barack Obama announced that he was nominating Tim Geithner to be his Treasury secretary, the Dow rose 494 points and broke through the 8,000 barrier. On February 10, when Geithner gave his first major speech as Treasury secretary, the Dow fell 273 points and broke through the 8,000 barrier.”

once wrote that “the market is a lot like a fun house mirror”. New data affects prices indirectly. And sometimes the reflection comes out warped. Ben Graham said it best:

“…the influence of…analytical factors over the market price is both partial and indirect – partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions.”

I’m not sure if the market decline had more to do with the substance of Geithner’s speech or the sentiments of traders. I certainly didn’t think it justified marking American businesses down a couple percentage points.

Personally, I didn’t find the plan especially bad. I thought it would have a lot more detail. I’m glad it didn’t. How could anyone come up with a detailed plan at this point?

Some banks – some very big banks – are going to have to be recapitalized. The only way to start that process is to look at the economic reality under the accounting fictions that are bank balance sheets.

It doesn’t matter if you use mark-to-market or mark-to-model, you’re still going to end up with some very inaccurate balance sheet numbers in times like these.

Markets – be they liquid or illiquid – value assets oddly from time to time. And models are as flawed as their makers.

At least Geithner is talking about a stress test. That sounds like the first step toward recapitalizations.

Unfortunately, he’s also talking about private money coming in to buy toxic assets. Unless there are ironclad government guarantees involved I’m not sure that will fly.

Some of these assets weren’t just overpriced the way houses were – they were inherently flawed.

Toxic Assets

Accountants record. They don’t analyze.

There isn’t a right number and a wrong number. There are just useful numbers and useless numbers.

For example, it makes not one iota of difference to me – as an investor – what dollar value public Company A assigns its 23% stake in public Company B, because public Company B files with the SEC. All I need to know is the number Company A put on its books and where I can read all about Company B. The rest is up to me.

Unfortunately, you can’t do this with “toxic assets”.

In her book Dear Mr. Buffett, Janet Tavakoli quotes an email from Warren Buffett:

“I’ve looked at the prospectuses, and they are not easy to read. If you want to

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Geoff Gannon February 1, 2009

On Buffett and Derivatives

Review by Geoff Gannon

Janet Tavakoli’s Dear Mr. Buffett is an unusual amalgam of a simple, personal story and a complex, public one.

The personal story begins with an invitation from the Oracle himself:

“Be sure to stop by if you are ever in Omaha and want to talk credit derivatives…”

Buffett had just re-read Tavakoli’s Credit Derivatives & Synthetic Structures and noticed a letter from the author tucked between the book’s pages. With a quick apology and the above invitation, Buffett unknowingly set in motion a process that would give the public a rare glimpse inside his inner sanctum.

Tavakoli took Buffett up on his offer and recorded the ensuing encounter in Chapter 2 of Dear Mr. Buffett.

The promise of this tantalizing morsel will draw buyers in. But readers will find much more than another book on Warren Buffett.

The real story begins in 1998. That’s when Buffett’s Berkshire Hathaway bought General Re. Berkshire was a major insurer with a home-grown reinsurance business. General Re was considered the crème de la crème of reinsurers.

I say “considered”, because unbeknownst to Buffett there was a lot of crap among the crème. That crap came in the form of derivatives.


Derivatives are exactly what they sound like. The value of a plain vanilla security like a stock or bond is derived from the underlying business – its assets, earnings, and capacity to meet obligations. These are simple, straight bets.

Derivatives are meta-bets. Like an ironic narrator, they stand a level above the action. Instead of betting on a business, they bet on the betting on that business. Instead of betting on a borrower’s future income and collateral they bet on the bet a banker made on that borrower’s future income and collateral.

If the investment banks that created these derivatives used the same ad agency as BASF, their slogan would be: “We don’t make a lot of the securities you buy; we make a lot of the securities you buy riskier”.

Theory of Everything

Tavakoli has her own Theory of Everything in Finance:

“The value of any financial transaction is based on the timing of cash flows, the frequency of cash flows, the magnitude of cash flows, and the probability of receipt of those cash flows.”

It’s a simple theory. Derivatives are complex. But no amount of complexity can free a security from this iron clad rule.

“In finance, we make up a lot of fancy and difficult to pronounce names and create complicated models to erect a barrier to entry that keeps out lay people. High barriers tend to protect high pay. I’ve written about some of these esoteric products: credit derivatives, CDOs, and more, but before I look at the latest hot label dreamt up, I look at the cash to find out what is really going on.”

So does Warren Buffett.

Buffett Bets

As Tavakoli points out, financial journalists seized on Buffett’s description of derivatives as “financial weapons of mass destruction” while completely ignoring another …

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