Sime----------5.45 Div 44 sen (x-24 Nov)
Tenaga-------5.95
Maybank----4.74
Commerz----5.65
IOI------------2.08
Wednesday, October 29, 2008
Saturday, October 18, 2008
Buy American. I Am.
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
Why?
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.
So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
Why?
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.
Thursday, October 16, 2008
Sunday, October 12, 2008
Despite rebound, stocks end worst week ever
By Charley Blaine and Elizabeth Strott
The stock market finished its worst week ever with a dramatic rebound from even worse lows.
The Dow Jones industrials moved more than 1,000 points during the session -- from a low of nearly 700 points to a gain of more than 300 -- before falling back again. It was the first 1,000-point swing for the blue-chip index.
The blue chips closed down 128 points, or 1.5%, to 8,451. Twice during the day, the index fell under 8,000 for the first time since April 2003. Twice it bounced back.
The Standard & Poor's 500 fell 11 points, or 1.2%, to 899. But the Nasdaq Composite Index gained 4 points, or 0.3%, to 1,650. A big engine in the Nasdaq's gain: a 9.1% gain to $96.80 in Apple (AAPL, news, msgs). The iPod maker had fallen as low as $85 at the open.
For the week, the Dow and S&P 500 were off 18.2%. It was the worst week for the Dow in its 112-year history and the worst week for the S&P 500 since the week of May 21, 1933. The Nasdaq's 15.3% loss was its worst since the week of April 10, 2000, as the dot-com bust broke.
The market turmoil was so great that crude oil tumbled in response, finishing Friday at $77.70, down 10.3% on the day and 17% on the week. The close was crude's lowest since September 2007. Energy stocks were slammed as well, with declines exacerbated by margin calls forcing many investors to sell shares.
"A psychiatrist is what is needed to help investors today," Tony Crescenzi, chief bond market strategist at Miller Tabak, told MarketWatch.com.
Did the rebound signal a bottom?
It's too early to say if Friday's rebound from its lows means stocks have seen a bottom. The Dow, S&P 500 and Nasdaq are all off more than 40% since peaks reached in October 2007 and have lost 27%, 30% and 30%, respectively, since Aug. 31.
But watch the Dow and S&P 500 on Monday. The Dow hit a low of 7,882.81 at 9:37 a.m. on Friday and nearly hit it a second time at 1:50 p.m. ET, bottoming in that round of selling at 7,978. The S&P 500 bottomed at 839.80 at 9:37 a.m. and tested that level again without falling below. The second bottom was 842.43.
If anything like a bottom was achieved, it came then. And it is possible that the market will rally sharply soon and then muddle along for a while waiting for a catalyst to send it higher. Two more market measures suggest the U.S. market is grossly oversold and could bounce higher:
The fear indicator. A widely watched measure of market fear, the CBOE Volatility Index ($VIX.X), hit a record 75.92 Friday before dropping back to 69.95. The higher the VIX, the more fear there is in the market. But often, when the VIX starts to drops, a sharp rally erupts.
The 200-day moving average. The S&P 500 closed Friday about 31% under its simple and exponential moving averages. Typically, the index level falling 12% to 15% under the 200-day moving average is a buy signal.
But a rally is no sure thing -- especially right now when raw fear rules the stock and credit markets.
A very negative catalyst -- such as weak market response to Friday's G7 announcement and the Treasury Department's plan announced Friday to buy stakes in banks -- could come as early as Monday.
And that's just the first headwind. The second wind gust will start big-time on Tuesday when the third-quarter earnings season kicks into high gear next week, and investors are bracing for lower profits and reduced profit estimates from companies. Among companies set to report: Intel (INTC, news, msgs), Johnson & Johnson (JNJ, news, msgs), JPMorgan Chase (JPM, news, msgs), Wells Fargo (WFC, news, msgs), Citigroup (C, news, msgs) and Google (GOOG, news, msgs).
If the reports are worse than expected, stocks could fall back.
But by far the largest problem remains the global credit crisis that has made banks in the United States and elsewhere unwilling to lend to each other. The crunch has threatened many businesses because they can't get short-term financing to fund daily operations. The crunch has also resulted in fewer customers getting approved for mortgages, car loans and credit cards.
In addition, many investors have lost confidence in markets, government solutions to fix the problems and corporate management skill.
"Things are still very stressed, and we don't know what's going to fix it, " Barry Moran, a currency trader with the Bank of Ireland in Dublin, told Bloomberg News.
The three-month London interbank offered rate, or Libor, rose to 4.82% Friday from 4.75% Thursday. It was the highest level all year and was up from 2.82% one month ago.
Higher Libor rates indicate aversion to lending and to risk generally. The Libor typically follows central banks' interest rates.
The stock market plunge -- the Dow has fallen 22% so far in October -- has forced many hedge funds to liquidate stocks to meet margin calls. Another casualty: Chesapeake Energy (CHK, news, msgs) CEO Aubrey McClendon was forced to sell "substantially all" of his company stock over the past three days to meet margin loan calls.
Unless the cash gets freed up, experts say, the U.S. could face a very serious recession. Other countries may face bigger problems.
Finance officials from the major industrial nations, the so-called G-7, were meeting this weekend in Washington, D.C., to discuss the situation. Late Friday, they agreed on common guidelines to address the world financial crisis, a move that opens the way for a series of government actions. But The Wall Street Journal said the agreement falls short of the joint plan that many investors had sought.
Among the guidelines, countries agreed to "use all available tools" to prevent systemically important financial institutions from failing, and to ensure that bank deposit insurance programs are solid; to ensure that banks can raise capital from government as well as private sources.
Many investors and traders were disappointed in the deal; they'd hoped for a dramatic G-7 accord, such as a concrete agreement to guarantee bank debt.
U.S. to buy stakes in banks
While the G7 ministers were working on a comprehensive plan, Treasury Secretary Hank Paulson said late Friday that the government will move ahead with plans to buy equity stakes in financial institutions. The administration received authority to make direct purchases of stock in the $700 billion rescue bill Congress recently passed.
Paulson said the program to purchase stock in financial institutions will be open to a broad array of institutions.
The new plan seems to supplant the $700-billion plan to buy distressed mortgage-backed securities that the administration convinced Congress to approve only a week ago. That plan seems to have been put on a back burner in favor of this new approach which would, in effect, partially nationalize the industry.
While the Treasury department says it still plans to buy up distressed assets, the scope of that plan is unclear, The New York Times said. And, The Time said, the federal government meanwhile has directed Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs), the government-controlled mortgage giants, to ramp up their purchases of troubled mortgage bonds, in what could be a speedier and less formal process than the reverse auctions proposed by the Treasury.
The markets for the week Close for week Wk. ago close % chg. YTD. chg.
Dow Jones industrials
8,451.19 10,325.38 -18.15% -36.29%
S&P 500 899.22 1,099.23 -18.20% -38.76%
Nasdaq Composite 1,649.5 1,947.39 -15.30% -37.81%
Crude oil per barrel $77.70 $93.8 -17.23% -19.05%
Gold per troy ounce $859.00 $833.2 3.10% 2.51%
A wild last hour of trading
The last hour of trading Friday had been billed as potentially crazy, and it delivered. There were reports that hedge funds are being forced to sell stocks to meet margin calls from brokers. The market is also being hit by redemptions by mutual funds.
Then, the rally took off, in part because many investors began to sense that a credit plan would emerge this weekend.
The biggest losses came from energy stocks, which were falling because of a sharp decline in crude oil. Crude in New York fell 10.3% to $77.70. That's the lowest close for crude since September 2007.
Losses for Dow components Chevron (CVX, news, msgs), down 9.6% to $57.83, and ExxonMobil (XOM, news, msgs), down 8.3% to $62.36, were worth about 93 points of the Dow's loss by themselves.
Twenty of the 30 Dow stocks were lower on the day along with 321 S&P 500 stocks and 61 Nasdaq-100 ($NDX.X) stocks. The Nasdaq-100, which tracks the largest Nasdaq stocks, was down 5 points, or 0.4% to 1,270. Apple's gain was worth 11 points for the index.
Energy prices -- New York close Fri. Thur. Chg. Month chg. YTD chg.
Crude oil (NYMEX) (per barrel)
$77.70
$86.59
-$8.89
-22.79%
-19.05%
Heating oil (per gallon)
$2.2131
$2.4186
-$0.2055
-22.69%
-16.47%
Natural gas (per million BTU)
$6.5380
$6.8250
-$0.2870
-12.10%
-12.63%
Unleaded gasoline (per gallon)
$1.8070
$2.0273
-$0.2203
-27.27%
-27.45%
That’s the upshot of an unusual auction process Friday that established the price for defaulted Lehman debt and, in turn, potential claims payouts on insurance protecting that debt, known as credit default swaps.
Certainly, some firms will take a hit because of the pricing, potentially amounting to billions of dollars in combined losses. In the Lehman auction, participants included most major financial firms from around the world. But it’s too early to tell which companies will be on the hook or for how much. Some of the sellers bought protection for themselves, for example.
In a best-case scenario, said Barry Silbert, chief executive of SecondMarket, a marketplace for trading illiquid assets, financial companies that sold default swap contracts would make their payouts in the coming weeks, have enough capital to cover all the positions, and take their losses and move on.
In a worst-case scenario, sellers of the swaps would not have the cash to make the payments and would have to liquidate their assets to cover their positions.
"The next two weeks will be very telling," Silbert added.
The auction had been watched closely as a gauge for valuing the problems faced by financial companies from the mortgage and housing collapse. And it was one reason why Goldman Sachs (GS, news, msgs) fell 12.4% to $88.80. For the week, Goldman Sachs was down 30.6%.
Moody’s also raised concerns about Goldman’s long-term credit rating on Thursday, lowering its outlook to negative.
Europe and Asia have an ugly day
The American market took its cue at the open from Europe and Asia.
London's FTSE 100 Index ($GB:UKX) fell 8.9%, Germany's Xetra DAX Index ($DE:DAX) was down 7%, and Europe's broader Dow Jones Stoxx600 Index lost 7.5%. Japan's Nikkei 225 Index ($N225) plunged 9.6% and Hong Kong's Hang Seng Index ($HSIX) closed down 7.2%.
Equity trading was halted in Austria, Russia, Indonesia, Ukraine and Iceland.
Is it the end of the financial world?
Investors are selling everything during the current financial panic, but when they realize the end of the world hasn't arrived, we might be in for a big rally. MSN Money's Jim Jubak thinks we'll have a clearer picture of the financial landscape by Oct. 23.
GM talked merger with Ford and Chrysler
General Motors (GM, news, msgs) approached Ford Motor (F, news, msgs) in recent months about a possible merger, but Ford called off the talks after the auto maker concluded it should continue to go it alone, The Wall Street Journal and The New York Times reported.
News of the merger talks came one day after reports surfaced that GM has recently been in discussions about acquiring privately held Chrysler.Stock Charts (Year)
General Motors
General Electric
Ford was down 4.3% to $1.99.
GM shares rose 2.7% to $4.89 after getting walloped Thursday, when the Dow component lost 31% of its value and fell to $4.76. The last time GM traded at that level was in spring 1950. GM shares had been up in pre-open trading Friday.
Analysis: Can GM and Ford survive?
GM stock tanked after ratings company Standard & Poor's put the auto maker's credit ratings under review Thursday. S&P said GM has enough cash to make it through 2008, but a worsening picture for the auto industry could cause more trouble next year.
GM said Friday morning that it is facing "unprecedented challenges," but "bankruptcy protection is not an option."
GE earnings are inline
Another Dow component, General Electric (GE, news, msgs), reported third-quarter results that were in line with recently lowered forecasts.
GE earned $4.31 billion, or 43 cents per share, a 22% drop from last year's results. On an operating basis, GE earned 45 cents per share, in line with its lowered guidance of 41 to 45 cents made at the end of September. Analysts were looking for 46 cents per share.
GE has a big financial business, and like the rest of the sector, it has been struggling amid the turmoil.
GE shares closed up 13% to $21.50.
Worries about Morgan Stanley weigh on stock
Morgan Stanley (MS, news, msgs) shares fell 22.3% to $9.68.
That was something of a victory; the shares had been down as much as 40% early in the day after plunging Thursday on worries that its deal with Japan's Mitsubishi UFJ wouldn't go through.
Adding to the worry were comments from Moody's Investors Service that it may cut Morgan Stanley's credit rating.
Mitsubishi UFJ two weeks ago offered $9 billion for a 21% stake in Morgan Stanley. At the time, Morgan was trading at $25 per share.
The Wall Street Journal has said the deal with Mitsubishi UFJ is set to close on Tuesday.
"The company must have the ability to roll over its debt and operate with counterparties in the market on a daily basis," Ladenburg Thalmann analyst Dick Bove said in a note on Saturday. "If it can do this, it will survive and ultimately thrive. If it cannot it faces a difficult future."
An injection of $9 billion in cash won't solve Morgan Stanley's problem, he added. The company’s debt must be guaranteed.
The problem with Warren Buffett
By Michael Brush
Has Warren Buffett lost his touch?
With more than a hundred investments carefully handpicked by the Oracle of Omaha and his disciples -- plus a huge cash hoard of $28 billion -- Buffett's Berkshire Hathaway (BRK.A, news, msgs) was supposed to be a bastion of safety in this turbulent market.
But Buffett, or at least Berkshire, hasn't been immune to the market's volatility. When the market rallied late last week on news of a financial-sector bailout, Berkshire shot up nearly 20%. On Monday, it gave up more than half of that advance.
Before this recent run, it was down 20% since early December, only slightly better than the 22% decline of the S&P 500 Index ($INX) over the same time frame.
Understandably, many Berkshire Hathaway investors feel shaken. They're wondering whether Buffett has finally turned into an investing has-been.
Oh, he's still wealthy enough to rank second in the latest edition of the Forbes 400. But he's down from No. 1, and his $50 billion net worth represents a $12 billion decline in the past six months, Forbes reported.
On Tuesday, Berkshire announced plans to plunk down $5 billion to take a stake in Goldman Sachs Group (GS, news, msgs), at a time when many investors are running scared from the financial sector. In market downturns past, Buffett has made smart buys at the bottom, but it remains to be seen whether this is one of those or will go the way of less fortunate investments in companies such as USAir, now US Airways Group (LCC, news, msgs).
Several theories floating around purportedly make the has-been case. But just one explanation makes sense. We'll get to it in a moment.
First, here are the three bogus theories you need to ignore if you want to play Berkshire Hathaway right -- or if you're one of the many who follow Buffett's every word of advice.
No. 1: No more 'skin in the game'
More than two years ago, Buffett generously decided to give his stake in Berkshire to charitable foundations. This means he won't personally profit from Berkshire's performance.
But it's a mistake to think this makes Buffett less motivated, analysts say, because a guy like Buffett hasn't been in it for the money for quite some time. (Read "Buy the stock Buffett's giving away.")
As for the actual stock sales to raise funds for charity, "he said a while ago that there would only be a small portion liquidated annually," says Justin Fuller, an analyst who follows Berkshire Hathaway for Morningstar (MORN, news, msgs). So his selling won't drive down the stocks.
No. 2: The 'succession issue'
Another explanation for Berkshire Hathaway's weakness is that investors are worried that Buffett, 78, could soon step aside or pass away. But Whitney Tilson, a co-portfolio manager of the Tilson Focus Fund (TILFX), which holds shares of Berkshire Hathaway, says you shouldn't worry about this.
"There is no evidence that he is mentally or physically slowing down," says Tilson. Plus, according to insurance company estimates, a healthy 78-year-old lives on average for an additional 15 years, Tilson says. He expects Buffett will be running Berkshire for the next decade.
No. 3: Buffett has lost his Midas touch
Like any good investor, Buffett readily admits he makes mistakes. But the recent numbers are shocking.
The value of unrealized gains on his stock holdings fell $7 billion by the end of the second quarter compared with the end of 2007, and unrealized losses grew to $3.9 billion from about $1 billion.
Two of his biggest turkeys are newspaper companies: Gannett (GCI, news, msgs) is down 61% in the past year, and The Washington Post (WPO, news, msgs) has shed 20%.
Do these big losses mean that Buffett's brain has actually gone into retirement without giving notice?
I doubt it. First off, Buffett's holdings are bought "for life," as he likes to say. So it's unfair to judge them over the short term. Even if you do this, you can make the case that Buffett's performance is telling us his brain is working better than ever. Because so far this quarter, Buffett has turned in an enviable performance.
As of Sept. 23, his holdings were up 9% during the third quarter, compared with a 5.9% decline for the S&P 500, according to an analysis of his portfolio by Bespoke Investment Group, an investment research shop. His best performers were Wells Fargo (WFC, news, msgs), SunTrust Banks (STI, news, msgs), Bank of America (BAC, news, msgs), Kraft Foods (KFT, news, msgs) and Lowe's (LOW, news, msgs), up anywhere from 15% to 47% so far during the quarter.
Buffett's real problem
The real reason Berkshire Hathaway stock is weak is that despite Buffett's investment prowess, his company is still mainly a property and casualty insurance business.
And that's been a terrible business of late because pricing is so weak in property and casualty insurance, as well as most other segments of the sector, says Stephen Shueh, a managing partner at Roundview Capital. Shueh is a value investor who holds Berkshire Hathaway shares.
The problem is that -- Hurricane Ike notwithstanding -- there haven't been big disasters in the recent past to force insurers to make big payouts. Insurance companies have been growing fat on excess capital from all those premiums coming in. As they gain capital strength, they can offer more insurance -- but to win business, they have to lower prices.
Over the past year, commercial insurance pricing is off 5% to 6%, says John Iten, a senior analyst in Standard & Poor's insurance group. And pricing in reinsurance is down 10%, Iten says. Reinsurance is one of Buffett's fortes. It involves offering insurance to other insurance companies who write policies against major catastrophes.
All of this helps explain why Berkshire Hathaway's insurance earnings -- before taxes -- fell 20% in the second quarter and net income fell 7.6% to $2.88 billion. Both fell sharply in the first quarter as well.
To anyone who pays attention to Buffett, none of this is a surprise. In his most recent letter to shareholders, in February, Buffett warned investors that the "party is over." He told them straight out it was "a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008."
The other problem, of course, is that Buffett has collected a lot of companies with direct exposure to the housing sector. These include Shaw Industries, the world's largest carpet manufacturer, and Star Furniture, as well as Clayton Homes, Acme Building Brands, Benjamin Moore and Johns Manville, which sell manufactured homes, bricks, paint and insulation, respectively.
Buffett also has a lot of exposure to consumer-facing businesses like apparel, through companies such as Fruit of the Loom and H.H. Brown Shoe Group.
These businesses have been hit hard by weakness in the economy.
Buy or sell Buffett?
Because of the grim outlook for insurance pricing and the weak economy, analysts such as Gary Ransom of Fox-Pitt Kelton are not enthusiastic about Berkshire Hathaway's stock.
But for long-term investors, the stock looks like a good buy-and-hold and sleep-at-night investment.
"We still believe the conglomerate will do well by its shareholders for decades to come," says Morningstar's Fuller, who has a five-star rating on Berkshire Hathaway, Morningstar's highest rating.
Here are three reasons:
Berkshire Hathaway looks cheap. "It is trading below intrinsic value, and it always returns to intrinsic value sooner or later," says Tilson, of the Tilson Focus Fund. By tallying the value of cash per share and investments, and putting a reasonable valuation on Berkshire operating businesses, Tilson calculates intrinsic value to be as much as $160,000 per share. That suggests a potential gain of 19% just for getting back to a fair valuation for Buffett's stock.
Buffett has the best managers in the business. Buffett doesn't put much value on résumés. Instead, he looks for a good track record and passion. Most of the chiefs running his operating businesses no longer have any financial need to work. They sold their businesses to Buffett but continue working for him because they love it. "They have exactly the job they want for the rest of their working years. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage," Buffett told shareholders in his most recent letter to them.
Buffett has the cash to take advantage of the train wreck in the market. "As the markets get more and more chaotic, that works to Buffett's benefit," Tilson says. While others panic, Buffett will pick up bargains. Last week, for example, Buffett stepped up and bought Constellation Energy Group (CEG, news, msgs) after its shares swooned because of concerns about its financial strength. "It would be hard to find a better example of why this market is so perfect for Buffett," Tilson says.
Undervalued or not, a share of BRK.A at more than $130,000 may be beyond the average investor's means. The other option is BRK.B, now trading around $4,400.
6 Buffett stock picks
If you want to try your hand instead at individual holdings in the Berkshire Hathaway portfolio, consider these stocks. Three are positions that Berkshire added to during last quarter. Three others are holdings favored by value investors and Buffettologists around current levels.
Berkshire Hathaway took on one new position last quarter when it bought 3.24 million shares of NRG Energy (NRG, news, msgs), a utility. At $30 a share, NRG trades about 30% below where Berkshire probably bought last quarter.
Berkshire also added to Sanofi-Aventis (SNY, news, msgs), a pharmaceutical company with most of its sales in the U.S. and Europe, and Ingersoll-Rand (IR, news, msgs), which sells industrial equipment such as climate control and security systems. Morningstar analysts have five-star ratings on both companies. Each stock trades at or near lows for the second quarter. So if you buy now, you'll get about the same price that Berkshire Hathaway got, or even better.
Wells Fargo looks like a buy because as a financially sound survivor, it will likely benefit from the banking mess by making acquisitions or expanding, says Todd Lowenstein, a co-portfolio manager of the HighMark Value Momentum Fund (HMVMX). Wells Fargo is one of Buffett's top five holdings.
Tilson thinks American Express (AXP, news, msgs) looks "very attractive" at current levels. Fears about weak consumer spending and losses on credit card debt could hold the stock down for a while. "But they will emerge from this with a brilliant franchise intact and incredible earnings power," Tilson says. "This is one of the world's great businesses."
Just be patient, and don't expect gains right way, as there is no known near-term catalyst for the stock. American Express is also one of Buffett's top five holdings.
Another Buffett holding in the financial sector, M&T Bank (MTB, news, msgs) also looks attractive around current levels, says Ed Walczak, a portfolio manager at Vontobel Asset Management's Phoenix Focused Value Fund. The stock is weak this year with the rest of the group. But this doesn't make sense because it has "a lot less exposure to the bad stuff that is out there, like residential mortgages," Walczak says.
The faint of heart may find comfort in the fact that half of the float of M&T Bank stock is held by Buffett and other serious long-term investors, Walczak says, which means there may be "less craziness" in terms of stock price.
Has Warren Buffett lost his touch?
With more than a hundred investments carefully handpicked by the Oracle of Omaha and his disciples -- plus a huge cash hoard of $28 billion -- Buffett's Berkshire Hathaway (BRK.A, news, msgs) was supposed to be a bastion of safety in this turbulent market.
But Buffett, or at least Berkshire, hasn't been immune to the market's volatility. When the market rallied late last week on news of a financial-sector bailout, Berkshire shot up nearly 20%. On Monday, it gave up more than half of that advance.
Before this recent run, it was down 20% since early December, only slightly better than the 22% decline of the S&P 500 Index ($INX) over the same time frame.
Understandably, many Berkshire Hathaway investors feel shaken. They're wondering whether Buffett has finally turned into an investing has-been.
Oh, he's still wealthy enough to rank second in the latest edition of the Forbes 400. But he's down from No. 1, and his $50 billion net worth represents a $12 billion decline in the past six months, Forbes reported.
On Tuesday, Berkshire announced plans to plunk down $5 billion to take a stake in Goldman Sachs Group (GS, news, msgs), at a time when many investors are running scared from the financial sector. In market downturns past, Buffett has made smart buys at the bottom, but it remains to be seen whether this is one of those or will go the way of less fortunate investments in companies such as USAir, now US Airways Group (LCC, news, msgs).
Several theories floating around purportedly make the has-been case. But just one explanation makes sense. We'll get to it in a moment.
First, here are the three bogus theories you need to ignore if you want to play Berkshire Hathaway right -- or if you're one of the many who follow Buffett's every word of advice.
No. 1: No more 'skin in the game'
More than two years ago, Buffett generously decided to give his stake in Berkshire to charitable foundations. This means he won't personally profit from Berkshire's performance.
But it's a mistake to think this makes Buffett less motivated, analysts say, because a guy like Buffett hasn't been in it for the money for quite some time. (Read "Buy the stock Buffett's giving away.")
As for the actual stock sales to raise funds for charity, "he said a while ago that there would only be a small portion liquidated annually," says Justin Fuller, an analyst who follows Berkshire Hathaway for Morningstar (MORN, news, msgs). So his selling won't drive down the stocks.
No. 2: The 'succession issue'
Another explanation for Berkshire Hathaway's weakness is that investors are worried that Buffett, 78, could soon step aside or pass away. But Whitney Tilson, a co-portfolio manager of the Tilson Focus Fund (TILFX), which holds shares of Berkshire Hathaway, says you shouldn't worry about this.
"There is no evidence that he is mentally or physically slowing down," says Tilson. Plus, according to insurance company estimates, a healthy 78-year-old lives on average for an additional 15 years, Tilson says. He expects Buffett will be running Berkshire for the next decade.
No. 3: Buffett has lost his Midas touch
Like any good investor, Buffett readily admits he makes mistakes. But the recent numbers are shocking.
The value of unrealized gains on his stock holdings fell $7 billion by the end of the second quarter compared with the end of 2007, and unrealized losses grew to $3.9 billion from about $1 billion.
Two of his biggest turkeys are newspaper companies: Gannett (GCI, news, msgs) is down 61% in the past year, and The Washington Post (WPO, news, msgs) has shed 20%.
Do these big losses mean that Buffett's brain has actually gone into retirement without giving notice?
I doubt it. First off, Buffett's holdings are bought "for life," as he likes to say. So it's unfair to judge them over the short term. Even if you do this, you can make the case that Buffett's performance is telling us his brain is working better than ever. Because so far this quarter, Buffett has turned in an enviable performance.
As of Sept. 23, his holdings were up 9% during the third quarter, compared with a 5.9% decline for the S&P 500, according to an analysis of his portfolio by Bespoke Investment Group, an investment research shop. His best performers were Wells Fargo (WFC, news, msgs), SunTrust Banks (STI, news, msgs), Bank of America (BAC, news, msgs), Kraft Foods (KFT, news, msgs) and Lowe's (LOW, news, msgs), up anywhere from 15% to 47% so far during the quarter.
Buffett's real problem
The real reason Berkshire Hathaway stock is weak is that despite Buffett's investment prowess, his company is still mainly a property and casualty insurance business.
And that's been a terrible business of late because pricing is so weak in property and casualty insurance, as well as most other segments of the sector, says Stephen Shueh, a managing partner at Roundview Capital. Shueh is a value investor who holds Berkshire Hathaway shares.
The problem is that -- Hurricane Ike notwithstanding -- there haven't been big disasters in the recent past to force insurers to make big payouts. Insurance companies have been growing fat on excess capital from all those premiums coming in. As they gain capital strength, they can offer more insurance -- but to win business, they have to lower prices.
Over the past year, commercial insurance pricing is off 5% to 6%, says John Iten, a senior analyst in Standard & Poor's insurance group. And pricing in reinsurance is down 10%, Iten says. Reinsurance is one of Buffett's fortes. It involves offering insurance to other insurance companies who write policies against major catastrophes.
All of this helps explain why Berkshire Hathaway's insurance earnings -- before taxes -- fell 20% in the second quarter and net income fell 7.6% to $2.88 billion. Both fell sharply in the first quarter as well.
To anyone who pays attention to Buffett, none of this is a surprise. In his most recent letter to shareholders, in February, Buffett warned investors that the "party is over." He told them straight out it was "a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008."
The other problem, of course, is that Buffett has collected a lot of companies with direct exposure to the housing sector. These include Shaw Industries, the world's largest carpet manufacturer, and Star Furniture, as well as Clayton Homes, Acme Building Brands, Benjamin Moore and Johns Manville, which sell manufactured homes, bricks, paint and insulation, respectively.
Buffett also has a lot of exposure to consumer-facing businesses like apparel, through companies such as Fruit of the Loom and H.H. Brown Shoe Group.
These businesses have been hit hard by weakness in the economy.
Buy or sell Buffett?
Because of the grim outlook for insurance pricing and the weak economy, analysts such as Gary Ransom of Fox-Pitt Kelton are not enthusiastic about Berkshire Hathaway's stock.
But for long-term investors, the stock looks like a good buy-and-hold and sleep-at-night investment.
"We still believe the conglomerate will do well by its shareholders for decades to come," says Morningstar's Fuller, who has a five-star rating on Berkshire Hathaway, Morningstar's highest rating.
Here are three reasons:
Berkshire Hathaway looks cheap. "It is trading below intrinsic value, and it always returns to intrinsic value sooner or later," says Tilson, of the Tilson Focus Fund. By tallying the value of cash per share and investments, and putting a reasonable valuation on Berkshire operating businesses, Tilson calculates intrinsic value to be as much as $160,000 per share. That suggests a potential gain of 19% just for getting back to a fair valuation for Buffett's stock.
Buffett has the best managers in the business. Buffett doesn't put much value on résumés. Instead, he looks for a good track record and passion. Most of the chiefs running his operating businesses no longer have any financial need to work. They sold their businesses to Buffett but continue working for him because they love it. "They have exactly the job they want for the rest of their working years. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage," Buffett told shareholders in his most recent letter to them.
Buffett has the cash to take advantage of the train wreck in the market. "As the markets get more and more chaotic, that works to Buffett's benefit," Tilson says. While others panic, Buffett will pick up bargains. Last week, for example, Buffett stepped up and bought Constellation Energy Group (CEG, news, msgs) after its shares swooned because of concerns about its financial strength. "It would be hard to find a better example of why this market is so perfect for Buffett," Tilson says.
Undervalued or not, a share of BRK.A at more than $130,000 may be beyond the average investor's means. The other option is BRK.B, now trading around $4,400.
6 Buffett stock picks
If you want to try your hand instead at individual holdings in the Berkshire Hathaway portfolio, consider these stocks. Three are positions that Berkshire added to during last quarter. Three others are holdings favored by value investors and Buffettologists around current levels.
Berkshire Hathaway took on one new position last quarter when it bought 3.24 million shares of NRG Energy (NRG, news, msgs), a utility. At $30 a share, NRG trades about 30% below where Berkshire probably bought last quarter.
Berkshire also added to Sanofi-Aventis (SNY, news, msgs), a pharmaceutical company with most of its sales in the U.S. and Europe, and Ingersoll-Rand (IR, news, msgs), which sells industrial equipment such as climate control and security systems. Morningstar analysts have five-star ratings on both companies. Each stock trades at or near lows for the second quarter. So if you buy now, you'll get about the same price that Berkshire Hathaway got, or even better.
Wells Fargo looks like a buy because as a financially sound survivor, it will likely benefit from the banking mess by making acquisitions or expanding, says Todd Lowenstein, a co-portfolio manager of the HighMark Value Momentum Fund (HMVMX). Wells Fargo is one of Buffett's top five holdings.
Tilson thinks American Express (AXP, news, msgs) looks "very attractive" at current levels. Fears about weak consumer spending and losses on credit card debt could hold the stock down for a while. "But they will emerge from this with a brilliant franchise intact and incredible earnings power," Tilson says. "This is one of the world's great businesses."
Just be patient, and don't expect gains right way, as there is no known near-term catalyst for the stock. American Express is also one of Buffett's top five holdings.
Another Buffett holding in the financial sector, M&T Bank (MTB, news, msgs) also looks attractive around current levels, says Ed Walczak, a portfolio manager at Vontobel Asset Management's Phoenix Focused Value Fund. The stock is weak this year with the rest of the group. But this doesn't make sense because it has "a lot less exposure to the bad stuff that is out there, like residential mortgages," Walczak says.
The faint of heart may find comfort in the fact that half of the float of M&T Bank stock is held by Buffett and other serious long-term investors, Walczak says, which means there may be "less craziness" in terms of stock price.
Musings from a Crazy Day
1. The American baby boom generation has seen their buy and hold retirement accounts shredded in the last year. Shredded. An entire generation, perhaps the most influential American generation, was sold the story that buy and hold would take them to retirement shangri-la. Anyone got plan B for these folks?
2. I just caught a Russian market official speaking about Russian market distress. He said that the Russians were responsible for their troubles 10 years ago, but now the Americans are responsible for the latest crisis. Nice try. The current global meltdown is a result of first greed then fear. Those emotions don’t care about nationalities or borders. So if you, or if anyone, regardless of country, don’t like your portfolio’s direction…look in the mirror.
3. How far can the Dow drop? I don’t know. No one knows. If someone tells you they know, and you believe them, please go see a medical doctor to ask for a full frontal lobotomy.
http://www.michaelcovel.com/
2. I just caught a Russian market official speaking about Russian market distress. He said that the Russians were responsible for their troubles 10 years ago, but now the Americans are responsible for the latest crisis. Nice try. The current global meltdown is a result of first greed then fear. Those emotions don’t care about nationalities or borders. So if you, or if anyone, regardless of country, don’t like your portfolio’s direction…look in the mirror.
3. How far can the Dow drop? I don’t know. No one knows. If someone tells you they know, and you believe them, please go see a medical doctor to ask for a full frontal lobotomy.
http://www.michaelcovel.com/
Friday, October 10, 2008
When fortune frowned
Oct 9th 2008
From The Economist print edition
The worst financial crisis since the Depression is redrawing the boundaries between government and markets, says Zanny Minton Beddoes (interviewed here). Will they end up in the right place?
AFTER the stockmarket crash of October 1929 it took over three years for America’s government to launch a series of dramatic efforts to end the Depression, starting with Roosevelt’s declaration of a four-day bank holiday in March 1933. In-between, America saw the worst economic collapse in its history. Thousands of banks failed, a devastating deflation set in, output plunged by a third and unemployment rose to 25%. The Depression wreaked enormous damage across the globe, but most of all on America’s economic psyche. In its aftermath the boundaries between government and markets were redrawn.
During the past month, little more than a year after the financial storm first struck in August 2007, America’s government made its most dramatic interventions in financial markets since the 1930s. At the time it was not even certain that the economy was in recession and unemployment stood at 6.1%. In two tumultuous weeks the Federal Reserve and the Treasury between them nationalised the country’s two mortgage giants, Fannie Mae and Freddie Mac; took over AIG, the world’s largest insurance company; in effect extended government deposit insurance to $3.4 trillion in money-market funds; temporarily banned short-selling in over 900 mostly financial stocks; and, most dramatic of all, pledged to take up to $700 billion of toxic mortgage-related assets on to its books. The Fed and the Treasury were determined to prevent the kind of banking catastrophe that precipitated the Depression. Shell-shocked lawmakers cavilled, but Congress and the administration eventually agreed.
The landscape of American finance has been radically changed. The independent investment bank—a quintessential Wall Street animal that relied on high leverage and wholesale funding—is now all but extinct. Lehman Brothers has gone bust; Bear Stearns and Merrill Lynch have been swallowed by commercial banks; and Goldman Sachs and Morgan Stanley have become commercial banks themselves. The “shadow banking system”—the money-market funds, securities dealers, hedge funds and the other non-bank financial institutions that defined deregulated American finance—is metamorphosing at lightning speed. And in little more than three weeks America’s government, all told, expanded its gross liabilities by more than $1 trillion—almost twice as much as the cost so far of the Iraq war.
Beyond that, few things are certain. In late September the turmoil spread and intensified. Money markets seized up across the globe as banks refused to lend to each other. Five European banks failed and European governments fell over themselves to prop up their banking systems with rescues and guarantees. As this special report went to press, it was too soon to declare the crisis contained.
Anatomy of a collapse
That crisis has its roots in the biggest housing and credit bubble in history. America’s house prices, on average, are down by almost a fifth. Many analysts expect another 10% drop across the country, which would bring the cumulative decline in nominal house prices close to that during the Depression. Other countries may fare even worse. In Britain, for instance, households are even more indebted than in America, house prices rose faster and have so far fallen by less. On a quarterly basis prices are now falling in at least half the 20 countries in The Economist’s house-price index.
The credit losses on the mortgages that financed these houses and on the pyramids of complicated debt products built on top of them are still mounting. In its latest calculations the IMF reckons that worldwide losses on debt originated in America (primarily related to mortgages) will reach $1.4 trillion, up by almost half from its previous estimate of $945 billion in April. So far some $760 billion has been written down by the banks, insurance companies, hedge funds and others that own the debt.
Globally, banks alone have reported just under $600 billion of credit-related losses and have raised some $430 billion in new capital. It is already clear that many more write-downs lie ahead. The demise of the investment banks, with their far higher gearing, as well as deleveraging among hedge funds and others in the shadow-banking system will add to a global credit contraction of many trillions of dollars. The IMF’s “base case” is that American and European banks will shed some $10 trillion of assets, equivalent to 14.5% of their stock of bank credit in 2009. In America overall credit growth will slow to below 1%, down from a post-war annual average of 9%. That alone could drag Western economies’ growth rates down by 1.5 percentage points. Without government action along the lines of America’s $700 billion plan, the IMF reckons credit could shrink by 7.3% in America, 6.3% in Britain and 4.5% in the rest of Europe.
Much of the rich world is already in recession, partly because of tighter credit and partly because of the surge in oil prices earlier this year. Output is falling in Britain, France, Germany and Japan. Judging by the pace of job losses and the weakness of consumer spending, America’s economy is also shrinking.
The average downturn after recent banking crises in rich countries lasted four years as banks retrenched and debt-laden households and firms were forced to save more. This time firms are in relatively good shape, but households, particularly in Britain and America, have piled up unprecedented debts. And because the asset and credit bubbles formed in many countries simultaneously, the hangover this time may well be worse.
But history teaches an important lesson: that big banking crises are ultimately solved by throwing in large dollops of public money, and that early and decisive government action, whether to recapitalise banks or take on troubled debts, can minimise the cost to the taxpayer and the damage to the economy. For example, Sweden quickly took over its failed banks after a property bust in the early 1990s and recovered relatively fast. By contrast, Japan took a decade to recover from a financial bust that ultimately cost its taxpayers a sum equivalent to 24% of GDP.
All in all, America’s government has put some 7% of GDP on the line, a vast amount of money but well below the 16% of GDP that the average systemic banking crisis (if there is such a thing) ultimately costs the public purse. Just how America’s proposed Troubled Asset Relief Programme (TARP) will work is still unclear. The Treasury plans to buy huge amounts of distressed debt using a reverse auction process, where banks offer to sell at a price and the government buys from the lowest price upwards. The complexities of thousands of different mortgage-backed assets will make this hard. If direct bank recapitalisation is still needed, the Treasury can do that too. The main point is that America is prepared to act, and act decisively.
For the time being, that offers a reason for optimism. So, too, does the relative strength of the biggest emerging markets, particularly China. These economies are not as “decoupled” from the rich world’s travails as they once seemed. Their stockmarkets have plunged and many currencies have fallen sharply. Domestic demand in much of the emerging world is slowing but not collapsing. The IMF expects emerging economies, led by China, to grow by 6.9% in 2008 and 6.1% in 2009. That will cushion the world economy but may not save it from recession.
Another short-term fillip comes from the recent plunge in commodity prices, particularly oil. During the first year of the financial crisis the boom in commodities that had been building up for five years became a headlong surge. In the year to July the price of oil almost doubled. The Economist’s food-price index jumped by nearly 55% (see chart 1). These enormous increases pushed up consumer prices across the globe. In July average headline inflation was over 4% in rich countries and almost 9% in emerging economies, far higher than central bankers’ targets (see chart 2).
High and rising inflation coupled with financial weakness left central bankers with perplexing and poisonous trade-offs. They could tighten monetary policy to prevent higher inflation becoming entrenched (as the European Central Bank did), or they could cut interest rates to cushion financial weakness (as the Fed did). That dilemma is now disappearing. Thanks to the sharp fall in commodity prices, headline consumer prices seem to have peaked and the immediate inflation risk has abated, particularly in weak and financially stressed rich economies. If oil prices stay at today’s levels, headline consumer-price inflation in America may fall below 1% by the middle of next year. Rather than fretting about inflation, policymakers may soon be worrying about deflation.
The trouble is that because of its large current-account deficit America is heavily reliant on foreign funding. It has the advantage that the dollar is the world’s reserve currency, and as the financial turmoil has spread the dollar has strengthened. But today’s crisis is also testing many of the foundations on which foreigners’ faith in the dollar is based, such as limited government and stable capital markets. If foreigners ever flee the dollar, America will face the twin nightmares that haunt emerging countries in a financial collapse: simultaneous banking and currency crises. America’s debts, unlike those in many emerging economies, are denominated in its own currency, but a collapse of the dollar would still be a catastrophe.
Tipping point
What will be the long-term effect of this mess on the global economy? Predicting the consequences of an unfinished crisis is perilous. But it is already clear that, even in the absence of a calamity, the direction of globalisation will change. For the past two decades the growing integration of the world economy has coincided with the intellectual ascent of the Anglo-Saxon brand of free-market capitalism, with America as its cheerleader. The freeing of trade and capital flows and the deregulation of domestic industry and finance have both spurred globalisation and come to symbolise it. Global integration, in large part, has been about the triumph of markets over governments. That process is now being reversed in three important ways.
First, Western finance will be re-regulated. At a minimum, the most freewheeling areas of modern finance, such as the $55 trillion market for credit derivatives, will be brought into the regulatory orbit. Rules on capital will be overhauled to reduce leverage and enhance the system’s resilience. America’s labyrinth of overlapping regulators will be reordered. How much control will be imposed will depend less on ideology (both of America’s presidential candidates have promised reform) than on the severity of the economic downturn. The 1980s savings-and-loan crisis amounted to a sizeable banking bust, but because it did not result in an economic catastrophe, the regulatory consequences were modest. The Depression, in contrast, not only refashioned the structure of American finance but brought regulation to whole swathes of the economy.
That leads to the second point: the balance between state and market is changing in areas other than finance. For many countries a more momentous shock over the past couple of years has been the soaring price of commodities, which politicians have also blamed on financial speculation. The food-price spike in late 2007 and early 2008 caused riots in some 30 countries. In response, governments across the emerging world extended their reach, increasing subsidies, fixing prices, banning exports of key commodities and, in India’s case, restricting futures trading. Concern about food security, particularly in India and China, was one of the main reasons why the Doha round of trade negotiations collapsed this summer.
Third, America is losing economic clout and intellectual authority. Just as emerging economies are shaping the direction of global trade, so they will increasingly shape the future of finance. That is particularly true of capital-rich creditor countries such as China. Deleveraging in Western economies will be less painful if savings-rich Asian countries and oil-exporters inject more capital. Influence will increase along with economic heft. China’s vice-premier, Wang Qishan, reportedly told his American counterparts at a recent Sino-American summit that “the teachers now have some problems.”
The enduring attraction of markets
The big question is what lessons the emerging students—and the disgraced teacher—should learn from recent events. How far should the balance between governments and markets shift? This special report will argue that although some rebalancing is needed, particularly in financial regulation, where innovation outpaced a sclerotic supervisory regime, it would be a mistake to blame today’s mess only, or even mainly, on modern finance and “free-market fundamentalism”. Speculative excesses existed centuries before securitisation was invented, and governments bear direct responsibility for some of today’s troubles. Misguided subsidies, on everything from biofuels to mortgage interest, have distorted markets. Loose monetary policy helped to inflate a global credit bubble. Provocative as it may sound in today’s febrile and dangerous climate, freer and more flexible markets will still do more for the world economy than the heavy hand of government.
Bad, or worse - A global recession is almost certainly on the way
DEPRIVE a person of oxygen and he will turn blue, collapse and eventually die. Deprive economies of credit and a similar process kicks in. As the financial crisis has broadened and intensified, the global economy has begun to suffocate. That is why the world’s central banks have been administering emergency measures, including a round of co-ordinated interest-rate cuts on Wednesday October 8th. With luck they will prevent catastrophe. They are unlikely to avert a global recession.
According to the IMF’s most recent World Economic Outlook, published on Wednesday, the world economy is “entering a major downturn” in the face of “the most dangerous shock” to rich-country financial markets since the 1930s. The fund expects global growth, measured on the basis of purchasing-power parity (PPP), to come down to 3% in 2009, the slowest pace since 2002 and on the verge of what it considers to be a global recession. (The fund’s definition of global recession takes many factors into account, including the rate of population growth.) Given the scale of the financial freeze, the fund’s forecast looks optimistic. Other forecasters are convinced that a global recession is inevitable. Economists at UBS, for instance, expect global growth of only 2.2% in 2009.
The rich world’s economies were either shrinking, or close to it, long before September. Recent weeks have made a rich-world recession all but inevitable. America’s economy lost steam throughout the summer. Temporarily buoyed by fiscal stimulus and strong exports, output grew at a solid 2.8% annualised rate between April and June. But as the stimulus wore off, the job market worsened, credit tightened and consumer spending slid.
That slide became a rout in September. The economy lost 159,000 jobs, the most in a month since 2003. Car sales fell to a 16-year low as would-be buyers were unable to get credit. The economy may already have shrunk in the third quarter. The rest of the year is likely to be worse. Some economists expect consumer spending to fall at its fastest pace since the 1980 recession. Add in other gloomy evidence, such as a survey of purchasing managers that suggests manufacturing is extremely weak, and it is clear that output is now falling. America’s recession may not yet be official, but it is well under way.
In Europe the outlook is equally grim. The British economy, which stalled in the second quarter, is now unmistakably falling into recession. The IMF’s forecasts suggest that Britain will see the worst performance of any big economy in the year to the fourth quarter of 2008. The economies of the euro area, too, are struggling badly. Figures released on Wednesday showed that output in the euro area fell at an annualised rate of 0.8% in the second quarter. GDP shrank in the currency zone’s three largest countries—Germany, France and Italy. The fourth largest, Spain, barely grew.
As elsewhere, the most recent figures have grown grimmer still. Business confidence has turned down and a closely watched survey of purchasing managers points to a further contraction in activity over the summer months. Even the European economies that are less directly affected by housing busts, such as Germany, have been hard hit. The big hope for the euro area was that German shoppers, relatively free of debt and with scope to save a little less, would make up for weakness in debt-laden economies such as Spain. But household spending in Germany has been falling since the end of last year.
Japan, too, is looking weak. Its economy shrank at an annualised rate of 3% in the second quarter as exports fell, investment slowed and high food and fuel prices dented consumer confidence. Japanese banks are less embroiled in the financial crisis than those in Europe and America, but with other economies falling into recession and the yen soaring, the prospects for Japan’s exports and economy are dark.
This gloomy backdrop explains why the co-ordinated rate cuts were so essential. Even without the financial seizure, the case for cheaper money was becoming abundantly clear. With commodity prices falling sharply (the price of a barrel of crude was down to $88 on October 8th) and economies suffering, inflation risks are evaporating in the rich world. If oil prices remain at around today’s levels, headline inflation will be below 1% in America by next summer. Deflation is an increasing risk. That suggests more rate cuts will be needed, particularly in Europe.
All told, the IMF expects the rich-world economies to grow by only 0.5% in 2009. Its forecast of 3% global growth depends on reasonably robust expansion in emerging economies. The fund expects developing countries, as a group, to grow by 6.1% in 2009, more slowly than their blistering 8% pace of recent years, but far from recession. That would imply an unprecedented growth gap between the rich and emerging world (see chart).
Some emerging economies, notably China, have shown remarkable resilience to the financial storm. Many other markets, however, are being hit hard as investors flee risk. Analysts at Morgan Stanley estimate that capital flows to emerging economies could fall to $550 billion in 2009 from around $750 billion in 2007 and 2008. Such a sharp drop would hit economies that rely heavily on foreign finance: more than 80 developing countries are likely to run current-account deficits of more than 5% of GDP this year.
The links in the real economy could also be stronger than many imagine. Exports will be hit as recession grips the rich world. Falling commodity prices bode ill for the countries that produce them, notably in Latin America. The Brazilian real has fallen by more than a quarter against the dollar in the past month. Thanks to more disciplined macroeconomic policies and large cushions of reserves, many emerging economies have strong defences against a rich-world downturn. But they will not escape unscathed. A mild global recession is the best that can be hoped for.
According to the IMF’s most recent World Economic Outlook, published on Wednesday, the world economy is “entering a major downturn” in the face of “the most dangerous shock” to rich-country financial markets since the 1930s. The fund expects global growth, measured on the basis of purchasing-power parity (PPP), to come down to 3% in 2009, the slowest pace since 2002 and on the verge of what it considers to be a global recession. (The fund’s definition of global recession takes many factors into account, including the rate of population growth.) Given the scale of the financial freeze, the fund’s forecast looks optimistic. Other forecasters are convinced that a global recession is inevitable. Economists at UBS, for instance, expect global growth of only 2.2% in 2009.
The rich world’s economies were either shrinking, or close to it, long before September. Recent weeks have made a rich-world recession all but inevitable. America’s economy lost steam throughout the summer. Temporarily buoyed by fiscal stimulus and strong exports, output grew at a solid 2.8% annualised rate between April and June. But as the stimulus wore off, the job market worsened, credit tightened and consumer spending slid.
That slide became a rout in September. The economy lost 159,000 jobs, the most in a month since 2003. Car sales fell to a 16-year low as would-be buyers were unable to get credit. The economy may already have shrunk in the third quarter. The rest of the year is likely to be worse. Some economists expect consumer spending to fall at its fastest pace since the 1980 recession. Add in other gloomy evidence, such as a survey of purchasing managers that suggests manufacturing is extremely weak, and it is clear that output is now falling. America’s recession may not yet be official, but it is well under way.
In Europe the outlook is equally grim. The British economy, which stalled in the second quarter, is now unmistakably falling into recession. The IMF’s forecasts suggest that Britain will see the worst performance of any big economy in the year to the fourth quarter of 2008. The economies of the euro area, too, are struggling badly. Figures released on Wednesday showed that output in the euro area fell at an annualised rate of 0.8% in the second quarter. GDP shrank in the currency zone’s three largest countries—Germany, France and Italy. The fourth largest, Spain, barely grew.
As elsewhere, the most recent figures have grown grimmer still. Business confidence has turned down and a closely watched survey of purchasing managers points to a further contraction in activity over the summer months. Even the European economies that are less directly affected by housing busts, such as Germany, have been hard hit. The big hope for the euro area was that German shoppers, relatively free of debt and with scope to save a little less, would make up for weakness in debt-laden economies such as Spain. But household spending in Germany has been falling since the end of last year.
Japan, too, is looking weak. Its economy shrank at an annualised rate of 3% in the second quarter as exports fell, investment slowed and high food and fuel prices dented consumer confidence. Japanese banks are less embroiled in the financial crisis than those in Europe and America, but with other economies falling into recession and the yen soaring, the prospects for Japan’s exports and economy are dark.
This gloomy backdrop explains why the co-ordinated rate cuts were so essential. Even without the financial seizure, the case for cheaper money was becoming abundantly clear. With commodity prices falling sharply (the price of a barrel of crude was down to $88 on October 8th) and economies suffering, inflation risks are evaporating in the rich world. If oil prices remain at around today’s levels, headline inflation will be below 1% in America by next summer. Deflation is an increasing risk. That suggests more rate cuts will be needed, particularly in Europe.
All told, the IMF expects the rich-world economies to grow by only 0.5% in 2009. Its forecast of 3% global growth depends on reasonably robust expansion in emerging economies. The fund expects developing countries, as a group, to grow by 6.1% in 2009, more slowly than their blistering 8% pace of recent years, but far from recession. That would imply an unprecedented growth gap between the rich and emerging world (see chart).
Some emerging economies, notably China, have shown remarkable resilience to the financial storm. Many other markets, however, are being hit hard as investors flee risk. Analysts at Morgan Stanley estimate that capital flows to emerging economies could fall to $550 billion in 2009 from around $750 billion in 2007 and 2008. Such a sharp drop would hit economies that rely heavily on foreign finance: more than 80 developing countries are likely to run current-account deficits of more than 5% of GDP this year.
The links in the real economy could also be stronger than many imagine. Exports will be hit as recession grips the rich world. Falling commodity prices bode ill for the countries that produce them, notably in Latin America. The Brazilian real has fallen by more than a quarter against the dollar in the past month. Thanks to more disciplined macroeconomic policies and large cushions of reserves, many emerging economies have strong defences against a rich-world downturn. But they will not escape unscathed. A mild global recession is the best that can be hoped for.
Thursday, October 9, 2008
An unprecedented crisis
Malcolm Maiden
October 10, 2008 - 1:49PM
Page 1 of 2
The continuing sharemarket crisis is like nothing I have reported on, and I have witnessed some doozies: the long, painful market slump in the seventies that followed the 1973 OPEC oil price shock, the October 1987 market crash, the Long Term Capital Management crisis in 1998, the 2001 dot.com meltdown and the World-com-Enron crisis that followed, and 9-11, to name some of the highlights, or lowlights.
This is one is different because it is more than a year old, and there is still no clear picture about how it is going to be fixed.
The slump induced by the OPEC oil shock was also a slow burn, but Fed boss Paul Volcker eventually sterilised inflation by controlling money supply. The market slumps in 1987 and 1998 were much shorter in duration, and were solved essentially by liquidity injections.
The dot.com crisis was self-inflicted, and allowed to run its course, and the World-Com-Enron crises were also allowed to work their way through the markets ahead of accounting reform.
Already in this crisis we have seen liquidity injection of unprecedented magnitude, a raft of bank rescues, unprecedented co-ordinated central bank rate cuts this week, and the nationalisation of failed operators in the US, Britain and Europe, including Fannie Mae and Freddie Mac, the groups which between them finance half of America's $US12 trillion mortgage market. None of it has so far unblocked what are, in essence, crucial global financing arteries.
The increasingly obvious fact that the crisis is seriously contaminating economic growth worldwide was behind Wall Street's overnight fall, which spilled over today into more carnage for markets around the world, including Australia.
But the more primal concern driving the markets down is the lack of clarity about the nature of this implosion, and what is needed to cure it.
It seems likely now that major co-ordinated international action is coming.
The US is now considering using part of its $700 billion bailout fund to buy shares in beleaguered banks, the British Government has this week announced plans to spend up to 50 billion pounds on shares in its banks, and European bailouts of groups including Fortis and Dexia have also involved governments taking equity.
Government buy-ins have occurred before: Hong Kong's Monetary Authority bought a major stake in HSBC during the 1997 Asian markets crisis, and later sold out at a sizeable profit, for example.
But the scale of the government buy-ins this time is larger, and are set to become larger still.
Other extreme steps are possible, including even a global trading halt, to give the markets time to catch their breath, and regulators time to frame their next moves.
But it is far from clear what those moves would usefully be. Enough cash has been injected world-wide now to get the debt markets moving again, in theory, and some of the weakest links in the system have been removed - by collapses, buyouts, forced mergers and nationalisations. But the banks are still not lending to each other.
They simply don't trust their counterparties to repay the dough, and that is the heart of the problem. The depressing truth is that there are still vast sections of the market that may contain huge pools of losses that have been fully disclosed.
Hedge funds accounted for about 40% of market activity at the peak of the boom. They were big players in commodities and currencies too, and some think the Australian dollar's sudden slide and the slump in commodity prices is partly due to them retreating. But we really just don't know: the hedge funds are private companies, and disclosure is minimal.
Other potential black holes are theoretically open for inspection, but aren't really. Banks are, for example, marking their exposures at market value - losses that the IMF says could reach $US1.4 trillion are a result of that process - but the bog, chunky end of the global property market is frozen. There are no landmark property sales occurring. Until sales do happen, the extent of the losses in that sector is a matter of guesswork.
But the scale of the government buy-ins this time is larger, and are set to become larger still.
Other extreme steps are possible, including even a global trading halt, to give the markets time to catch their breath, and regulators time to frame their next moves.
But it is far from clear what those moves would usefully be. Enough cash has been injected world-wide now to get the debt markets moving again, in theory, and some of the weakest links in the system have been removed - by collapses, buyouts, forced mergers and nationalisations. But the banks are still not lending to each other.
They simply don't trust their counterparties to repay the dough, and that is the heart of the problem. The depressing truth is that there are still vast sections of the market that may contain huge pools of losses that have been fully disclosed.
Hedge funds accounted for about 40% of market activity at the peak of the boom. They were big players in commodities and currencies too, and some think the Australian dollar's sudden slide and the slump in commodity prices is partly due to them retreating. But we really just don't know: the hedge funds are private companies, and disclosure is minimal.
Other potential black holes are theoretically open for inspection, but aren't really. Banks are, for example, marking their exposures at market value - losses that the IMF says could reach $US1.4 trillion are a result of that process - but the bog, chunky end of the global property market is frozen. There are no landmark property sales occurring. Until sales do happen, the extent of the losses in that sector is a matter of guesswork.
October 10, 2008 - 1:49PM
Page 1 of 2
The continuing sharemarket crisis is like nothing I have reported on, and I have witnessed some doozies: the long, painful market slump in the seventies that followed the 1973 OPEC oil price shock, the October 1987 market crash, the Long Term Capital Management crisis in 1998, the 2001 dot.com meltdown and the World-com-Enron crisis that followed, and 9-11, to name some of the highlights, or lowlights.
This is one is different because it is more than a year old, and there is still no clear picture about how it is going to be fixed.
The slump induced by the OPEC oil shock was also a slow burn, but Fed boss Paul Volcker eventually sterilised inflation by controlling money supply. The market slumps in 1987 and 1998 were much shorter in duration, and were solved essentially by liquidity injections.
The dot.com crisis was self-inflicted, and allowed to run its course, and the World-Com-Enron crises were also allowed to work their way through the markets ahead of accounting reform.
Already in this crisis we have seen liquidity injection of unprecedented magnitude, a raft of bank rescues, unprecedented co-ordinated central bank rate cuts this week, and the nationalisation of failed operators in the US, Britain and Europe, including Fannie Mae and Freddie Mac, the groups which between them finance half of America's $US12 trillion mortgage market. None of it has so far unblocked what are, in essence, crucial global financing arteries.
The increasingly obvious fact that the crisis is seriously contaminating economic growth worldwide was behind Wall Street's overnight fall, which spilled over today into more carnage for markets around the world, including Australia.
But the more primal concern driving the markets down is the lack of clarity about the nature of this implosion, and what is needed to cure it.
It seems likely now that major co-ordinated international action is coming.
The US is now considering using part of its $700 billion bailout fund to buy shares in beleaguered banks, the British Government has this week announced plans to spend up to 50 billion pounds on shares in its banks, and European bailouts of groups including Fortis and Dexia have also involved governments taking equity.
Government buy-ins have occurred before: Hong Kong's Monetary Authority bought a major stake in HSBC during the 1997 Asian markets crisis, and later sold out at a sizeable profit, for example.
But the scale of the government buy-ins this time is larger, and are set to become larger still.
Other extreme steps are possible, including even a global trading halt, to give the markets time to catch their breath, and regulators time to frame their next moves.
But it is far from clear what those moves would usefully be. Enough cash has been injected world-wide now to get the debt markets moving again, in theory, and some of the weakest links in the system have been removed - by collapses, buyouts, forced mergers and nationalisations. But the banks are still not lending to each other.
They simply don't trust their counterparties to repay the dough, and that is the heart of the problem. The depressing truth is that there are still vast sections of the market that may contain huge pools of losses that have been fully disclosed.
Hedge funds accounted for about 40% of market activity at the peak of the boom. They were big players in commodities and currencies too, and some think the Australian dollar's sudden slide and the slump in commodity prices is partly due to them retreating. But we really just don't know: the hedge funds are private companies, and disclosure is minimal.
Other potential black holes are theoretically open for inspection, but aren't really. Banks are, for example, marking their exposures at market value - losses that the IMF says could reach $US1.4 trillion are a result of that process - but the bog, chunky end of the global property market is frozen. There are no landmark property sales occurring. Until sales do happen, the extent of the losses in that sector is a matter of guesswork.
But the scale of the government buy-ins this time is larger, and are set to become larger still.
Other extreme steps are possible, including even a global trading halt, to give the markets time to catch their breath, and regulators time to frame their next moves.
But it is far from clear what those moves would usefully be. Enough cash has been injected world-wide now to get the debt markets moving again, in theory, and some of the weakest links in the system have been removed - by collapses, buyouts, forced mergers and nationalisations. But the banks are still not lending to each other.
They simply don't trust their counterparties to repay the dough, and that is the heart of the problem. The depressing truth is that there are still vast sections of the market that may contain huge pools of losses that have been fully disclosed.
Hedge funds accounted for about 40% of market activity at the peak of the boom. They were big players in commodities and currencies too, and some think the Australian dollar's sudden slide and the slump in commodity prices is partly due to them retreating. But we really just don't know: the hedge funds are private companies, and disclosure is minimal.
Other potential black holes are theoretically open for inspection, but aren't really. Banks are, for example, marking their exposures at market value - losses that the IMF says could reach $US1.4 trillion are a result of that process - but the bog, chunky end of the global property market is frozen. There are no landmark property sales occurring. Until sales do happen, the extent of the losses in that sector is a matter of guesswork.
Wednesday, October 8, 2008
Buffett's Goldman, GE Warrants Worthless After Rout
Oct. 8 (Bloomberg) -- Billionaire investor Warren Buffett's instant paper profits on Goldman Sachs Group Inc. and General Electric Co. have been wiped out amid the stock market's worst yearly slump since 1937.
Goldman, the most profitable Wall Street firm, fell 1.7 percent today in New York trading to $113. That leaves Goldman, for the first time, below the price at which Buffett can buy $5 billion of shares (i.e $115). When the deal was announced last month, Goldman closed at $125.05, meaning Buffett was up $437 million.
Goldman and GE also sold Buffett a combined $8 billion in preferred shares that pay a 10 percent dividend, allowing his Berkshire Hathaway Inc. to earn $800 million a year without the warrants unless the companies collapse. In exchange, the firms got Berkshire's cash and endorsement by the ``Oracle of Omaha'' at a time when stock prices are falling on concern that a tightening credit market may hobble even the largest companies.
Buffett ``doesn't have a two-week time horizon,'' said Frank Betz, a partner at Warren, New Jersey-based Carret Zane Capital Management, which holds Berkshire and GE shares. ``Just because these prices drop below the strike price, it doesn't suggest that either of them are not exceptionally good investments.''
GE, the world's biggest maker of jet engines, agreed Oct. 1 to give Berkshire warrants to purchase $3 billion in shares at $22.25 apiece. As with the Goldman deal, Buffett's warrants for GE stock are good for five years. The shares, which closed at $24.50 the day of the agreement, have for five days ended trading below Buffett's strike price. The rose 1.7 percent to $20.65 today in New York Stock Exchange composite trading.
Pick and Hold
``You've got to pick them and hold them,'' said Gerald Martin, a finance professor at American University's Kogod School of Business in Washington. ``He admits that he can't time markets, and he takes a very long time horizon.''
Buffett, heralded as the world's best stock picker, agreed to the investments while some rivals find themselves short of cash. The worst housing slump since the Great Depression has resulted in record mortgage defaults in the U.S. and a yearlong contraction in global credit markets, driving down stock prices and sending firms like Goldman and GE in search of funds.
For Buffett, whose Berkshire Hathaway had $44.3 billion in cash at the start of the year, it's also been a call to action. He's committed at least $28 billion this year to acquire companies, finance buyouts and purchase securities for Omaha, Nebraska-based Berkshire. Buffett is Berkshire's chairman.
``We want to use cash,'' Buffett told PBS's Charlie Rose in an interview last week. ``There are times when cash buys more than other times, and this is one of those times where it buys more.''
`Beginning to Scream'
Goldman has fallen 47 percent this year in New York Stock Exchange composite trading; GE has declined 44 percent. The Standard & Poor's 500 Index slid 1.1 percent to 984.94 today, extending its 2008 tumble to 33 percent in the market's worst yearly slump in 71 years.
``Top-quality, well-managed firms like Goldman and GE are getting to the point where the values are beginning to scream,'' Betz said. ``Those are the sorts of companies that will continue to earn money and continue to function well.''
Buffett, ranked the second-richest man in the U.S. by Forbes magazine, transformed Berkshire from a failing textile maker into an enterprise with businesses ranging from ice cream and underwear to corporate jet leasing and insurance.
Goldman, the most profitable Wall Street firm, fell 1.7 percent today in New York trading to $113. That leaves Goldman, for the first time, below the price at which Buffett can buy $5 billion of shares (i.e $115). When the deal was announced last month, Goldman closed at $125.05, meaning Buffett was up $437 million.
Goldman and GE also sold Buffett a combined $8 billion in preferred shares that pay a 10 percent dividend, allowing his Berkshire Hathaway Inc. to earn $800 million a year without the warrants unless the companies collapse. In exchange, the firms got Berkshire's cash and endorsement by the ``Oracle of Omaha'' at a time when stock prices are falling on concern that a tightening credit market may hobble even the largest companies.
Buffett ``doesn't have a two-week time horizon,'' said Frank Betz, a partner at Warren, New Jersey-based Carret Zane Capital Management, which holds Berkshire and GE shares. ``Just because these prices drop below the strike price, it doesn't suggest that either of them are not exceptionally good investments.''
GE, the world's biggest maker of jet engines, agreed Oct. 1 to give Berkshire warrants to purchase $3 billion in shares at $22.25 apiece. As with the Goldman deal, Buffett's warrants for GE stock are good for five years. The shares, which closed at $24.50 the day of the agreement, have for five days ended trading below Buffett's strike price. The rose 1.7 percent to $20.65 today in New York Stock Exchange composite trading.
Pick and Hold
``You've got to pick them and hold them,'' said Gerald Martin, a finance professor at American University's Kogod School of Business in Washington. ``He admits that he can't time markets, and he takes a very long time horizon.''
Buffett, heralded as the world's best stock picker, agreed to the investments while some rivals find themselves short of cash. The worst housing slump since the Great Depression has resulted in record mortgage defaults in the U.S. and a yearlong contraction in global credit markets, driving down stock prices and sending firms like Goldman and GE in search of funds.
For Buffett, whose Berkshire Hathaway had $44.3 billion in cash at the start of the year, it's also been a call to action. He's committed at least $28 billion this year to acquire companies, finance buyouts and purchase securities for Omaha, Nebraska-based Berkshire. Buffett is Berkshire's chairman.
``We want to use cash,'' Buffett told PBS's Charlie Rose in an interview last week. ``There are times when cash buys more than other times, and this is one of those times where it buys more.''
`Beginning to Scream'
Goldman has fallen 47 percent this year in New York Stock Exchange composite trading; GE has declined 44 percent. The Standard & Poor's 500 Index slid 1.1 percent to 984.94 today, extending its 2008 tumble to 33 percent in the market's worst yearly slump in 71 years.
``Top-quality, well-managed firms like Goldman and GE are getting to the point where the values are beginning to scream,'' Betz said. ``Those are the sorts of companies that will continue to earn money and continue to function well.''
Buffett, ranked the second-richest man in the U.S. by Forbes magazine, transformed Berkshire from a failing textile maker into an enterprise with businesses ranging from ice cream and underwear to corporate jet leasing and insurance.
Sunday, October 5, 2008
Economics 101
Steve Keen
October 6, 2008
IN MAY 2007, the Organisation for Economic Co-operation and Development (OECD) commented that "the current economic situation is in many ways better than what we have experienced in years. Our central forecast remains indeed quite benign".
Three months later, the financial crisis began: the US stockmarket started its long decline and house prices fell. Financial institutions began to resemble tenpins rather than the pillars of society they had once been.
G4 leaders stop short of bailout
European leaders vow to help banks out at the end of an emergency summit in France to try to shore up confidence in the banking system.
A year later, the crisis has become even more extreme, with five more large international banks failing the weekend the US
Government devised a $US700 billion ($897 billion) bailout plan, only to have it rejected by Congress.
WHAT CAUSED THE CRISIS?
The immediate cause was the collapse in American house prices, which had doubled between January 2000 and August 2006, and have since fallen by 20%. More than 1% of American households have defaulted on their mortgages.
Up to a quarter of mortgages were "subprime", and fi nanced by the issuing of "residential mortgage-backed securities" rather than by traditional bank loans. The bonds were then sold to investors, pension funds and councils all over the world. Those buyers have since lost not just their anticipated interest but also much of their principal.
The bonds were also used by lenders to raise money through repo agreements - a contract in which one finance company sells another a bond in return for cash, and is then obligated to buy the same bond. By August 2007, so many households
had defaulted that the bond prices began to plunge, and suddenly lenders refused to accept them as collateral for loans.
The wholesale money market collapsed, and the credit crunch began. The long-term cause of the crisis was the dramatic growth in private debt in America - from a low of 37% of GDP in 1945 to 290% now - and across the OECD. The subprime fiasco was the final stage in a process that has seen lending extended to progressively riskier and less viable borrowers.
This final lending spree drove both stock and house prices to historically unprecedented levels, from which they are now falling, bankrupting both borrowers and lenders.
WHY DOES IT MATTER THAT THESE SUBPRIME BONDS ARE WORTHLESS?
The long-term problem is that buyers of these bonds are getting far lower returns than they expected from their investments. The money they used to buy the bonds has essentially been lost. They will have far less income - and far less capital - than they had anticipated and may face bankruptcy.
The more immediate problem is that, when the financial bubble was at its biggest, these bonds were the mainstay of the repo trade. Now no one wants to buy a bond in case the seller is unable to buy it back as promised. The repo market has
therefore dried up, and the bonds are effectively worthless.
However, many financial institutions still record the value of these bonds at the original sale price - their nominal or "book value" - rather than their market value.
If they were instead valued at what they could be sold for now, next to nothing, the recorded value of those companies' assets would fall, making them effectively insolvent and unable to lend. Their managers live in dread of some event forcing
them to do that - such as a distress sale by a company trying to avoid bankruptcy.
This is why the US rescue plan was devised: to buy these toxic bonds, euphemistically called "troubled assets", before the
fi nancial institutions were forced to value them.
If a global recession results from this crisis, it would be diffi cult for us to avoid a recession here as well.
WHAT IS THE US RESCUE PLAN?
The plan involves the US treasury buying up to $US700 billion worth of "troubled assets" from financial institutions, then covering that cost by selling $US700 billion in new government bonds to the public.
SO WOULD THE PLAN WORK?
That's very hard to say, but the details are not promising. This is a rescue plan devised by people who didn't see the crisis coming in the first place - otherwise they would never have allowed subprime loans to be created. If they didn't understand
the problem with subprimes, then it's possible they don't understand the system they're now trying to rescue.
Even the amount nominated, almost US$150 billion more than the US has spent on the war in Iraq, was not chosen in any scientific way. A US treasury spokeswoman told Forbes magazine: "It's not based on any particular data point. We just wanted to choose a really large number."
There's also the problem of how much the plan would pay for these toxic bonds. The initial proposal was to set the price through a "reverse auction": start by offering a low purchase price, and progressively increase it until individual financial
corporations decide to sell.
However, this could result in sales by more solvent firms at prices that would bankrupt less solvent ones, so it is likely that this, and many other, aspects of the plan will change in time - if it is passed into law by Congress.
If the US financial system is to continue, then the assets of financial institutions must be increased - and this bailout would enable them to replace some of their impaired assets with $US700 billion in cash. But this could still cause a significant fall in their assets, depending on the sale price. And the book value of outstanding mortgage debt is $US14 trillion. With mortgage defaults at unprecedented levels and still on the rise, there's no guarantee the plan is big enough to succeed.
SO HOW DOES ALL THIS AFFECT AUSTRALIA?
In our globalised fi nancial system, crises anywhere can cause ructions elsewhere. Banks and investors throughout the world hold CDOs linked to the American crisis, so that bankruptcies in the US can damage the financial security of a municipal council in Australia.
ARE COMPARISONS WITH THE GREAT DEPRESSION JUSTIFIED?
The real comparison now is with the financial crisis that preceded the Great Depression, centred on the stockmarket collapse of 1929. Then, despite a 36% fall in the share index that year, all the Wall Street merchant banks made it through
the Great Depression.
This time, all fi ve Wall Street behemoths have either failed (Lehman Brothers), been taken over at bargain-basement prices
(Bear Stearns, Merrill Lynch), or have sought to change their status to that of commercial banks before they failed (Morgan Stanley and Goldman Sachs). And the expected economic downturn has only begun. So the financial crisis is much worse than in 1929.
So is the level of private debt. When the 1929 crisis began, America's private debt was equivalent to 1.5 years of the nation's GDP.
It is now equivalent to 2.9 years of GDP - and that doesn't include the net debt involved in the $US500 trillion derivatives market. So the debt situation is almost twice as bad.
One attenuating factor is that the US is not as economically dominant as in the 1920s, and the emerging economies of China and India may counteract America's downturn.
But the US is still the world's largest economy, and many other OECD nations are as indebted as the US. How the now widely expected economic downturn compares to the Great Depression remains to be seen.
Associate Professor Steve Keen is from the school of economics and finance at the University of Western Sydney.
October 6, 2008
IN MAY 2007, the Organisation for Economic Co-operation and Development (OECD) commented that "the current economic situation is in many ways better than what we have experienced in years. Our central forecast remains indeed quite benign".
Three months later, the financial crisis began: the US stockmarket started its long decline and house prices fell. Financial institutions began to resemble tenpins rather than the pillars of society they had once been.
G4 leaders stop short of bailout
European leaders vow to help banks out at the end of an emergency summit in France to try to shore up confidence in the banking system.
A year later, the crisis has become even more extreme, with five more large international banks failing the weekend the US
Government devised a $US700 billion ($897 billion) bailout plan, only to have it rejected by Congress.
WHAT CAUSED THE CRISIS?
The immediate cause was the collapse in American house prices, which had doubled between January 2000 and August 2006, and have since fallen by 20%. More than 1% of American households have defaulted on their mortgages.
Up to a quarter of mortgages were "subprime", and fi nanced by the issuing of "residential mortgage-backed securities" rather than by traditional bank loans. The bonds were then sold to investors, pension funds and councils all over the world. Those buyers have since lost not just their anticipated interest but also much of their principal.
The bonds were also used by lenders to raise money through repo agreements - a contract in which one finance company sells another a bond in return for cash, and is then obligated to buy the same bond. By August 2007, so many households
had defaulted that the bond prices began to plunge, and suddenly lenders refused to accept them as collateral for loans.
The wholesale money market collapsed, and the credit crunch began. The long-term cause of the crisis was the dramatic growth in private debt in America - from a low of 37% of GDP in 1945 to 290% now - and across the OECD. The subprime fiasco was the final stage in a process that has seen lending extended to progressively riskier and less viable borrowers.
This final lending spree drove both stock and house prices to historically unprecedented levels, from which they are now falling, bankrupting both borrowers and lenders.
WHY DOES IT MATTER THAT THESE SUBPRIME BONDS ARE WORTHLESS?
The long-term problem is that buyers of these bonds are getting far lower returns than they expected from their investments. The money they used to buy the bonds has essentially been lost. They will have far less income - and far less capital - than they had anticipated and may face bankruptcy.
The more immediate problem is that, when the financial bubble was at its biggest, these bonds were the mainstay of the repo trade. Now no one wants to buy a bond in case the seller is unable to buy it back as promised. The repo market has
therefore dried up, and the bonds are effectively worthless.
However, many financial institutions still record the value of these bonds at the original sale price - their nominal or "book value" - rather than their market value.
If they were instead valued at what they could be sold for now, next to nothing, the recorded value of those companies' assets would fall, making them effectively insolvent and unable to lend. Their managers live in dread of some event forcing
them to do that - such as a distress sale by a company trying to avoid bankruptcy.
This is why the US rescue plan was devised: to buy these toxic bonds, euphemistically called "troubled assets", before the
fi nancial institutions were forced to value them.
If a global recession results from this crisis, it would be diffi cult for us to avoid a recession here as well.
WHAT IS THE US RESCUE PLAN?
The plan involves the US treasury buying up to $US700 billion worth of "troubled assets" from financial institutions, then covering that cost by selling $US700 billion in new government bonds to the public.
SO WOULD THE PLAN WORK?
That's very hard to say, but the details are not promising. This is a rescue plan devised by people who didn't see the crisis coming in the first place - otherwise they would never have allowed subprime loans to be created. If they didn't understand
the problem with subprimes, then it's possible they don't understand the system they're now trying to rescue.
Even the amount nominated, almost US$150 billion more than the US has spent on the war in Iraq, was not chosen in any scientific way. A US treasury spokeswoman told Forbes magazine: "It's not based on any particular data point. We just wanted to choose a really large number."
There's also the problem of how much the plan would pay for these toxic bonds. The initial proposal was to set the price through a "reverse auction": start by offering a low purchase price, and progressively increase it until individual financial
corporations decide to sell.
However, this could result in sales by more solvent firms at prices that would bankrupt less solvent ones, so it is likely that this, and many other, aspects of the plan will change in time - if it is passed into law by Congress.
If the US financial system is to continue, then the assets of financial institutions must be increased - and this bailout would enable them to replace some of their impaired assets with $US700 billion in cash. But this could still cause a significant fall in their assets, depending on the sale price. And the book value of outstanding mortgage debt is $US14 trillion. With mortgage defaults at unprecedented levels and still on the rise, there's no guarantee the plan is big enough to succeed.
SO HOW DOES ALL THIS AFFECT AUSTRALIA?
In our globalised fi nancial system, crises anywhere can cause ructions elsewhere. Banks and investors throughout the world hold CDOs linked to the American crisis, so that bankruptcies in the US can damage the financial security of a municipal council in Australia.
ARE COMPARISONS WITH THE GREAT DEPRESSION JUSTIFIED?
The real comparison now is with the financial crisis that preceded the Great Depression, centred on the stockmarket collapse of 1929. Then, despite a 36% fall in the share index that year, all the Wall Street merchant banks made it through
the Great Depression.
This time, all fi ve Wall Street behemoths have either failed (Lehman Brothers), been taken over at bargain-basement prices
(Bear Stearns, Merrill Lynch), or have sought to change their status to that of commercial banks before they failed (Morgan Stanley and Goldman Sachs). And the expected economic downturn has only begun. So the financial crisis is much worse than in 1929.
So is the level of private debt. When the 1929 crisis began, America's private debt was equivalent to 1.5 years of the nation's GDP.
It is now equivalent to 2.9 years of GDP - and that doesn't include the net debt involved in the $US500 trillion derivatives market. So the debt situation is almost twice as bad.
One attenuating factor is that the US is not as economically dominant as in the 1920s, and the emerging economies of China and India may counteract America's downturn.
But the US is still the world's largest economy, and many other OECD nations are as indebted as the US. How the now widely expected economic downturn compares to the Great Depression remains to be seen.
Associate Professor Steve Keen is from the school of economics and finance at the University of Western Sydney.
Friday, October 3, 2008
People have never been so fearful, says Buffett
Erik Holm and Andrew Frye
October 3, 2008
THE billionaire investor Warren Buffett says the US economy is "flat on the floor" after a cardiac arrest as companies struggle to secure funding and unemployment increases.
"In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now," Mr Buffett told PBS yesterday.
"The economy is going to be getting worse for a while."
His comments came as new figures showed US manufacturing contracted last month at the fastest pace since the last recession, as the credit crisis spread beyond Wall Street.
The contraction was more severe than expected - hitting the lowest level since the aftermath of the September 11, 2001, terror attacks - as new orders slowed dramatically.
The reading of 43.5 from the Institute for Supply Management was down from 49.9 in August. A reading of more than 50 signals growth.
Ian Shepherdson, chief US economist at High Frequency Economics, said: "The headline ISM has plunged into recession territory."
The index has been hovering on what economists call "the boom-bust" line for most of the year, but this is the first time it has dropped significantly.
Other figures from the US Commerce Department said construction activity was unchanged in August, even though spending for residential projects rose for the first time in 17 months - good news in the midst of the worst housing downturn in decades.
The report said construction activity was flat in August, an outcome better than the 0.5 per cent fall economists had expected.
The big surprise was a 0.3 per cent rise in residential activity, the first increase in housing activity since March last year.
The biggest US housing slump since the Great Depression has spurred a wave of defaults and a year-long contraction in global credit markets, squeezing companies' capacity for investment.
The credit freeze was "sucking blood" from the US economy, Mr Buffett said.
The bankruptcy of Lehman Brothers and Washington Mutual, and the emergency sales of Merrill Lynch and Wachovia, fuelled fears about the vulnerability of companies that rely on capital markets for short-term funding.
Because of the recent drought in credit market activity, more big companies are having trouble getting loans at rates they can afford and, as a result, they are altering their business plans.
The longer the credit markets stay tight, the longer many companies will have to draw down their reserves and credit lines.
Eventually, companies' inability to get credit could deliver a big blow to the already deteriorating economy.
The chief executive of the consumer products maker, Procter & Gamble, wrote in a newspaper column that its customers were feeling pinched, and small- and mid-sized suppliers were not finding enough money to run their businesses.
Car makers revealed dismal monthly sales results for September, with potential customers unable to obtain car loans and dealerships unable to secure financing to maintain inventories.
Bloomberg, Associated Press
October 3, 2008
THE billionaire investor Warren Buffett says the US economy is "flat on the floor" after a cardiac arrest as companies struggle to secure funding and unemployment increases.
"In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now," Mr Buffett told PBS yesterday.
"The economy is going to be getting worse for a while."
His comments came as new figures showed US manufacturing contracted last month at the fastest pace since the last recession, as the credit crisis spread beyond Wall Street.
The contraction was more severe than expected - hitting the lowest level since the aftermath of the September 11, 2001, terror attacks - as new orders slowed dramatically.
The reading of 43.5 from the Institute for Supply Management was down from 49.9 in August. A reading of more than 50 signals growth.
Ian Shepherdson, chief US economist at High Frequency Economics, said: "The headline ISM has plunged into recession territory."
The index has been hovering on what economists call "the boom-bust" line for most of the year, but this is the first time it has dropped significantly.
Other figures from the US Commerce Department said construction activity was unchanged in August, even though spending for residential projects rose for the first time in 17 months - good news in the midst of the worst housing downturn in decades.
The report said construction activity was flat in August, an outcome better than the 0.5 per cent fall economists had expected.
The big surprise was a 0.3 per cent rise in residential activity, the first increase in housing activity since March last year.
The biggest US housing slump since the Great Depression has spurred a wave of defaults and a year-long contraction in global credit markets, squeezing companies' capacity for investment.
The credit freeze was "sucking blood" from the US economy, Mr Buffett said.
The bankruptcy of Lehman Brothers and Washington Mutual, and the emergency sales of Merrill Lynch and Wachovia, fuelled fears about the vulnerability of companies that rely on capital markets for short-term funding.
Because of the recent drought in credit market activity, more big companies are having trouble getting loans at rates they can afford and, as a result, they are altering their business plans.
The longer the credit markets stay tight, the longer many companies will have to draw down their reserves and credit lines.
Eventually, companies' inability to get credit could deliver a big blow to the already deteriorating economy.
The chief executive of the consumer products maker, Procter & Gamble, wrote in a newspaper column that its customers were feeling pinched, and small- and mid-sized suppliers were not finding enough money to run their businesses.
Car makers revealed dismal monthly sales results for September, with potential customers unable to obtain car loans and dealerships unable to secure financing to maintain inventories.
Bloomberg, Associated Press
Aust -Brace for economic misery
Michael West
October 3, 2008 - 11:00AM
UPDATE The US national debt ticked over $US10 trillion for the first time last night. There is no more significance to this number other than it being a big, bad, round symbolic figure.
Though it does serve to illustrate one of the concerns over the $700 billion ($900 billion) bail-out package, that even if it were good policy it's just too damned small.
And it comes at a time when America is about to dive deeper into debt to bail out Wall Street. Interbank rates hovered at all-time highs last night as banks refused to lend to each other.
Meanwhile, stock prices careered down again as a slather of poor economic data and company downgrades all pointed one way...deep recession. In Australia, stocks are back to late-2005 levels.
Is Australia in for a hard landing?
Apart from the layman's observation that global recession is taking grip - and nine of Australia's top ten trading partners are all facing slower growth this year (Thailand being the only exception) - this story should be prefaced by the fact that economists and assorted pundits have not yet deemed Australia to be heading for a soft landing, let alone a hard landing.
The official line remains that there will be no recession at all, recession being a decline in economic activity for two consecutive quarters.
Economists' forecasts are clustered around the number 2.6% for GDP growth in 2008 and 2.8% for 2009.
Economists really ought to show disclaimers such as the ''past performance is no indicator of future success'' which can be found in product disclosure statements.
Or perhaps past performance is an excellent indicator of future success.
Forecast follies
Let's take a look. Where were the pundits clustered before the last recession, not the blip in the aftermath of the dotcom bubble but the big one in 1991-92 which saw a million people out of work?
The prelude to the recession of the early 1990s was characterised by an asset price bubble and excessive corporate gearing levels. Unemployment had fallen to 5.6%, real domestic demand growth surpassed 8% at its peak, and inflation touched 8.6%.
Under the Prime Minister of the day, Paul Keating - who incidentally told the ABC's Lateline show this week that the global financial system was disintegrating and things were far more serious this time around - tightened the cash rate to 17.5% to prick the asset-price bubble. Commercial property and bank share prices crashed. Recession ensued.
What were the forecasters of the day saying? In the 1989 lead-up to the recession, the Government Budget was forecasting 2.75% real growth for 1989-90.
Market economists were gunning for GDP growth to slow to 2% to 2.2%. Not a stretch from the present estimates.
Commonwealth Bank was tipping growth to drop from 4.5% to 1% in 1990, National Australia was gunning for a ''slowdown''. The NAB business survey had the outlook positive and the OECD estimated employment would grow, inflation would fall and demand would rise just as quickly as it had in 1989. There would be no recession, was the tip from the OECD.
Actual outcome? GDP growth in 1990 was 0.65% and the following year the economy contracted by 0.8%.
In December the following year, the OECD was still saying a recession would probably be avoided. In May 1990, the IMF was forecasting growth of 1% after inflation and a rebound in 1991.
Debt binge
What is different this time around?
The critical, and most dangerous, factor is that last time a corporate debt binge was the culprit and this time it is household gearing.
Australia's private debt was less than 70% of GDP in 1990. In 2008 it is 150%. That is a frightening figure. Aussies have borrowed everything from the monster flat screen from Harvey Norman to the car, the share portfolio and the kids' school fees.
It would not be too bold a call to suggest that if there is a hard landing in Australia this time around the human suffering could be far greater than in the early 90s.
On a bright note it should be said that the stock market did rally 30% from December 1990 to December 1991 and the hammering in world markets now is merely part of the cycle.
It is always darkest before dawn. Markets, again, will rebound in anticipation of an economic recovery. Right now, though, it is an almost unassailable conclusion that share prices are factoring in a significant recession.
What else is different this time?
House prices are higher in both real and relative terms, interest rates are lower, inflation is running at 4% versus a peak of 8.6%, the debt service burden is 11.5% of income against a high of 9.5% in 1990, the oil price is five times higher.
Further, the unemployment rate bottomed out at 5.6% last time and this year it's hovered around 4.3%. In 2007, domestic demand surged to 6.6% as the economy hotted up while it hit its straps at a tad over 8% in the lead-up to the 90s recession.
China factor
The shape of the world economy has changed in the last 18 years. China has boomed.
Although Australia's GDP growth has historically tracked the US, this time we are in a particularly fortunate position of having a mining boom (although commodity prices have begun to come off sharply). And Government debt is not an issue.
That said, Australia like the US is a current account deficit country (currently 6.2% of GDP) which means our banking system borrows from the rest of the world to support our lavish lifestyle.
No longer can this country rely on a debt-funded spending spree to fuel a recovery. This is bad news for both the banks and the consumer.
What is the range of views now? The Government is sanguine about growth. Finance Minister Lindsay Tanner debunked ''gloom and doom'' assessments saying recession was unlikely, or at least that calling a recession was ''premature''.
Isn't making premature judgements called forecasting?
Tanner conceded that Australia was not immune to events in the US but was on a more ''solid'' footing. While he could be right, being Finance Minister he does have something of a duty in ''jawboning'' the economy.
Zero growth
One of the outliers in economic circles, Associate Professor Steve Keen of University of Western Sydney has GDP growth this calendar year at 2% and zero growth for the year to June.
''Today, we owe 165% of GDP - that's more than twice the level of the Great Depression,'' said Keen recently.
''In the US, in 1929 before the big crash, it owed 150% of GDP, now it owes nearly 300% of GDP. So we are obviously in a more precarious position now than in the run-up to 1929.''
Keen has drawn all sorts of flak for predicting a sub-prime crisis in Australia triggered by a mass of loan defaults in the mortgage belts of western Sydney and elsewhere.
The credit crisis he reckons will expedite the deleveraging of households which will culminate in a ''long, deep recession'' the likes of the Japanese experience in the 1990s.
Recession risks
To the market economists then: AMP's Shane Oliver is forecasting a 40% chance of a recession some time next year with Australia to be protected to an extent by mining revenues.
JP Morgan's Stephen Walters says the risks are rising though he is yet to pull back his 2.6% growth forecast for 2009.
Tim Toohey from Goldman Sachs is tipping 2.7% growth for 2009 and Merrills' Peter Osborne forecasts 2.5% growth for 2008 and 2.7% for 2009 with the risk ''on the downside''.
Not one of the mainstream market strategists or economists predicted the events of this year - not that they could be expected to - and the only pundits who got it right were those who were last year regarded as crackpots and conspiracy theorists.
Some of these ''marginal'' types, operating mostly in the blogosphere, are now looking decidedly bard-like. Their ranks are proliferating, and as officialdom and the mainstream pundits stick to their upbeat numbers, the ratio of ''D'' words to ''R'' words is on the increase in cyberspace.
The proponents of the ''D'' word are not all crackpots by the way. Though at this point a ''D'' would appear somewhat alarmist. An ''R'', however, would seem entirely on the cards.
And the sheer magnitude of household debt would render such an outcome ugly.
October 3, 2008 - 11:00AM
UPDATE The US national debt ticked over $US10 trillion for the first time last night. There is no more significance to this number other than it being a big, bad, round symbolic figure.
Though it does serve to illustrate one of the concerns over the $700 billion ($900 billion) bail-out package, that even if it were good policy it's just too damned small.
And it comes at a time when America is about to dive deeper into debt to bail out Wall Street. Interbank rates hovered at all-time highs last night as banks refused to lend to each other.
Meanwhile, stock prices careered down again as a slather of poor economic data and company downgrades all pointed one way...deep recession. In Australia, stocks are back to late-2005 levels.
Is Australia in for a hard landing?
Apart from the layman's observation that global recession is taking grip - and nine of Australia's top ten trading partners are all facing slower growth this year (Thailand being the only exception) - this story should be prefaced by the fact that economists and assorted pundits have not yet deemed Australia to be heading for a soft landing, let alone a hard landing.
The official line remains that there will be no recession at all, recession being a decline in economic activity for two consecutive quarters.
Economists' forecasts are clustered around the number 2.6% for GDP growth in 2008 and 2.8% for 2009.
Economists really ought to show disclaimers such as the ''past performance is no indicator of future success'' which can be found in product disclosure statements.
Or perhaps past performance is an excellent indicator of future success.
Forecast follies
Let's take a look. Where were the pundits clustered before the last recession, not the blip in the aftermath of the dotcom bubble but the big one in 1991-92 which saw a million people out of work?
The prelude to the recession of the early 1990s was characterised by an asset price bubble and excessive corporate gearing levels. Unemployment had fallen to 5.6%, real domestic demand growth surpassed 8% at its peak, and inflation touched 8.6%.
Under the Prime Minister of the day, Paul Keating - who incidentally told the ABC's Lateline show this week that the global financial system was disintegrating and things were far more serious this time around - tightened the cash rate to 17.5% to prick the asset-price bubble. Commercial property and bank share prices crashed. Recession ensued.
What were the forecasters of the day saying? In the 1989 lead-up to the recession, the Government Budget was forecasting 2.75% real growth for 1989-90.
Market economists were gunning for GDP growth to slow to 2% to 2.2%. Not a stretch from the present estimates.
Commonwealth Bank was tipping growth to drop from 4.5% to 1% in 1990, National Australia was gunning for a ''slowdown''. The NAB business survey had the outlook positive and the OECD estimated employment would grow, inflation would fall and demand would rise just as quickly as it had in 1989. There would be no recession, was the tip from the OECD.
Actual outcome? GDP growth in 1990 was 0.65% and the following year the economy contracted by 0.8%.
In December the following year, the OECD was still saying a recession would probably be avoided. In May 1990, the IMF was forecasting growth of 1% after inflation and a rebound in 1991.
Debt binge
What is different this time around?
The critical, and most dangerous, factor is that last time a corporate debt binge was the culprit and this time it is household gearing.
Australia's private debt was less than 70% of GDP in 1990. In 2008 it is 150%. That is a frightening figure. Aussies have borrowed everything from the monster flat screen from Harvey Norman to the car, the share portfolio and the kids' school fees.
It would not be too bold a call to suggest that if there is a hard landing in Australia this time around the human suffering could be far greater than in the early 90s.
On a bright note it should be said that the stock market did rally 30% from December 1990 to December 1991 and the hammering in world markets now is merely part of the cycle.
It is always darkest before dawn. Markets, again, will rebound in anticipation of an economic recovery. Right now, though, it is an almost unassailable conclusion that share prices are factoring in a significant recession.
What else is different this time?
House prices are higher in both real and relative terms, interest rates are lower, inflation is running at 4% versus a peak of 8.6%, the debt service burden is 11.5% of income against a high of 9.5% in 1990, the oil price is five times higher.
Further, the unemployment rate bottomed out at 5.6% last time and this year it's hovered around 4.3%. In 2007, domestic demand surged to 6.6% as the economy hotted up while it hit its straps at a tad over 8% in the lead-up to the 90s recession.
China factor
The shape of the world economy has changed in the last 18 years. China has boomed.
Although Australia's GDP growth has historically tracked the US, this time we are in a particularly fortunate position of having a mining boom (although commodity prices have begun to come off sharply). And Government debt is not an issue.
That said, Australia like the US is a current account deficit country (currently 6.2% of GDP) which means our banking system borrows from the rest of the world to support our lavish lifestyle.
No longer can this country rely on a debt-funded spending spree to fuel a recovery. This is bad news for both the banks and the consumer.
What is the range of views now? The Government is sanguine about growth. Finance Minister Lindsay Tanner debunked ''gloom and doom'' assessments saying recession was unlikely, or at least that calling a recession was ''premature''.
Isn't making premature judgements called forecasting?
Tanner conceded that Australia was not immune to events in the US but was on a more ''solid'' footing. While he could be right, being Finance Minister he does have something of a duty in ''jawboning'' the economy.
Zero growth
One of the outliers in economic circles, Associate Professor Steve Keen of University of Western Sydney has GDP growth this calendar year at 2% and zero growth for the year to June.
''Today, we owe 165% of GDP - that's more than twice the level of the Great Depression,'' said Keen recently.
''In the US, in 1929 before the big crash, it owed 150% of GDP, now it owes nearly 300% of GDP. So we are obviously in a more precarious position now than in the run-up to 1929.''
Keen has drawn all sorts of flak for predicting a sub-prime crisis in Australia triggered by a mass of loan defaults in the mortgage belts of western Sydney and elsewhere.
The credit crisis he reckons will expedite the deleveraging of households which will culminate in a ''long, deep recession'' the likes of the Japanese experience in the 1990s.
Recession risks
To the market economists then: AMP's Shane Oliver is forecasting a 40% chance of a recession some time next year with Australia to be protected to an extent by mining revenues.
JP Morgan's Stephen Walters says the risks are rising though he is yet to pull back his 2.6% growth forecast for 2009.
Tim Toohey from Goldman Sachs is tipping 2.7% growth for 2009 and Merrills' Peter Osborne forecasts 2.5% growth for 2008 and 2.7% for 2009 with the risk ''on the downside''.
Not one of the mainstream market strategists or economists predicted the events of this year - not that they could be expected to - and the only pundits who got it right were those who were last year regarded as crackpots and conspiracy theorists.
Some of these ''marginal'' types, operating mostly in the blogosphere, are now looking decidedly bard-like. Their ranks are proliferating, and as officialdom and the mainstream pundits stick to their upbeat numbers, the ratio of ''D'' words to ''R'' words is on the increase in cyberspace.
The proponents of the ''D'' word are not all crackpots by the way. Though at this point a ''D'' would appear somewhat alarmist. An ''R'', however, would seem entirely on the cards.
And the sheer magnitude of household debt would render such an outcome ugly.
Buffett Says Economy on Floor after heart attack
Oct. 2 (Bloomberg) -- Billionaire Warren Buffett talked with Charlie Rose yesterday in San Diego about Berkshire Hathaway Inc.'s $3 billion investment in General Electric Co., debate in Congress on a $700 billion financial-rescue package and the outlook for the U.S. economy and financial markets. ("Charlie Rose" airs weeknights on PBS. Source: Charlie Rose)
(This is not a legal transcript of the interview. Bloomberg LP cannot guarantee its accuracy.)
CHARLIE ROSE, ANCHOR, PBS: We are in San Diego, California this afternoon for a conversation with Warren Buffett. He is the man Congressional leaders, the administration, and the Federal Reserve want to talk and talk to. He is a legendary Chairman and CEO of Berkshire Hathaway. Its success has made him the world's richest man. He's admired for his investment results over a long period of time.
He is trusted for his common sense and the fact he has warned over the years in his annual letter to stockholders about some of the things that are contributing to the crisis facing America and the global economy.
For all those reasons, we have come to see him in San Diego, where he is attending the 'Fortune' magazine's most powerful women summit. Later, he will be interviewed at that conference by the 'Fortune' reporter and long time friend Carol Loomis.
We come this evening from the studios of our public television affiliate in San Diego, KPBS. I thank my friend Warren Buffett for taking time in a busy schedule to talk to us.
WARREN BUFFETT, INVESTOR: My pleasure, Charlie.
ROSE: Let me talk with the news today. You have announced an investment of $3 billion in General Electric, along the same terms as the Goldman Sachs.
BUFFETT: Almost identical.
ROSE: Why GE?
BUFFETT: Well, I got a call this morning from a friend of mine at Goldman Sachs saying they might be interested in such an investment. I'm familiar with the company. I've known the management, the current management, Jack Welsh, before Jeff Immelt. I've known him for decades. So I understand their businesses. We do a lot of business with them.
And GE is going to spend - I think it's the longest running stock in the Dow Jones Industrial Average. It will be 100 years now it will be around. I hope I'm around then too.
And it was an attractive investment. And we've had a lot of money around over the last few years and we're seeing some things that are attractive now.
ROSE: Are you looking at other things?
BUFFETT: I look at everything, Charlie. That's my job. I really do, every day. I think about everything.
ROSE: Cash is said to be king now. Are you sitting on a lot of cash so that this is the time for Berkshire Hathaway and Warren Buffett to look carefully at a lot of opportunities?
BUFFETT: Yes. We want to use cash. The reason we haven't used our cash, two years ago, we just didn't find things that were that attractive. But when people talk about cash being king, it's not king if it just sits there and never does anything. There are times when cash buys more than other times, and this is one of the times when it buys a fair amount more. And so we use it.
ROSE: There's a time accumulate and a time to spend.
BUFFETT: Absolutely. You want to be greedy when others are fearful. You want to be fearful when others are greedy. It's that simple.
ROSE: Where are they now?
BUFFETT: They're pretty fearful. In fact, in my adult lifetime, I don't think I've ever seen people as fearful economically as they are right now.
ROSE: And why is that?
BUFFETT: Well, it's because they have seen the credit market seize up. They've gotten worried about money market funds, although the latest proposition from the government should take care of that. They've seen 8 percent of the bank deposits in the United States get moved, very skillfully, I might say, within the last couple weeks from institutions that they thought were fine a few months ago to other institutions. They're not wrong to be worried.
ROSE: Is it being felt, as people often point out, on Main Street?
BUFFETT: I read about auto sales today. If you're an auto dealer, you're feeling it. If you're a furniture retailer, like we are, you're feeling it. If you're a jewelry retailer, you're feeling it. I know some of these businesses because we're in them. Yes, it's being felt, but it will be felt big time more if we don't do something about it, what's going on.
ROSE: The Senate will vote sometime this evening. Are you satisfied with that rescue plan?
BUFFETT: Well, I don't think it's perfect, but I don't know that I could draw one that's perfect. I would rather be approximately right than precisely wrong. And it would be precisely wrong to turn it down. We need - we have a terrific economy. It's like a great athlete that's had a cardiac arrest. And it's flat on the floor, and paramedics have arrived.
And they shouldn't argue about whether they put the resuscitation equipment a quarter of an inch this way or a quarter of an inch that way. Or they shouldn't start criticizing the patient because he didn't have blood pressure tests or something like that.
They should do what's needed right now and I think they will. I think the Congress will do the right thing. I think that they've gotten into certain arguments and then they start worry about assessing blame and there's a little demagoguery. But in the end, something this important, they'll do the right thing. This is really an economic Pearl Harbor. That sounds melodramatic, but I've never used that phrase before, and this really is one.
ROSE: Go through why that is true, beyond the fact that there's a freeze on credit, beyond the fact nobody's making loans, beyond the fact that banks don't lend to banks, beyond the fact that Treasury bills are at a low.
BUFFETT: When 40 billion of Treasury bills are sold, like they were last week, seven day Treasury bills, at a yield of 1/20th of 1 percent, that means the whole country is basically at the point, virtually - or a lot of the country is at the point of putting their money under the mattress. You're only 1/20th percent away from where it's better to put it under the mattress.
You don't want 300 million Americans putting their money under the mattress. This economy doesn't work well without the lubrication of credit and trust. And that's been lost and it's a huge problem.
What you have is you have the major institutions of the world all wanting to de-leverage. They want to take down their assets and liabilities. What seemed so easy to borrow against a year ago now looks like rat poison to them. So they're trying to de-leverage. There's only one institution in the world that can leverage up in a way that's at all a countervailing force to that. And that's the United States Treasury.
ROSE: Are you approving of what's been taking place along the stages that got us to where we are now. Whether it's Bear Stearns or Lehman Brothers or AIG, Freddie and Fannie, or what you've done with Goldman Sachs and the rest?
BUFFETT: Yes, I think basically the right things have been done, but no one saw the tsunami coming fully. And so when Bear Stearns came along, it looked like if you stopped the flood at that point, you didn't have to worry about being down stream from it. And I think the Fed did the right thing there.
And I really thought that would probably halt runs on other major institutions, but it didn't. We have seen wave after wave. And admittedly, there has been somewhat of an ad hoc response to there. I would rather have an ad hoc than no response at all.
And I don't think the Treasury could remotely have gone to Congress three or four months ago and laid out the scenario of what's happened and been credible and gotten the necessary tools. I think it took a crisis like this.
ROSE: And asking for the powers asking for and the levels it was asking for.
BUFFETT: They wouldn't have gotten it. So I think it's been kind of like a tragic play to this point. But at this point, I think it's clear and will be clear to the majority of the Congress, and I think it's clear to the American people, that there is only one countervailing force to a world where financial institutions are trying to sell instruments every day, and where credit is dried up. And that's the United States Treasury.
ROSE: But at the same time, there has been, and Congressmen and women will tell you this, a resistance across the country because they think, as you well know, it's a bailout of Wall Street, and that they are sitting there in their own economic life, and nobody's coming along to say we're here to help you; we're from the government.
BUFFETT: Well, the patient that's on the floor with the cardiac arrest is not Wall Street. It's the American economy.
ROSE: Do you think they understand that yet?
BUFFETT: I think they probably don't and I think any time you couple the term Wall Street with bailout or something like that - you know, I don't like what's going on in Wall Street. I don't like what's going on in executive compensation. But I don't want to give a lecture to this body that's out there having had the heart attack. I want to get it back functioning.
And as a practical matter, if you were at Bear Stearns and you were a shareholder, you lost 90 to 95 percent of your money. Good many lost their jobs. They lost very cushy lives, many of them. If you were at Lehman, the same thing happened. If you were at AIG, the share holders are getting creamed on these things.
And those share holders are not just a bunch of big shots on Wall Street. Those are pension funds. Those are investors all over the country.
I wouldn't worry too much about that. Justice won't be perfect on it. You may be very mad at some guy who walked away with a huge golden parachute, but that really isn't the important thing.
If Pearl Harbor came along, you could have said the planning was wrong by the military ahead of time, or maybe the battleship shouldn't have been in the harbor and all of that kind of thing. It doesn't make any difference. It's Pearl Harbor.
And you better not spend weeks and weeks trying to assign blame or deciding on a complete plan for fighting the whole war, and letting a committee decide where the battleship should go and all of that. You better spring into action with the best people you have.
ROSE: You have never seen anything like this in your life?
BUFFETT: No, I haven't.
ROSE: There are those who argue that we're headed for a recession, you know, and they look at Depression as the great fear.
BUFFETT: Sure.
ROSE: Is that a possibility if this plan doesn't work.
BUFFETT: Yes, it's a possibility. We have about 6.1 percent unemployment now. We've been in a recession by any common sense definition, because if you look at the American public, they've got $20 billion - $20 trillion, I should say, worth of residential homes. They've got $20 trillion worth of stocks, very roughly. Those are the two big assets of American families. They're both down dramatically for different families.
But 95 percent of the people, at least, are worse off in terms of their residential wealth plus stock wealth from a year ago or two years ago.
That is bleeding into the real economy. I mean that's bleeding into auto sales and jewelry sales and furniture sales and all that. But that wave is just starting to hit. And if the paralysis we have in the credit markets, if every company continues to feel all we want to do is get our balance sheet down, sell assets, it's just the start of what can happen.
Unemployment is going to go up under any circumstances. The 6.1 is going to go higher. But whether it goes and quits at seven or whether it quits at ten or 11 or 12 depends on, among other things, the wisdom of Congress and then the wisdom of - in terms of carrying out the plan that Congress authorizes.
ROSE: Would you say that this plan, which you have argued very strongly the Senate ought to pass and the House ought to pass, is simply the plan that we have and I don't have a better idea, but it's essential for the confidence of the nation and the system?
BUFFETT: Yes. I just worry about whether it's enough but -
ROSE: Enough what?
BUFFETT: Every day that goes by - if you don't react to Pearl Harbor for a week or two weeks or three weeks, you're behind in the war that you otherwise would have fought. But it's very important that the determination of the U.S. Congress to do what is needed be made evident this week, and by the actions of most of the members. You're not going to get total assent.
ROSE: What makes you confident that this plan will work?
BUFFETT: I think you've got - I don't think you could have a better secretary of the Treasury than Hank Paulson. He is in there at the wrong time. He probably should haven't taken the job. He's a friend of mine. But he knows markets. He knows how corporations work. He knows money. And he's got the interest of the country at heart.
And so you've got the right - you've got a wonderful person with Sheila Bair. Most of the viewers have never heard of Sheila Bair. Sheila Bair, in the last two weeks, has taken 8 percent of the deposits of the United States and seamlessly moved those over to sound institutions, which in turn have gotten more capital. It's been a magnificent job, 8 percent of the deposits of the United States, tens of millions of depositors.
Nobody has ever heard of her. She'll never get a golden parachute or severance pay or anything. She's done a great job. We have some great public servants. We have, I think, the right people in there to get the job done and they need more tools.
ROSE: And those more tools might be, in addition to what's in this plan?
BUFFETT: Well, they need plenty of money, and they really need plenty of flexibility to carry out this plan. They also need, in my view, to very much tie it to market prices.
I have said, Charlie, that the $700 billion, if they buy mortgages related securities or mortgages themselves, at current market prices, they're going to make money over time because the United States government has staying power, and it has a low cost of borrowing.
And if I could take 1 percent of that $700 billion pot and take the gain or loss from it and be their partner, and they would buy the stuff at market, I'd make a lot of money.
No, it's - I mean, you have hedge funds and people like that buying these assets to yield 15 or 20 percent. I mean, that's the buyer for these people that are trying to unload them. The U.S. Treasury has got borrowing costs like nobody else has. They can borrow basically unlimited amounts. They can stay there for years and years. These assets will be worth more money over time.
So when Merrill Lynch sells a bunch of mortgage related assets at $0.22 on the dollar, like they did a month ago, the buyer of those is going to make money and he's going to make a lot more money if it happens to be an institution like the U.S. government, which has very, very cheap borrowing costs.
ROSE: So you are saying to those tax payers who are worried about what's going to happen to $700 billion, chances are good that when these securities are purchased and sold, you will got a lot of your money back or all of your money back, and maybe something else.
BUFFETT: I would bet on it. If I got a chance to take 1 percent of the deal either way, I'm going to make that bet. When Berkshire Hathaway laid out $3 billion for GE today, we didn't spend it. We invested it. When the federal government buys the mortgages, they're not spending it, they're investing it.
Now they're investing it in distressed type assets, but they're buying them at distressed prices, if they buy them at market. It's the kind of stuff I love to do. I just don't have $700 billion. Maybe we can go in it together. With your money and my brains, there's no telling how far we can go.
ROSE: Whatever. I'll take the deal, whatever you want to do. There is this, though, in terms of alternative; some people have suggested, for example, that why don't we - why isn't America doing what Berkshire Hathaway is doing? Why isn't that a better deal for America?
BUFFETT: I don't think it would be crazy to have a model - an entity modeled on the Reconstruction Finance Corp. That goes back to 1932, although it was really implemented in '33 under Jessie Jones. And it invested in mostly banks, initially, and preferred stock and that sort of thing.
So there is - there are two things needed in the system. The one that's needed overwhelmingly is liquidity. When people are trying to de-leverage, there has to be somebody there to buy. And they don't have to buy at fancy prices, but to buy.
And then there's also a capital problem with some of the institutions. We have provided capital here with a couple institutions recently. The federal government did that in the '30s for the RFC and I think there could well be a proper role for government in that.
ROSE: Would that have been a better idea today?
BUFFETT: It wouldn't have been big enough today. You couldn't have - if you set up an RFC today and you gave them $100 billion to invest in the capital, there would be a very cumbersome type of application process and everything. These assets are getting shoved out day by day and loans are coming to - commercial papers not being renewed.
The commercial paper market, when that dries up, that's just like sucking the blood out of the economic body of the United States. And that's happening.
So I would say that an RFC like thing might make sense. I probably would do it myself, but I don't think trying to combine that with what's going through now - I think what's needed now is liquidity.
ROSE: Right. There are those who - you just said you would do it yourself - there are those who believe, and it has been suggested, that this is the time for Warren Buffett to answer the call of his government in a country that's been very good to him. What are you prepared to do yourself beyond run Berkshire Hathaway well?
BUFFETT: That's my job. Any time I can be of help to the government, in terms of giving advice - I've given a little advice, actually.
(CROSSTALK)
BUFFETT: Trouble is it gets when it really counts. But anyway, obviously, I'm here tonight talking about this for that reason. It isn't going to do anything for Berkshire Hathaway. That isn't really true.
Anything that enables this economy to run in the manner that it should - we've got the same plants out there we had two years ago. We got the houses. We've got people that are more productive than they've ever been in the history of this country. We've got a wonderful economic formula in this country. But right now it is being - it's been brought to a halt by -
ROSE: By?
BUFFETT: It's the de-leveraging that's going on right now that has caused the credit crisis.
ROSE: I mentioned earlier in this introduction to you, if you read your letters to your stock holders, which you write and Carol Loomis edits every year, and you think of your sister as a person -
(CROSSTALK)
ROSE: You have talked about derivatives. Derivatives are, in part, at the core of this problem. Yes?
BUFFETT: AIG would be doing fine today. It was one of the ten largest companies of the United States in terms of market value, over $200 billion, the most respected insurer in the world. If they never heard of the word derivatives, they would be doing fine. Everybody would be going to work in the morning and they would have no troubles.
But they - it was very easy to do, because very tempting to write numbers on little pieces of paper, and you can kind of report the profits you want to, and there's no limit on it. I mean, there's no capital requirements to it or anything of the sort.
And basically I said they were possibly financial weapons of mass destruction and they have been. I mean, they destroyed AIG. They certainly contributed to the destruction of Bear Stearns and Lehman, although Lehman had other problems too.
ROSE: I'm interested in this, because people are asking me, did people get away with murder here? Were there people who simply gamed the system and took advantage and made huge amounts of profit and we had excesses that inevitably led to where we are today?
BUFFETT: Well we had all of that. But I would say the biggest single cause was that we had an incredible residential real estate bubble. You can go back to tulip bulbs in Holland 400 years ago, human beings going through combinations of fear and greed and all of that sort of thing, their behavior can lead to bubbles.
And they've had an Internet bubble at one time. You've had a farm bubble, farm land bubble in the Midwest, which resulted in all kinds of tragedy in the early 80s.
But we've had 300 million Americans, their lending institutions, their government, their media, all believed that house prices were going to go up consistently. And that got built into a $20 trillion residential home market. Lending was done based on it. And everybody did a lot of foolish things.
And where people really behaved in a fraudulent way or something, they'll go back and find the culprits later on. But that really isn't the problem we have. That's where it came from, though.
We leveraged up. And if you have a 20 percent fall in the value of a $20 trillion asset, that's $4 trillion. And when $4 trillion losses land in the wrong part of this economy, it can gum up the whole place.
ROSE: And it continues with respect to the housing market.
BUFFETT: It continues.
ROSE: And some will argue that we have to do something about that, in terms of the long-term recovery of the American economy.
BUFFETT: There's no question we have an excess stock. The good thing is we have household formation in this country. We have a country where - I don't know whether it's a million households a year or more, but get formed (ph). So we can eat off an inventory.
But the inventory is too big and house prices just soared beyond reason in many places. And they got financed in silly ways and people lied about loans, all kinds of excesses entered into it. But that is the single biggest cause of why we are here.
ROSE: And should wise people have known better?
BUFFETT: People always should know better. People don't get - they don't get smarter about things that get as basic as greed. And you can't stand to see your neighbor getting rich. You know you're smarter than he is and he's doing these things and he's getting rich. And your spouse is getting unhappy with you because you aren't doing. Pretty soon, you start doing it.
And so you get what I call the natural progression, the three Is - the innovators, the imitators and the idiots. Everybody just kind of goes along and you look kind of silly if you disagree.
You can have these crazy Internet valuations in the late 1990s, but they proved themselves out in the market. I mean, the next day, they were selling for more than they were the day before. And people said, you're crazy if you don't get in on this. So it's very human.
Now with housing, it's something even more dramatic than that, because most people aspire to own their own home. And if you really think that housing prices are going to go up next year and the year after, you feel, if I don't buy it this year, I'm going to have to buy it next year. That's not true of an Internet stock, but it is true of a home.
And then when somebody makes it very easy for you to do it, by saying you don't really have to put up any money or you can lie about your income a little, or we'll give you 100 percent mortgage, you're going to do it, because everybody that's done it has been proven right. It's what they call social proof. And you're going to feel like an idiot if you didn't do it. And next year, the house costs more.
ROSE: It's found money.
BUFFETT: It's found money, sure.
ROSE: So when you look at where we are going, there seem to be two issues that are apparent, to me at least - risk and leverage. We just lost sight of risk and leverage of what was appropriate.
BUFFETT: People will do it, again, because it pays off for a while. I mean, you can lose leverage and it's the only way a smart guy can go broke, basically. If you owe money, you can't pay them off. You just pay for everything and if you do smart things, you eventually get very rich. You can do smart things and use leverage and if you do one wrong thing along the way, it can wipe you out, because anything times zero is zero.
But it's so reinforcing when the people around you are doing it successfully, you're doing it successfully. And it's a lot like Cinderella at the ball. You know at midnight everything's going to turn to pumpkins and mice. Right? But as the evening goes along, the guys look better all the time, the music sounds better, it's more and more fun.
You think why the hell should I leave at quarter of 12? I'll leave at two minutes to 12. But the trouble is, there are no clocks on the wall. Everybody thinks they're going to leave at two minutes to 12.
ROSE: And you're having a good time.
BUFFETT: Sure.
ROSE: So if this plan - you hope it will do what? It will loosen credit? It will stop the slide and the panic? People will have more confidence?
BUFFETT: Confidence is key. Confidence is key. You're not going to put you money - you're not going to leave your money with me unless you're confident I'm going to give it back to you. And at this point, when Treasury bills, like seven-day Treasury bills at 1/20th of 1 percent, it's not because people want to earn 1/20th of 1 percent. It's because they trust the fact that the Treasury will give it back to them next week.
And I'm sitting with $6.5 billion we're going to use to close the (inaudible) deal October 6th. I've got to hand over that $6.5 billion on October 6th. Now I have to be very careful about where I leave it between now and then, because they're expecting me to show up.
But I lose confidence in other people, all kinds of institutions. And there are plenty of them that I've lost confidence in. Then they get - their funds aren't available. They don't have it for the next guy. The whole economy just comes to a grinding halt.
Confidence in markets and in institutions, it's a lot like oxygen. When you have it, you don't even think about it. It's indispensable. You can go years without thinking about it. When it's gone for five minutes, it's the only thing to think about. The oxygen has been sucked out of the credit markets and confidence. And there has to be - it's got to be given a jump start, basically.
ROSE: And that's what this - ?
BUFFETT: And that's what I hope gets done.
ROSE: And if it doesn't work?
BUFFETT: You turn the spigot. But you don't get - I've argued with the senators and Congressmen I've talked to, you don't want to be too little, too late. Now they're being somewhat too late, in my view. But I'm glad - but that's okay.
We're going to argue for a few weeks after Pearl Harbor to decide whether it was really the Japanese that attacked and whether we should commit a few battleships. But the too little part, it could be a mistake. I mean, this has to be done.
ROSE: Too little, meaning in terms of dramatic steps or the amount of money you're spending?
BUFFETT: It's whether people think it's too little, when you get all through it. In the end, $700 billion is a lot of money, and it will buy a lot of distressed property. And if you buy them at the right price, you may be buying $2 trillion of face value. The one thing you don't want to do - doesn't make any difference what the guy paid for it that you're buying it from, or what is carrying value is. You've got to buy it at market.
And one way to do that is if some institution wants to sell you a $1 billion worth of mortgages, they might have to sell $100 million in the market, and then you'll buy the other $900 million on the same terms.
Now, the very act that you're - the very fact that this has been authorized or will be authorized, I hope, will firm a up the market to some degree and that's fine. But you don't want to have artificial prices being paid.
ROSE: What do you believe might never be the same?
BUFFETT: Oh, I think confidence will come back. I will tell you this, this country is going - will be living better ten years from now than it is now. It will be living better 20 years from now then ten years from now. The ingredients that made this country, the miracle of the world. We had a seven for one improvement in the average American's standard of living in the 20th Century.
We had the Great Depression. We had two World Wars. We had the flu epidemic. We had oil shock. We had all these terrible things happen, but something about the American system unleashed more and more of the potential of human beings over that 100 years, so that we had a seven for one improvement.
You have centuries where if you got a 1 percent improvement, then there's something. So we've got a great system. And we've got more productive capacity now than we ever have. The American worker's more productive than he's ever been. We've got more people to do it. We've got all the ingredients for a sensational future. It's just right now the athletes on the floor. This is a super athlete.
ROSE: And what's the impact of the athlete being on the floor around the globe?
BUFFETT: Plenty, plenty. And we're finding that out. And the same things happen to quite an extent around the globe. The European banks were doing what the American banks were doing.
ROSE: They're failing now.
BUFFETT: Yes. They were getting a mortgage from some guy in Omaha, you know, securitized a couple times. You have all these types from Wall Street. They had advanced degrees and they looked very learned. And they came with these things that said Gamma and Alpha and Sigma. All I can say is beware of geeks bearing formulas.
ROSE: Have we learned something about decoupling or the American economy in terms of its impact? For example, China, a place where you've had investments and you know well.
BUFFETT: Yes. We just made a new one a couple days ago.
ROSE: What was that?
BUFFETT: A company called BYB, may develop a really good electric car, I hope.
ROSE: Is there operative narrative to the kinds of investments you're making, other than you look at and you buy on value. You look at management. You look at a place that can absorb the amount of money you want to invest. And you look at its prospects. And you look at price.
BUFFETT: They have to be pretty good size for us now to move the needle. But we look for fairly large situations. We look for things I can understand. A lot of businesses I don't understand. So some guy may know how to make money in Coco Beans, but I don't. So I just let him have that.
But it's got to be something I understand. It's got to be a business with fundamentally good economics. There has to be a management that I like and trust and admire. And there's got to be a price that makes sense.
ROSE: Price makes sense.
BUFFETT: Prices make a lot more sense now, yes
ROSE: Is it -
BUFFETT: And I'm not worried at all about the investments we make. This country, we've got $46,000 or $47,000 of GDP per capita now. We've done darn well. We'll do better in the future. I'm not worried about the country. I'm just worried about anything that gums up the potential of the country and right now it's pretty gummed up.
ROSE: Okay, but we do this emergency, urgent rescue. Come January, we have a new president. We have a new Treasury secretary. We have a new legislature. What's their imperative? What will be the challenge for them, because they then can take a little bit of a longer-term look? Maybe the patient's getting up off the ground, but you want to get him or her moving faster.
BUFFETT: Yes. Well, I think it will get moving faster once - I mean once you get - once credit flows. Now, the recession is going to get worse. I mean, I don't want to hold out false hopes that by some magic moment that things will turn around in a couple months, because they won't, Charlie.
It's a big mistake to try and mislead people. They will turn around. I don't know whether it will be six months or whether it will be two years.
ROSE: More likely two years than six months.
BUFFETT: I don't know. It isn't going to be one month or two months, no matter what happens.
ROSE: You can imagine six months from now it's beginning to turn around, with conditions that you know?
BUFFETT: That's sort of the best case. Yes. That's sort of the best case
ROSE: And the worst case?
BUFFETT: The worst case is a long time.
ROSE: Five years or -
BUFFETT: If we don't do the things we should do, it could be five years.
ROSE: Beyond where we are now, what are those things?
BUFFETT: Well I would say this - if it becomes evident that - I understand the latest bill, they're talking about 350 billion early and then going back. But we need to throw the resources at this. Like I say, we're not spending the money.
If we buy these assets intelligently, the United States Treasury will make money. I mean, it's borrowing money. It's just a few percent a year and these assets are better than that.
ROSE: Okay. That's a very big if.
BUFFETT: The Treasury Secretary.
ROSE: That's the important question, in terms of whether we buy these assets wisely.
BUFFETT: I would say it's more important who the Treasury Secretary is than who the Vice President is. If you want to have a debate here, I would like to debate between two potential treasury secretaries than the vice presidential candidates.
ROSE: It might be a good thing for the presidential candidates to tell you who it is they're going to be listening to and who might be a potential Treasury secretary.
BUFFETT: Well Presidential candidates will tell you they'll listen to you.
ROSE: I assume they're telling you that, aren't they?
BUFFETT: It's not their job to narrow the candidacy field.
BUFFETT: When all these people call you up, what are they asking you? You're hearing from your friends and people at the Fed. You've been through this before too. I mean, you were that long-term capital. A lot of other times, you have had to face difficult crises.
BUFFETT: I've seen a lot of things happen.
ROSE: So they come to you and they say, you've fought wars before, Warren, we'd like to talk to you. But what's the questions they're asking? What is it they want to know? And I'm talking about smart people who are charged with fixing it.
BUFFETT: Well, lately they've been asking will this work.
ROSE: Right. And you're assuring them that if they do it, it will.
BUFFETT: I said, if they do it - I don't know who the next Treasury secretary will be. I would say this - I would - they hate this term in Washington, obviously, but I would hand something pretty close to a blank check to a fellow like Hank Paulson.
ROSE: Would you really? A blank check, $700 billion, go spend it.
BUFFETT: Yes. Go invest it.
ROSE: Invest it.
BUFFETT: Put a little of your own money beside it. I might ask Hank to co-invest with me.
ROSE: That's right.
BUFFETT: But no, I think that trying to invest through 535 people is a tough job. So I would give more latitude. That isn't going to happen. And I am -
(CROSSTALK)
BUFFETT: I think oversight is great. And I think that oversight ought to be devoted almost entirely to the question is this being done at market, you know. In other words, you want to make sure that the government isn't investing foolishly, but you don't want to care about which Congressional districts it goes to or whether banks get favored over -
ROSE: How do we determine whether it's being done wisely? That's a big question.
BUFFETT: I think you will have plenty of scrutiny as how the money's invested. Just like the RFC; when the RFC operated, people knew which institutions they were buying preferred stock in. And it worked very well.
ROSE: But is this different from the Resolution Trust Company because they're talking about securities and not real estate?
BUFFETT: Well Resolution Trust Company was set up to liquidate a bunch of assets that the government had inherited because the Savings and Loans went broke. So the Savings and Loans went broke, the government stepped in, paid off depositors. And now they're left with this mass of assets to sell.
We're not talking about selling here. We're talking about buying intelligently. They were selling what they got handed to them by a bunch of savings and loan operators that had, in many cases, had done some very dumb thing. But their job was to liquidate. They liquidated it. This is an entirely different proposition.
ROSE: You have said to me before that capitalism is not a perfect system. It may be better than all the other systems, but it's not a perfect system. You've talked about it in terms of some of its failings.
People are looking at this now and saying, excesses of capitalism, number one, markets that don't work. And there are some people in certain countries that are pointing their finger at us and saying, see? We told you, that markets was not - the markets will not always deliver for you.
BUFFETT: Markets aren't perfect - people do - as long as you have markets, you'll have excesses. People went crazy with the tulip bulbs. They went crazy with the South Sea bubble. They went crazy with Internet stocks. They went crazy with the Uranium stocks back when I was first getting started.
You're not going to change the human animal, and the human animal really doesn't get a lot smarter. Now you can have institutions that put curbs on that in various ways.
And actually with the banks, they have various capital ratios and that sort of thing. But the banks got around them. They set up sieves and that sort of thing just to get more leverage. People love more leverage when it's working. It's so easy to borrow money from a guy -
(CROSS-TALK)
BUFFETT: But if you don't get X plus one back, you still owe the X on the other side. You're in trouble.
ROSE: Are Morgan Stanley and Goldman Sachs, for example, better off in the end because they now have a holding company, because they are not standing alone (ph), because they have now listened to different rules.
BUFFETT: Well they both sent - they both converting to bank holding companies that I've not been (inaudible). That's probably part of a longer-range strategy, but it doesn't solve the lobbyings with the present.
ROSE: There is this too, accounting. You have strong feelings about accounting and mark to market. Tell me where you are on that issue.
BUFFETT: I - a lot of people disagree with me on this. I believe in mark to market. I think that accounting - in 1974, Charlie - it's either 1974 or 1975 - we owned a bunch of common stocks at Berkshire Hathaway. I told our shareholders what the market was and we used that.
I said, I think these things are worth a lot more than market, and I think we're going to make a lot of money out of it. But this is what they're worth today. And I don't think anybody gets hurt by telling the truth on that sort of thing.
And I think that once you start saying we're going to peg these things at some price that isn't market, God knows what a financial -
ROSE: These people who argue against you will say the assets are worth much more than mark to market says. And therefore, we're not seeing a reality.
BUFFETT: Well that is the reality, and that's the reality of what they're going to sell them to the Treasury for too. You'll get in a lot of trouble when you start putting fictitious numbers on value. You can explain the fact that these are depressed prices, you know, we think these assets are going to be worth a lot more. And I think that case could be made in certain situations.
But I think to just say, you know, we're going to say a $1 of cash is worth $2 all of a sudden, you know, it isn't worth $2; it's worth a $1 today. I think once you start putting phony figures into financial statements, you can get into a lot of trouble. We've seen so much of that in the last 20 years.
ROSE: Is it getting worse?
BUFFETT: No, I don't think it's getting worse. I think what people want to do is make it get worse.
ROSE: But what would reform about that, in terms of the accounting process? I think you'd keep mark to market.
BUFFETT: The rules get ungodly complicated. It's a nightmare to administer some of this sort of thing. But I want to tell the shareholders of Berkshire, to the extent we own marketable securities or things for which there are markets, even if those markets - I'm going to tell them what it's all about.
As a matter of fact, I have already written a section of the Annual Report for next year explaining why I think, in one case, that the figures on our balance sheet, as calculated, are wrong. But it's the standard way of doing it. It's holy writ. The SEC want us to do it that way, and we'll do it that way. Then I'll explain why I think it's wrong and the shareholders can read it and say whether they agree with my logic or don't.
ROSE: When you look at the prospects for this country, there are other people who argue that America, as good as it is, lives in a world today, and there are books being written, in which our supremacy, our primacy will now have to be shared, that we may still own as much of the pie as we have, but other people will own a lot more.
BUFFETT: That's great. I want our pie to grow all the time, but if some other guy's pie is growing a little faster, that's terrific. It will be good for us in the long run. And there are 6.5 billion people in this world. And it's great for 300 million to keep enjoying more and more prosperity. But I think it's terrific if the remainder do it.
I think if they can learn something from us, in terms of our system, and I think they have, they're learning more about how to unleash the potential of their citizenry to turn out more goods and services that their citizens want or that we want. I think that's terrific.
And I think it's much better to live in a world where those around you, particularly when some of them have nuclear bombs - I think it's much better to live in a world where their lives are getting better also.
ROSE: When you look at China today, and you look at some Asian countries, and the amount of American debt they have, how much does that concern you in today's economic circumstances? And are they losing some of their confidence in America? And does that pose a huge problem for us?
BUFFETT: Somebody buying these Treasury bills at 1/20th of 1 percent. We have been consuming about $2 billion a day of goods and services beyond what we're producing. In other words, the rest of the world sends us about $2 billion a day net of something. We've got to send them something in return, don't we? So we send them little pieces of paper.
Now, it would be nice if they stuck them all under a mattress, but they have to buy something with them. Sometimes, they buy our Treasury notes. Sometimes they set up sovereign wealth funds. They can do all kinds of things. They can buy our companies here.
As long as we consume more than we produce and we trade away a little piece of the country daily, they're going to own something. Now, on the other hand they can't run from American assets. I mean, every day the rest of the world's going to have about $2 billion more of American assets than we have, as long as they sell us these goods.
ROSE: Because we're borrowing $2 billion a day?
BUFFETT: Yes, and they want to sell us these goods.
ROSE: You don't believe that's good. You believe that an increasing current accounts deficit is bad.
BUFFETT: I think it's bad.
ROSE: And it reflects America's consumption ideas, rather than its saving ideas. But how does that change?
BUFFETT: Well, I laid out kind of a Rube Goldberg plan a few years ago, which I don't like myself, except I like it better than the alternative, which is what we're doing. But we've actually been pretty good on exports. We are exporting 12 percent of our GDP now, roughly.
That was 5 percent many years ago of a much smaller GDP. So the rest of the world really likes our stuff pretty well. It's just we buy so damn much of what they produce. And I think that should be something addressed by - I don't think it's the most pressing problem now at all.
We are trading away a little bit of our country all the time for this excess consumption that we have over what we produce. That is not good. I think it's terrible over time. But our country's productive capacity grows enough so we actually can do that and will still be better off. We just won't be as well off as if we hadn't done it.
ROSE: What's all this going to do to the price of the dollar?
BUFFETT: It could be very tough. Inflation could be a very - is a likely consequence on what's going on now. Right now, we're, in effect, making - to some extent, making a choice between future inflation and getting off the floor. And we're likely to have more inflation in the future as a consequence of the things we do to fight the present situation.
ROSE: Senator Obama, who you support, I think, and I don't want to be clear on this, but made an economic speech today - talks about another stimulus program. Is that essential at this time?
BUFFETT: I think the biggest thing we need now is to unclog the credit markets. And we may need other stimulus. If we do, it should go to the lower and middle income people.
The truth is, I have never had it so good in terms of taxes. I am paying the lowest tax rate that I've ever paid in my life. Now that's crazy, you know.
And if you look at Forbes 400, they are paying a lower rate, counting payroll taxes, than their secretary or whomever around their office, on average. And so I think that actually people in my situation should be paying more taxes. I think the rest of the country should be paying less than the 95 percent that Obama talks about, or maybe even a little higher than that.
But I think that a stimulus plan should really be geared to the people. You've got, what, 24 million households - one fifth of the households of the United States, you have earning $21,000 a year or less, an average of close to four people or three people in those households, two and-a-half people actually probably. But just imagine living on $21,000 a year, Charlie, $22,000 a year. You have 20 percent of the population doing that.
So they don't have to worry about guys like me. I would push purchasing power. You push out $1,000 a person to those people, it's going to get spent. And it needs to be spent. They need it. It should come, to some extent, from guys like me.
ROSE: So you're recommending, A, changing, as Senator Obama had and Senator McCain is not, in terms of supporting Bush's permanent tax cuts, and Senator Obama would talk about it different - tax involve people over whatever it is, $200,000. And reduce impacts (ph). But what about the capital gains tax?
BUFFETT: The capital gains tax is 15 percent now. So I sit there in my office and I make a lot of money by capital gains and I pay 15 percent, and I pay no payroll tax on it. The woman that comes in to take the waste basket away, she's paying 15.3 or whatever it is, just payroll tax alone. I mean, it is - I never had it so good.
ROSE: But so therefore the capital gains tax should be changed to 18, 20, 25, 30?
BUFFETT: I think it's terrible for people, in effect, to say that income from investments should be taxed at a much lower rate than income from labor. I just think that - we're going to spent $3.1 trillion or something like that. We only going to raise about $2.6 trillion. You're going to raise it from somebody, you know.
Now, who are you going to get it from? You going to get it from me and you, or are you going to get it from the people that drive the taxi that brings me here or whatever it may be? You've got to get it from somebody. And you know, everybody's against paying taxes themselves. I feel the same - everybody feels that way.
If you want a government that's going to do the things we ask our government to do, you've got to get it from somebody. And over the years, particularly the last six or eight years, they've taken less and less from a guy like me.
Now everybody likes to talk about how the top 1 percent pays this percent in income. But the income tax will say $1.3 trillion. The payroll taxes are over $900 billion. That $900 billion, that doesn't come from me. I mean, I pay it on the first $100,000 or something like that. But that comes from the people in my office, and they are paying $900 billion.
Nobody ever talks about that when they talk about how the 1 percent is paying. They love to tell how I'm suffering, because 1 percent, we're paying 25 percent of the total. We're not paying 25 percent of the total taxes on individuals. We're paying maybe 25 percent of the income tax.
But the payroll tax is over a third of the receipts to the federal government. And they don't take that from me on capital gains. They don't take that from me on dividends. They take that from the woman who comes in and takes the waste baskets out.
ROSE: You mentioned inflation, possibilities of inflation - are you therefore - do you have a position on what interest rates - what the Fed should do about interest rates?
BUFFETT: Well I think that's almost - for the time being, that's just put it - yes, just put that aside and we'll get to that after the patient's up and walking. It's interesting, though. I mean, what's going to happen - things we're doing are going to have some inflationary consequences. But you see interest rates at very low levels, and including the long rates.
ROSE: When we watch this - you and I are having this conversation today. The Senate votes tonight. House may vote - people I talk to today believes it's going to pass. Whatever happened that changed minds.
Either the combination of what they did with the plan and tweaking the plan, or B, some people got so scared by the failure of the vote last time that it brought home the danger of not doing anything. All right, how will we measure the progress, whether this is working or not?
BUFFETT: It's going to be tough because the economy's going to be getting worse for a while. And it might fall off a cliff if this doesn't pass, but nobody will ever know that if it passes. So they will not see immediate reaction. We'll be pounding on that guy's chest on the floor.
And, you know, he's not going to just jump up all of a sudden. So it makes it tough. I mean it's tough to be in the legislature and vote for something and then people say, well, you voted all this money and it's all getting spent. It's isn't getting spent, it's getting invested. But it's all getting spent, nothing's happening, how can you have done that - you haven't done anything for me. You go through all of that. And that's going to be tough.
What it really takes is leadership that knows what it's all about and can explain what it's all about.
ROSE: But hasn't that been missing, though, leadership that can explain what it's all about.
BUFFETT: Absolutely.
ROSE: And the reason you're here and the reason I want to have a kind of fireside chat with you - it is that somehow it hasn't gotten through. The idea - go ahead.
BUFFETT: When the President of the United States goes out at 8:00 in the morning and his own party votes against him two to one in the House, you know that somehow a message is not getting out.
No, it takes real leadership. I mean, Roosevelt didn't - when he came in, he didn't print any money. Actually, he may have done a little bit of that. But it wasn't like you've gotten the greatest economics professor in the world or anything else. But he did restore confidence. And they did a lot of that. And you needed it. You needed to jump start the economy.
It took a long time. The world did not change in 1933 or 1934. But we put in things like the FDIC. I think the FDIC was one of the great inventions of the American economy (ph).
ROSE: Well they've had to tweak that in terms of this bill, did they not?
(CROSSTALK)
BUFFETT: Yes. They're going the right direction, yes.
ROSE: Roosevelt also said, "The only thing we have to fear is fear itself," which is clearly the fear that exists in the country. Tell me when you worried the most, of all the things that you have seen over the last three weeks - I mean, how long in the last month. When did you say, ?My God, I never are knew it could get to this point,??
BUFFETT: Well, I don't get that afraid in a sense, because I really do have faith. I know the country works extremely well. But when it isn't clogged up. And I know that Congress will do the right thing.
When I watched the House vote the other way, I wasn't afraid because I still felt something would pass. But we are going through a very, very tough period. And I did not think I would see the day when AIG would not be able to have its checks cleared.
ROSE: If AIG had failed, would Goldman Sachs have been exposed and at risk and Morgan Stanley - ?
BUFFETT: Everybody would have been exposed, Charlie, everybody.
ROSE: Why was there even a question of not rescuing AIG at that time?
BUFFETT: I think what people that understood it, they probably - well they were hoping the private sector would do it. That's the same way I would behave.
If I were the Treasury Secretary or head of the Fed, I would try to scare the hell out of the private sector and say, you better save this, because you're going down with the ship. So you guys save it. And I would wait as long as I could. If they didn't save it, I'd come in.
ROSE: Did that, in fact, happen during this crisis, in which the Secretary of the Treasury said, you better save this or we're all going down. You better put up some cash right now.
BUFFETT: I think they hoped the private sector would come in. And the private sector tried to come in until they saw the size of the problem.
There were people on that weekend that thought they had a solution. And then the hole kept getting bigger and bigger. And all of a sudden, it became apparent that $20 billion wouldn't do it and $30 billion wouldn't do it and $40 billion wouldn't do it. So it got beyond anybody's ability to certainly to do it in a short period of time.
ROSE: There was not enough capital available from the government.
BUFFETT: It's an unknown situation. You have a derivative book called 'AIG Financial Products'. Nobody's ever heard of it, except it was terrific profit center. You could manufacture earnings and do all these things. And I will guarantee you that the top management - and I'm not knocking them for this. I don't think I could have done it. They didn't - they couldn't get their mind around it.
I bought a company called 'General Reinsurance' in 1988 that had a similar but much smaller operation, had 23,000 contracts. And I said, I have to get out of this. It cost me 400 and some million dollars in a benign situation.
But this was not a benign situation. If AIG had tried to unwind the derivative book, I don't know. It would have hit every institution in the world.
ROSE: And there was no private capital to come in and do that?
BUFFETT: Not big enough.
ROSE: Not even Berkshire Hathaway?
BUFFETT: No, not even Berkshire Hathaway. If I thought 5 or 10 billion would have bought me a good deal, and I could have done it, I'd have done it.
(CROSSTALK)
ROSE: $10 billion was within reach, but $85 billion might not have been.
BUFFETT: And the Feds structured that thing very, very well. I mean, they have put themselves in a position where they are very likely to get their money back, maybe more. They participate 80 percent. They drove tough terms. I mean, I want to hire the guy that made that deal. He would fit in well at Berkshire.
ROSE: A lot of people look at you and Goldman Sachs and GE saying I want to hire the guy that made that deal for you.
BUFFETT: Tim Geitner did a better job on this one.
ROSE: So we've come down to the close of this conversation. And you have been warning us about certain kinds of things. I hear from this conversation, too, this plan is essential now, otherwise we're in a very, very difficult place. And each week we go beyond not doing something, we get deeper and it becomes more irreversible.
BUFFETT: And, yes. Whoever said, you know, an ounce of prevention is worth a pound of cure understated it. A pound of cure is delayed another six months, you need a ton of cure later on. I mean, it would be crazy not to do this. It will not produce dramatic results, though, in the economy.
That's what people have to understand. You're going to see unemployment go up. You're going to see lousy earnings in many businesses.
ROSE: You're going to see people unemployed.
BUFFETT: You're going to see more people unemployed. But the difference, Charlie, if we bottom this thing out at 7 percent unemployed versus 9 percent, that's 3 million people. That's 3 million people that, if we do it wrong, you know, lose their jobs unnecessarily, in my view.
You know, I have never been unemployed. I have never been very fully employed either. But just think of what it's like to go home with a mortgage payment and kids and everything else. My dad had that happen to him in the early 30s. You don't want to create 3 million people more - unnecessarily. But I don't think -
ROSE: That's the depression.
BUFFETT: It really is, and you can't help some increase from this point. I don't want any viewer to go away thinking a magic wand exists in Congress. So they're going to see some more bad news. But if we do this, we're doing the right thing. And the system will work over time. There's no question, and we've got a wonderful system.
ROSE: Okay, I'm going to come to that in the end. Do we need to do anything about the system, beyond the urgency of the moment, come January, about the system? Lots of talk about regulation, as you know, and finding the right balance. Lots of talk about whether government involvement is an idea we need more of rather than less of, rethinking sort of what President Reagan brought to fore.
BUFFETT: Once we get the athlete back, we can tell him to change his diet a little or exercise a little more. We can do all of that sort of thing. If I have any good ideas out of that, or I think they're good ideas, I'll be glad to contribute them. But the system will probably overdo some other things.
The nature of democracy is such that when there's - there'll be this revulsion, obviously, towards - that's never going to happen again. So we will probably attack it in various ways that don't make sense.
But I'm - that's what Congress is for and that's what advisers are for. And I'm all for getting the best minds to get to work on that kind of thing. Like I said, I don't think it will be done perfectly.
Maybe we'll end up with a little bit better system at the end. We had a pretty good system over time. When we went crazy, and we did go crazy on residential real estate, it set things in motion that just - the dominoes started toppling.
ROSE: Thank you for coming.
BUFFETT: Thank you, Charlie. Enjoyed it.
ROSE: Good to see you. Warren Buffett. We're in San Diego. My thanks to the people at KPBS here. A conversation here about the crisis that we all face and hearing from a man that a lot of people want to hear from. And I'm pleased that we were able to join with him here. Thank you for joining us. See you next time.
***END OF TRANSCRIPT***
(This is not a legal transcript of the interview. Bloomberg LP cannot guarantee its accuracy.)
CHARLIE ROSE, ANCHOR, PBS: We are in San Diego, California this afternoon for a conversation with Warren Buffett. He is the man Congressional leaders, the administration, and the Federal Reserve want to talk and talk to. He is a legendary Chairman and CEO of Berkshire Hathaway. Its success has made him the world's richest man. He's admired for his investment results over a long period of time.
He is trusted for his common sense and the fact he has warned over the years in his annual letter to stockholders about some of the things that are contributing to the crisis facing America and the global economy.
For all those reasons, we have come to see him in San Diego, where he is attending the 'Fortune' magazine's most powerful women summit. Later, he will be interviewed at that conference by the 'Fortune' reporter and long time friend Carol Loomis.
We come this evening from the studios of our public television affiliate in San Diego, KPBS. I thank my friend Warren Buffett for taking time in a busy schedule to talk to us.
WARREN BUFFETT, INVESTOR: My pleasure, Charlie.
ROSE: Let me talk with the news today. You have announced an investment of $3 billion in General Electric, along the same terms as the Goldman Sachs.
BUFFETT: Almost identical.
ROSE: Why GE?
BUFFETT: Well, I got a call this morning from a friend of mine at Goldman Sachs saying they might be interested in such an investment. I'm familiar with the company. I've known the management, the current management, Jack Welsh, before Jeff Immelt. I've known him for decades. So I understand their businesses. We do a lot of business with them.
And GE is going to spend - I think it's the longest running stock in the Dow Jones Industrial Average. It will be 100 years now it will be around. I hope I'm around then too.
And it was an attractive investment. And we've had a lot of money around over the last few years and we're seeing some things that are attractive now.
ROSE: Are you looking at other things?
BUFFETT: I look at everything, Charlie. That's my job. I really do, every day. I think about everything.
ROSE: Cash is said to be king now. Are you sitting on a lot of cash so that this is the time for Berkshire Hathaway and Warren Buffett to look carefully at a lot of opportunities?
BUFFETT: Yes. We want to use cash. The reason we haven't used our cash, two years ago, we just didn't find things that were that attractive. But when people talk about cash being king, it's not king if it just sits there and never does anything. There are times when cash buys more than other times, and this is one of the times when it buys a fair amount more. And so we use it.
ROSE: There's a time accumulate and a time to spend.
BUFFETT: Absolutely. You want to be greedy when others are fearful. You want to be fearful when others are greedy. It's that simple.
ROSE: Where are they now?
BUFFETT: They're pretty fearful. In fact, in my adult lifetime, I don't think I've ever seen people as fearful economically as they are right now.
ROSE: And why is that?
BUFFETT: Well, it's because they have seen the credit market seize up. They've gotten worried about money market funds, although the latest proposition from the government should take care of that. They've seen 8 percent of the bank deposits in the United States get moved, very skillfully, I might say, within the last couple weeks from institutions that they thought were fine a few months ago to other institutions. They're not wrong to be worried.
ROSE: Is it being felt, as people often point out, on Main Street?
BUFFETT: I read about auto sales today. If you're an auto dealer, you're feeling it. If you're a furniture retailer, like we are, you're feeling it. If you're a jewelry retailer, you're feeling it. I know some of these businesses because we're in them. Yes, it's being felt, but it will be felt big time more if we don't do something about it, what's going on.
ROSE: The Senate will vote sometime this evening. Are you satisfied with that rescue plan?
BUFFETT: Well, I don't think it's perfect, but I don't know that I could draw one that's perfect. I would rather be approximately right than precisely wrong. And it would be precisely wrong to turn it down. We need - we have a terrific economy. It's like a great athlete that's had a cardiac arrest. And it's flat on the floor, and paramedics have arrived.
And they shouldn't argue about whether they put the resuscitation equipment a quarter of an inch this way or a quarter of an inch that way. Or they shouldn't start criticizing the patient because he didn't have blood pressure tests or something like that.
They should do what's needed right now and I think they will. I think the Congress will do the right thing. I think that they've gotten into certain arguments and then they start worry about assessing blame and there's a little demagoguery. But in the end, something this important, they'll do the right thing. This is really an economic Pearl Harbor. That sounds melodramatic, but I've never used that phrase before, and this really is one.
ROSE: Go through why that is true, beyond the fact that there's a freeze on credit, beyond the fact nobody's making loans, beyond the fact that banks don't lend to banks, beyond the fact that Treasury bills are at a low.
BUFFETT: When 40 billion of Treasury bills are sold, like they were last week, seven day Treasury bills, at a yield of 1/20th of 1 percent, that means the whole country is basically at the point, virtually - or a lot of the country is at the point of putting their money under the mattress. You're only 1/20th percent away from where it's better to put it under the mattress.
You don't want 300 million Americans putting their money under the mattress. This economy doesn't work well without the lubrication of credit and trust. And that's been lost and it's a huge problem.
What you have is you have the major institutions of the world all wanting to de-leverage. They want to take down their assets and liabilities. What seemed so easy to borrow against a year ago now looks like rat poison to them. So they're trying to de-leverage. There's only one institution in the world that can leverage up in a way that's at all a countervailing force to that. And that's the United States Treasury.
ROSE: Are you approving of what's been taking place along the stages that got us to where we are now. Whether it's Bear Stearns or Lehman Brothers or AIG, Freddie and Fannie, or what you've done with Goldman Sachs and the rest?
BUFFETT: Yes, I think basically the right things have been done, but no one saw the tsunami coming fully. And so when Bear Stearns came along, it looked like if you stopped the flood at that point, you didn't have to worry about being down stream from it. And I think the Fed did the right thing there.
And I really thought that would probably halt runs on other major institutions, but it didn't. We have seen wave after wave. And admittedly, there has been somewhat of an ad hoc response to there. I would rather have an ad hoc than no response at all.
And I don't think the Treasury could remotely have gone to Congress three or four months ago and laid out the scenario of what's happened and been credible and gotten the necessary tools. I think it took a crisis like this.
ROSE: And asking for the powers asking for and the levels it was asking for.
BUFFETT: They wouldn't have gotten it. So I think it's been kind of like a tragic play to this point. But at this point, I think it's clear and will be clear to the majority of the Congress, and I think it's clear to the American people, that there is only one countervailing force to a world where financial institutions are trying to sell instruments every day, and where credit is dried up. And that's the United States Treasury.
ROSE: But at the same time, there has been, and Congressmen and women will tell you this, a resistance across the country because they think, as you well know, it's a bailout of Wall Street, and that they are sitting there in their own economic life, and nobody's coming along to say we're here to help you; we're from the government.
BUFFETT: Well, the patient that's on the floor with the cardiac arrest is not Wall Street. It's the American economy.
ROSE: Do you think they understand that yet?
BUFFETT: I think they probably don't and I think any time you couple the term Wall Street with bailout or something like that - you know, I don't like what's going on in Wall Street. I don't like what's going on in executive compensation. But I don't want to give a lecture to this body that's out there having had the heart attack. I want to get it back functioning.
And as a practical matter, if you were at Bear Stearns and you were a shareholder, you lost 90 to 95 percent of your money. Good many lost their jobs. They lost very cushy lives, many of them. If you were at Lehman, the same thing happened. If you were at AIG, the share holders are getting creamed on these things.
And those share holders are not just a bunch of big shots on Wall Street. Those are pension funds. Those are investors all over the country.
I wouldn't worry too much about that. Justice won't be perfect on it. You may be very mad at some guy who walked away with a huge golden parachute, but that really isn't the important thing.
If Pearl Harbor came along, you could have said the planning was wrong by the military ahead of time, or maybe the battleship shouldn't have been in the harbor and all of that kind of thing. It doesn't make any difference. It's Pearl Harbor.
And you better not spend weeks and weeks trying to assign blame or deciding on a complete plan for fighting the whole war, and letting a committee decide where the battleship should go and all of that. You better spring into action with the best people you have.
ROSE: You have never seen anything like this in your life?
BUFFETT: No, I haven't.
ROSE: There are those who argue that we're headed for a recession, you know, and they look at Depression as the great fear.
BUFFETT: Sure.
ROSE: Is that a possibility if this plan doesn't work.
BUFFETT: Yes, it's a possibility. We have about 6.1 percent unemployment now. We've been in a recession by any common sense definition, because if you look at the American public, they've got $20 billion - $20 trillion, I should say, worth of residential homes. They've got $20 trillion worth of stocks, very roughly. Those are the two big assets of American families. They're both down dramatically for different families.
But 95 percent of the people, at least, are worse off in terms of their residential wealth plus stock wealth from a year ago or two years ago.
That is bleeding into the real economy. I mean that's bleeding into auto sales and jewelry sales and furniture sales and all that. But that wave is just starting to hit. And if the paralysis we have in the credit markets, if every company continues to feel all we want to do is get our balance sheet down, sell assets, it's just the start of what can happen.
Unemployment is going to go up under any circumstances. The 6.1 is going to go higher. But whether it goes and quits at seven or whether it quits at ten or 11 or 12 depends on, among other things, the wisdom of Congress and then the wisdom of - in terms of carrying out the plan that Congress authorizes.
ROSE: Would you say that this plan, which you have argued very strongly the Senate ought to pass and the House ought to pass, is simply the plan that we have and I don't have a better idea, but it's essential for the confidence of the nation and the system?
BUFFETT: Yes. I just worry about whether it's enough but -
ROSE: Enough what?
BUFFETT: Every day that goes by - if you don't react to Pearl Harbor for a week or two weeks or three weeks, you're behind in the war that you otherwise would have fought. But it's very important that the determination of the U.S. Congress to do what is needed be made evident this week, and by the actions of most of the members. You're not going to get total assent.
ROSE: What makes you confident that this plan will work?
BUFFETT: I think you've got - I don't think you could have a better secretary of the Treasury than Hank Paulson. He is in there at the wrong time. He probably should haven't taken the job. He's a friend of mine. But he knows markets. He knows how corporations work. He knows money. And he's got the interest of the country at heart.
And so you've got the right - you've got a wonderful person with Sheila Bair. Most of the viewers have never heard of Sheila Bair. Sheila Bair, in the last two weeks, has taken 8 percent of the deposits of the United States and seamlessly moved those over to sound institutions, which in turn have gotten more capital. It's been a magnificent job, 8 percent of the deposits of the United States, tens of millions of depositors.
Nobody has ever heard of her. She'll never get a golden parachute or severance pay or anything. She's done a great job. We have some great public servants. We have, I think, the right people in there to get the job done and they need more tools.
ROSE: And those more tools might be, in addition to what's in this plan?
BUFFETT: Well, they need plenty of money, and they really need plenty of flexibility to carry out this plan. They also need, in my view, to very much tie it to market prices.
I have said, Charlie, that the $700 billion, if they buy mortgages related securities or mortgages themselves, at current market prices, they're going to make money over time because the United States government has staying power, and it has a low cost of borrowing.
And if I could take 1 percent of that $700 billion pot and take the gain or loss from it and be their partner, and they would buy the stuff at market, I'd make a lot of money.
No, it's - I mean, you have hedge funds and people like that buying these assets to yield 15 or 20 percent. I mean, that's the buyer for these people that are trying to unload them. The U.S. Treasury has got borrowing costs like nobody else has. They can borrow basically unlimited amounts. They can stay there for years and years. These assets will be worth more money over time.
So when Merrill Lynch sells a bunch of mortgage related assets at $0.22 on the dollar, like they did a month ago, the buyer of those is going to make money and he's going to make a lot more money if it happens to be an institution like the U.S. government, which has very, very cheap borrowing costs.
ROSE: So you are saying to those tax payers who are worried about what's going to happen to $700 billion, chances are good that when these securities are purchased and sold, you will got a lot of your money back or all of your money back, and maybe something else.
BUFFETT: I would bet on it. If I got a chance to take 1 percent of the deal either way, I'm going to make that bet. When Berkshire Hathaway laid out $3 billion for GE today, we didn't spend it. We invested it. When the federal government buys the mortgages, they're not spending it, they're investing it.
Now they're investing it in distressed type assets, but they're buying them at distressed prices, if they buy them at market. It's the kind of stuff I love to do. I just don't have $700 billion. Maybe we can go in it together. With your money and my brains, there's no telling how far we can go.
ROSE: Whatever. I'll take the deal, whatever you want to do. There is this, though, in terms of alternative; some people have suggested, for example, that why don't we - why isn't America doing what Berkshire Hathaway is doing? Why isn't that a better deal for America?
BUFFETT: I don't think it would be crazy to have a model - an entity modeled on the Reconstruction Finance Corp. That goes back to 1932, although it was really implemented in '33 under Jessie Jones. And it invested in mostly banks, initially, and preferred stock and that sort of thing.
So there is - there are two things needed in the system. The one that's needed overwhelmingly is liquidity. When people are trying to de-leverage, there has to be somebody there to buy. And they don't have to buy at fancy prices, but to buy.
And then there's also a capital problem with some of the institutions. We have provided capital here with a couple institutions recently. The federal government did that in the '30s for the RFC and I think there could well be a proper role for government in that.
ROSE: Would that have been a better idea today?
BUFFETT: It wouldn't have been big enough today. You couldn't have - if you set up an RFC today and you gave them $100 billion to invest in the capital, there would be a very cumbersome type of application process and everything. These assets are getting shoved out day by day and loans are coming to - commercial papers not being renewed.
The commercial paper market, when that dries up, that's just like sucking the blood out of the economic body of the United States. And that's happening.
So I would say that an RFC like thing might make sense. I probably would do it myself, but I don't think trying to combine that with what's going through now - I think what's needed now is liquidity.
ROSE: Right. There are those who - you just said you would do it yourself - there are those who believe, and it has been suggested, that this is the time for Warren Buffett to answer the call of his government in a country that's been very good to him. What are you prepared to do yourself beyond run Berkshire Hathaway well?
BUFFETT: That's my job. Any time I can be of help to the government, in terms of giving advice - I've given a little advice, actually.
(CROSSTALK)
BUFFETT: Trouble is it gets when it really counts. But anyway, obviously, I'm here tonight talking about this for that reason. It isn't going to do anything for Berkshire Hathaway. That isn't really true.
Anything that enables this economy to run in the manner that it should - we've got the same plants out there we had two years ago. We got the houses. We've got people that are more productive than they've ever been in the history of this country. We've got a wonderful economic formula in this country. But right now it is being - it's been brought to a halt by -
ROSE: By?
BUFFETT: It's the de-leveraging that's going on right now that has caused the credit crisis.
ROSE: I mentioned earlier in this introduction to you, if you read your letters to your stock holders, which you write and Carol Loomis edits every year, and you think of your sister as a person -
(CROSSTALK)
ROSE: You have talked about derivatives. Derivatives are, in part, at the core of this problem. Yes?
BUFFETT: AIG would be doing fine today. It was one of the ten largest companies of the United States in terms of market value, over $200 billion, the most respected insurer in the world. If they never heard of the word derivatives, they would be doing fine. Everybody would be going to work in the morning and they would have no troubles.
But they - it was very easy to do, because very tempting to write numbers on little pieces of paper, and you can kind of report the profits you want to, and there's no limit on it. I mean, there's no capital requirements to it or anything of the sort.
And basically I said they were possibly financial weapons of mass destruction and they have been. I mean, they destroyed AIG. They certainly contributed to the destruction of Bear Stearns and Lehman, although Lehman had other problems too.
ROSE: I'm interested in this, because people are asking me, did people get away with murder here? Were there people who simply gamed the system and took advantage and made huge amounts of profit and we had excesses that inevitably led to where we are today?
BUFFETT: Well we had all of that. But I would say the biggest single cause was that we had an incredible residential real estate bubble. You can go back to tulip bulbs in Holland 400 years ago, human beings going through combinations of fear and greed and all of that sort of thing, their behavior can lead to bubbles.
And they've had an Internet bubble at one time. You've had a farm bubble, farm land bubble in the Midwest, which resulted in all kinds of tragedy in the early 80s.
But we've had 300 million Americans, their lending institutions, their government, their media, all believed that house prices were going to go up consistently. And that got built into a $20 trillion residential home market. Lending was done based on it. And everybody did a lot of foolish things.
And where people really behaved in a fraudulent way or something, they'll go back and find the culprits later on. But that really isn't the problem we have. That's where it came from, though.
We leveraged up. And if you have a 20 percent fall in the value of a $20 trillion asset, that's $4 trillion. And when $4 trillion losses land in the wrong part of this economy, it can gum up the whole place.
ROSE: And it continues with respect to the housing market.
BUFFETT: It continues.
ROSE: And some will argue that we have to do something about that, in terms of the long-term recovery of the American economy.
BUFFETT: There's no question we have an excess stock. The good thing is we have household formation in this country. We have a country where - I don't know whether it's a million households a year or more, but get formed (ph). So we can eat off an inventory.
But the inventory is too big and house prices just soared beyond reason in many places. And they got financed in silly ways and people lied about loans, all kinds of excesses entered into it. But that is the single biggest cause of why we are here.
ROSE: And should wise people have known better?
BUFFETT: People always should know better. People don't get - they don't get smarter about things that get as basic as greed. And you can't stand to see your neighbor getting rich. You know you're smarter than he is and he's doing these things and he's getting rich. And your spouse is getting unhappy with you because you aren't doing. Pretty soon, you start doing it.
And so you get what I call the natural progression, the three Is - the innovators, the imitators and the idiots. Everybody just kind of goes along and you look kind of silly if you disagree.
You can have these crazy Internet valuations in the late 1990s, but they proved themselves out in the market. I mean, the next day, they were selling for more than they were the day before. And people said, you're crazy if you don't get in on this. So it's very human.
Now with housing, it's something even more dramatic than that, because most people aspire to own their own home. And if you really think that housing prices are going to go up next year and the year after, you feel, if I don't buy it this year, I'm going to have to buy it next year. That's not true of an Internet stock, but it is true of a home.
And then when somebody makes it very easy for you to do it, by saying you don't really have to put up any money or you can lie about your income a little, or we'll give you 100 percent mortgage, you're going to do it, because everybody that's done it has been proven right. It's what they call social proof. And you're going to feel like an idiot if you didn't do it. And next year, the house costs more.
ROSE: It's found money.
BUFFETT: It's found money, sure.
ROSE: So when you look at where we are going, there seem to be two issues that are apparent, to me at least - risk and leverage. We just lost sight of risk and leverage of what was appropriate.
BUFFETT: People will do it, again, because it pays off for a while. I mean, you can lose leverage and it's the only way a smart guy can go broke, basically. If you owe money, you can't pay them off. You just pay for everything and if you do smart things, you eventually get very rich. You can do smart things and use leverage and if you do one wrong thing along the way, it can wipe you out, because anything times zero is zero.
But it's so reinforcing when the people around you are doing it successfully, you're doing it successfully. And it's a lot like Cinderella at the ball. You know at midnight everything's going to turn to pumpkins and mice. Right? But as the evening goes along, the guys look better all the time, the music sounds better, it's more and more fun.
You think why the hell should I leave at quarter of 12? I'll leave at two minutes to 12. But the trouble is, there are no clocks on the wall. Everybody thinks they're going to leave at two minutes to 12.
ROSE: And you're having a good time.
BUFFETT: Sure.
ROSE: So if this plan - you hope it will do what? It will loosen credit? It will stop the slide and the panic? People will have more confidence?
BUFFETT: Confidence is key. Confidence is key. You're not going to put you money - you're not going to leave your money with me unless you're confident I'm going to give it back to you. And at this point, when Treasury bills, like seven-day Treasury bills at 1/20th of 1 percent, it's not because people want to earn 1/20th of 1 percent. It's because they trust the fact that the Treasury will give it back to them next week.
And I'm sitting with $6.5 billion we're going to use to close the (inaudible) deal October 6th. I've got to hand over that $6.5 billion on October 6th. Now I have to be very careful about where I leave it between now and then, because they're expecting me to show up.
But I lose confidence in other people, all kinds of institutions. And there are plenty of them that I've lost confidence in. Then they get - their funds aren't available. They don't have it for the next guy. The whole economy just comes to a grinding halt.
Confidence in markets and in institutions, it's a lot like oxygen. When you have it, you don't even think about it. It's indispensable. You can go years without thinking about it. When it's gone for five minutes, it's the only thing to think about. The oxygen has been sucked out of the credit markets and confidence. And there has to be - it's got to be given a jump start, basically.
ROSE: And that's what this - ?
BUFFETT: And that's what I hope gets done.
ROSE: And if it doesn't work?
BUFFETT: You turn the spigot. But you don't get - I've argued with the senators and Congressmen I've talked to, you don't want to be too little, too late. Now they're being somewhat too late, in my view. But I'm glad - but that's okay.
We're going to argue for a few weeks after Pearl Harbor to decide whether it was really the Japanese that attacked and whether we should commit a few battleships. But the too little part, it could be a mistake. I mean, this has to be done.
ROSE: Too little, meaning in terms of dramatic steps or the amount of money you're spending?
BUFFETT: It's whether people think it's too little, when you get all through it. In the end, $700 billion is a lot of money, and it will buy a lot of distressed property. And if you buy them at the right price, you may be buying $2 trillion of face value. The one thing you don't want to do - doesn't make any difference what the guy paid for it that you're buying it from, or what is carrying value is. You've got to buy it at market.
And one way to do that is if some institution wants to sell you a $1 billion worth of mortgages, they might have to sell $100 million in the market, and then you'll buy the other $900 million on the same terms.
Now, the very act that you're - the very fact that this has been authorized or will be authorized, I hope, will firm a up the market to some degree and that's fine. But you don't want to have artificial prices being paid.
ROSE: What do you believe might never be the same?
BUFFETT: Oh, I think confidence will come back. I will tell you this, this country is going - will be living better ten years from now than it is now. It will be living better 20 years from now then ten years from now. The ingredients that made this country, the miracle of the world. We had a seven for one improvement in the average American's standard of living in the 20th Century.
We had the Great Depression. We had two World Wars. We had the flu epidemic. We had oil shock. We had all these terrible things happen, but something about the American system unleashed more and more of the potential of human beings over that 100 years, so that we had a seven for one improvement.
You have centuries where if you got a 1 percent improvement, then there's something. So we've got a great system. And we've got more productive capacity now than we ever have. The American worker's more productive than he's ever been. We've got more people to do it. We've got all the ingredients for a sensational future. It's just right now the athletes on the floor. This is a super athlete.
ROSE: And what's the impact of the athlete being on the floor around the globe?
BUFFETT: Plenty, plenty. And we're finding that out. And the same things happen to quite an extent around the globe. The European banks were doing what the American banks were doing.
ROSE: They're failing now.
BUFFETT: Yes. They were getting a mortgage from some guy in Omaha, you know, securitized a couple times. You have all these types from Wall Street. They had advanced degrees and they looked very learned. And they came with these things that said Gamma and Alpha and Sigma. All I can say is beware of geeks bearing formulas.
ROSE: Have we learned something about decoupling or the American economy in terms of its impact? For example, China, a place where you've had investments and you know well.
BUFFETT: Yes. We just made a new one a couple days ago.
ROSE: What was that?
BUFFETT: A company called BYB, may develop a really good electric car, I hope.
ROSE: Is there operative narrative to the kinds of investments you're making, other than you look at and you buy on value. You look at management. You look at a place that can absorb the amount of money you want to invest. And you look at its prospects. And you look at price.
BUFFETT: They have to be pretty good size for us now to move the needle. But we look for fairly large situations. We look for things I can understand. A lot of businesses I don't understand. So some guy may know how to make money in Coco Beans, but I don't. So I just let him have that.
But it's got to be something I understand. It's got to be a business with fundamentally good economics. There has to be a management that I like and trust and admire. And there's got to be a price that makes sense.
ROSE: Price makes sense.
BUFFETT: Prices make a lot more sense now, yes
ROSE: Is it -
BUFFETT: And I'm not worried at all about the investments we make. This country, we've got $46,000 or $47,000 of GDP per capita now. We've done darn well. We'll do better in the future. I'm not worried about the country. I'm just worried about anything that gums up the potential of the country and right now it's pretty gummed up.
ROSE: Okay, but we do this emergency, urgent rescue. Come January, we have a new president. We have a new Treasury secretary. We have a new legislature. What's their imperative? What will be the challenge for them, because they then can take a little bit of a longer-term look? Maybe the patient's getting up off the ground, but you want to get him or her moving faster.
BUFFETT: Yes. Well, I think it will get moving faster once - I mean once you get - once credit flows. Now, the recession is going to get worse. I mean, I don't want to hold out false hopes that by some magic moment that things will turn around in a couple months, because they won't, Charlie.
It's a big mistake to try and mislead people. They will turn around. I don't know whether it will be six months or whether it will be two years.
ROSE: More likely two years than six months.
BUFFETT: I don't know. It isn't going to be one month or two months, no matter what happens.
ROSE: You can imagine six months from now it's beginning to turn around, with conditions that you know?
BUFFETT: That's sort of the best case. Yes. That's sort of the best case
ROSE: And the worst case?
BUFFETT: The worst case is a long time.
ROSE: Five years or -
BUFFETT: If we don't do the things we should do, it could be five years.
ROSE: Beyond where we are now, what are those things?
BUFFETT: Well I would say this - if it becomes evident that - I understand the latest bill, they're talking about 350 billion early and then going back. But we need to throw the resources at this. Like I say, we're not spending the money.
If we buy these assets intelligently, the United States Treasury will make money. I mean, it's borrowing money. It's just a few percent a year and these assets are better than that.
ROSE: Okay. That's a very big if.
BUFFETT: The Treasury Secretary.
ROSE: That's the important question, in terms of whether we buy these assets wisely.
BUFFETT: I would say it's more important who the Treasury Secretary is than who the Vice President is. If you want to have a debate here, I would like to debate between two potential treasury secretaries than the vice presidential candidates.
ROSE: It might be a good thing for the presidential candidates to tell you who it is they're going to be listening to and who might be a potential Treasury secretary.
BUFFETT: Well Presidential candidates will tell you they'll listen to you.
ROSE: I assume they're telling you that, aren't they?
BUFFETT: It's not their job to narrow the candidacy field.
BUFFETT: When all these people call you up, what are they asking you? You're hearing from your friends and people at the Fed. You've been through this before too. I mean, you were that long-term capital. A lot of other times, you have had to face difficult crises.
BUFFETT: I've seen a lot of things happen.
ROSE: So they come to you and they say, you've fought wars before, Warren, we'd like to talk to you. But what's the questions they're asking? What is it they want to know? And I'm talking about smart people who are charged with fixing it.
BUFFETT: Well, lately they've been asking will this work.
ROSE: Right. And you're assuring them that if they do it, it will.
BUFFETT: I said, if they do it - I don't know who the next Treasury secretary will be. I would say this - I would - they hate this term in Washington, obviously, but I would hand something pretty close to a blank check to a fellow like Hank Paulson.
ROSE: Would you really? A blank check, $700 billion, go spend it.
BUFFETT: Yes. Go invest it.
ROSE: Invest it.
BUFFETT: Put a little of your own money beside it. I might ask Hank to co-invest with me.
ROSE: That's right.
BUFFETT: But no, I think that trying to invest through 535 people is a tough job. So I would give more latitude. That isn't going to happen. And I am -
(CROSSTALK)
BUFFETT: I think oversight is great. And I think that oversight ought to be devoted almost entirely to the question is this being done at market, you know. In other words, you want to make sure that the government isn't investing foolishly, but you don't want to care about which Congressional districts it goes to or whether banks get favored over -
ROSE: How do we determine whether it's being done wisely? That's a big question.
BUFFETT: I think you will have plenty of scrutiny as how the money's invested. Just like the RFC; when the RFC operated, people knew which institutions they were buying preferred stock in. And it worked very well.
ROSE: But is this different from the Resolution Trust Company because they're talking about securities and not real estate?
BUFFETT: Well Resolution Trust Company was set up to liquidate a bunch of assets that the government had inherited because the Savings and Loans went broke. So the Savings and Loans went broke, the government stepped in, paid off depositors. And now they're left with this mass of assets to sell.
We're not talking about selling here. We're talking about buying intelligently. They were selling what they got handed to them by a bunch of savings and loan operators that had, in many cases, had done some very dumb thing. But their job was to liquidate. They liquidated it. This is an entirely different proposition.
ROSE: You have said to me before that capitalism is not a perfect system. It may be better than all the other systems, but it's not a perfect system. You've talked about it in terms of some of its failings.
People are looking at this now and saying, excesses of capitalism, number one, markets that don't work. And there are some people in certain countries that are pointing their finger at us and saying, see? We told you, that markets was not - the markets will not always deliver for you.
BUFFETT: Markets aren't perfect - people do - as long as you have markets, you'll have excesses. People went crazy with the tulip bulbs. They went crazy with the South Sea bubble. They went crazy with Internet stocks. They went crazy with the Uranium stocks back when I was first getting started.
You're not going to change the human animal, and the human animal really doesn't get a lot smarter. Now you can have institutions that put curbs on that in various ways.
And actually with the banks, they have various capital ratios and that sort of thing. But the banks got around them. They set up sieves and that sort of thing just to get more leverage. People love more leverage when it's working. It's so easy to borrow money from a guy -
(CROSS-TALK)
BUFFETT: But if you don't get X plus one back, you still owe the X on the other side. You're in trouble.
ROSE: Are Morgan Stanley and Goldman Sachs, for example, better off in the end because they now have a holding company, because they are not standing alone (ph), because they have now listened to different rules.
BUFFETT: Well they both sent - they both converting to bank holding companies that I've not been (inaudible). That's probably part of a longer-range strategy, but it doesn't solve the lobbyings with the present.
ROSE: There is this too, accounting. You have strong feelings about accounting and mark to market. Tell me where you are on that issue.
BUFFETT: I - a lot of people disagree with me on this. I believe in mark to market. I think that accounting - in 1974, Charlie - it's either 1974 or 1975 - we owned a bunch of common stocks at Berkshire Hathaway. I told our shareholders what the market was and we used that.
I said, I think these things are worth a lot more than market, and I think we're going to make a lot of money out of it. But this is what they're worth today. And I don't think anybody gets hurt by telling the truth on that sort of thing.
And I think that once you start saying we're going to peg these things at some price that isn't market, God knows what a financial -
ROSE: These people who argue against you will say the assets are worth much more than mark to market says. And therefore, we're not seeing a reality.
BUFFETT: Well that is the reality, and that's the reality of what they're going to sell them to the Treasury for too. You'll get in a lot of trouble when you start putting fictitious numbers on value. You can explain the fact that these are depressed prices, you know, we think these assets are going to be worth a lot more. And I think that case could be made in certain situations.
But I think to just say, you know, we're going to say a $1 of cash is worth $2 all of a sudden, you know, it isn't worth $2; it's worth a $1 today. I think once you start putting phony figures into financial statements, you can get into a lot of trouble. We've seen so much of that in the last 20 years.
ROSE: Is it getting worse?
BUFFETT: No, I don't think it's getting worse. I think what people want to do is make it get worse.
ROSE: But what would reform about that, in terms of the accounting process? I think you'd keep mark to market.
BUFFETT: The rules get ungodly complicated. It's a nightmare to administer some of this sort of thing. But I want to tell the shareholders of Berkshire, to the extent we own marketable securities or things for which there are markets, even if those markets - I'm going to tell them what it's all about.
As a matter of fact, I have already written a section of the Annual Report for next year explaining why I think, in one case, that the figures on our balance sheet, as calculated, are wrong. But it's the standard way of doing it. It's holy writ. The SEC want us to do it that way, and we'll do it that way. Then I'll explain why I think it's wrong and the shareholders can read it and say whether they agree with my logic or don't.
ROSE: When you look at the prospects for this country, there are other people who argue that America, as good as it is, lives in a world today, and there are books being written, in which our supremacy, our primacy will now have to be shared, that we may still own as much of the pie as we have, but other people will own a lot more.
BUFFETT: That's great. I want our pie to grow all the time, but if some other guy's pie is growing a little faster, that's terrific. It will be good for us in the long run. And there are 6.5 billion people in this world. And it's great for 300 million to keep enjoying more and more prosperity. But I think it's terrific if the remainder do it.
I think if they can learn something from us, in terms of our system, and I think they have, they're learning more about how to unleash the potential of their citizenry to turn out more goods and services that their citizens want or that we want. I think that's terrific.
And I think it's much better to live in a world where those around you, particularly when some of them have nuclear bombs - I think it's much better to live in a world where their lives are getting better also.
ROSE: When you look at China today, and you look at some Asian countries, and the amount of American debt they have, how much does that concern you in today's economic circumstances? And are they losing some of their confidence in America? And does that pose a huge problem for us?
BUFFETT: Somebody buying these Treasury bills at 1/20th of 1 percent. We have been consuming about $2 billion a day of goods and services beyond what we're producing. In other words, the rest of the world sends us about $2 billion a day net of something. We've got to send them something in return, don't we? So we send them little pieces of paper.
Now, it would be nice if they stuck them all under a mattress, but they have to buy something with them. Sometimes, they buy our Treasury notes. Sometimes they set up sovereign wealth funds. They can do all kinds of things. They can buy our companies here.
As long as we consume more than we produce and we trade away a little piece of the country daily, they're going to own something. Now, on the other hand they can't run from American assets. I mean, every day the rest of the world's going to have about $2 billion more of American assets than we have, as long as they sell us these goods.
ROSE: Because we're borrowing $2 billion a day?
BUFFETT: Yes, and they want to sell us these goods.
ROSE: You don't believe that's good. You believe that an increasing current accounts deficit is bad.
BUFFETT: I think it's bad.
ROSE: And it reflects America's consumption ideas, rather than its saving ideas. But how does that change?
BUFFETT: Well, I laid out kind of a Rube Goldberg plan a few years ago, which I don't like myself, except I like it better than the alternative, which is what we're doing. But we've actually been pretty good on exports. We are exporting 12 percent of our GDP now, roughly.
That was 5 percent many years ago of a much smaller GDP. So the rest of the world really likes our stuff pretty well. It's just we buy so damn much of what they produce. And I think that should be something addressed by - I don't think it's the most pressing problem now at all.
We are trading away a little bit of our country all the time for this excess consumption that we have over what we produce. That is not good. I think it's terrible over time. But our country's productive capacity grows enough so we actually can do that and will still be better off. We just won't be as well off as if we hadn't done it.
ROSE: What's all this going to do to the price of the dollar?
BUFFETT: It could be very tough. Inflation could be a very - is a likely consequence on what's going on now. Right now, we're, in effect, making - to some extent, making a choice between future inflation and getting off the floor. And we're likely to have more inflation in the future as a consequence of the things we do to fight the present situation.
ROSE: Senator Obama, who you support, I think, and I don't want to be clear on this, but made an economic speech today - talks about another stimulus program. Is that essential at this time?
BUFFETT: I think the biggest thing we need now is to unclog the credit markets. And we may need other stimulus. If we do, it should go to the lower and middle income people.
The truth is, I have never had it so good in terms of taxes. I am paying the lowest tax rate that I've ever paid in my life. Now that's crazy, you know.
And if you look at Forbes 400, they are paying a lower rate, counting payroll taxes, than their secretary or whomever around their office, on average. And so I think that actually people in my situation should be paying more taxes. I think the rest of the country should be paying less than the 95 percent that Obama talks about, or maybe even a little higher than that.
But I think that a stimulus plan should really be geared to the people. You've got, what, 24 million households - one fifth of the households of the United States, you have earning $21,000 a year or less, an average of close to four people or three people in those households, two and-a-half people actually probably. But just imagine living on $21,000 a year, Charlie, $22,000 a year. You have 20 percent of the population doing that.
So they don't have to worry about guys like me. I would push purchasing power. You push out $1,000 a person to those people, it's going to get spent. And it needs to be spent. They need it. It should come, to some extent, from guys like me.
ROSE: So you're recommending, A, changing, as Senator Obama had and Senator McCain is not, in terms of supporting Bush's permanent tax cuts, and Senator Obama would talk about it different - tax involve people over whatever it is, $200,000. And reduce impacts (ph). But what about the capital gains tax?
BUFFETT: The capital gains tax is 15 percent now. So I sit there in my office and I make a lot of money by capital gains and I pay 15 percent, and I pay no payroll tax on it. The woman that comes in to take the waste basket away, she's paying 15.3 or whatever it is, just payroll tax alone. I mean, it is - I never had it so good.
ROSE: But so therefore the capital gains tax should be changed to 18, 20, 25, 30?
BUFFETT: I think it's terrible for people, in effect, to say that income from investments should be taxed at a much lower rate than income from labor. I just think that - we're going to spent $3.1 trillion or something like that. We only going to raise about $2.6 trillion. You're going to raise it from somebody, you know.
Now, who are you going to get it from? You going to get it from me and you, or are you going to get it from the people that drive the taxi that brings me here or whatever it may be? You've got to get it from somebody. And you know, everybody's against paying taxes themselves. I feel the same - everybody feels that way.
If you want a government that's going to do the things we ask our government to do, you've got to get it from somebody. And over the years, particularly the last six or eight years, they've taken less and less from a guy like me.
Now everybody likes to talk about how the top 1 percent pays this percent in income. But the income tax will say $1.3 trillion. The payroll taxes are over $900 billion. That $900 billion, that doesn't come from me. I mean, I pay it on the first $100,000 or something like that. But that comes from the people in my office, and they are paying $900 billion.
Nobody ever talks about that when they talk about how the 1 percent is paying. They love to tell how I'm suffering, because 1 percent, we're paying 25 percent of the total. We're not paying 25 percent of the total taxes on individuals. We're paying maybe 25 percent of the income tax.
But the payroll tax is over a third of the receipts to the federal government. And they don't take that from me on capital gains. They don't take that from me on dividends. They take that from the woman who comes in and takes the waste baskets out.
ROSE: You mentioned inflation, possibilities of inflation - are you therefore - do you have a position on what interest rates - what the Fed should do about interest rates?
BUFFETT: Well I think that's almost - for the time being, that's just put it - yes, just put that aside and we'll get to that after the patient's up and walking. It's interesting, though. I mean, what's going to happen - things we're doing are going to have some inflationary consequences. But you see interest rates at very low levels, and including the long rates.
ROSE: When we watch this - you and I are having this conversation today. The Senate votes tonight. House may vote - people I talk to today believes it's going to pass. Whatever happened that changed minds.
Either the combination of what they did with the plan and tweaking the plan, or B, some people got so scared by the failure of the vote last time that it brought home the danger of not doing anything. All right, how will we measure the progress, whether this is working or not?
BUFFETT: It's going to be tough because the economy's going to be getting worse for a while. And it might fall off a cliff if this doesn't pass, but nobody will ever know that if it passes. So they will not see immediate reaction. We'll be pounding on that guy's chest on the floor.
And, you know, he's not going to just jump up all of a sudden. So it makes it tough. I mean it's tough to be in the legislature and vote for something and then people say, well, you voted all this money and it's all getting spent. It's isn't getting spent, it's getting invested. But it's all getting spent, nothing's happening, how can you have done that - you haven't done anything for me. You go through all of that. And that's going to be tough.
What it really takes is leadership that knows what it's all about and can explain what it's all about.
ROSE: But hasn't that been missing, though, leadership that can explain what it's all about.
BUFFETT: Absolutely.
ROSE: And the reason you're here and the reason I want to have a kind of fireside chat with you - it is that somehow it hasn't gotten through. The idea - go ahead.
BUFFETT: When the President of the United States goes out at 8:00 in the morning and his own party votes against him two to one in the House, you know that somehow a message is not getting out.
No, it takes real leadership. I mean, Roosevelt didn't - when he came in, he didn't print any money. Actually, he may have done a little bit of that. But it wasn't like you've gotten the greatest economics professor in the world or anything else. But he did restore confidence. And they did a lot of that. And you needed it. You needed to jump start the economy.
It took a long time. The world did not change in 1933 or 1934. But we put in things like the FDIC. I think the FDIC was one of the great inventions of the American economy (ph).
ROSE: Well they've had to tweak that in terms of this bill, did they not?
(CROSSTALK)
BUFFETT: Yes. They're going the right direction, yes.
ROSE: Roosevelt also said, "The only thing we have to fear is fear itself," which is clearly the fear that exists in the country. Tell me when you worried the most, of all the things that you have seen over the last three weeks - I mean, how long in the last month. When did you say, ?My God, I never are knew it could get to this point,??
BUFFETT: Well, I don't get that afraid in a sense, because I really do have faith. I know the country works extremely well. But when it isn't clogged up. And I know that Congress will do the right thing.
When I watched the House vote the other way, I wasn't afraid because I still felt something would pass. But we are going through a very, very tough period. And I did not think I would see the day when AIG would not be able to have its checks cleared.
ROSE: If AIG had failed, would Goldman Sachs have been exposed and at risk and Morgan Stanley - ?
BUFFETT: Everybody would have been exposed, Charlie, everybody.
ROSE: Why was there even a question of not rescuing AIG at that time?
BUFFETT: I think what people that understood it, they probably - well they were hoping the private sector would do it. That's the same way I would behave.
If I were the Treasury Secretary or head of the Fed, I would try to scare the hell out of the private sector and say, you better save this, because you're going down with the ship. So you guys save it. And I would wait as long as I could. If they didn't save it, I'd come in.
ROSE: Did that, in fact, happen during this crisis, in which the Secretary of the Treasury said, you better save this or we're all going down. You better put up some cash right now.
BUFFETT: I think they hoped the private sector would come in. And the private sector tried to come in until they saw the size of the problem.
There were people on that weekend that thought they had a solution. And then the hole kept getting bigger and bigger. And all of a sudden, it became apparent that $20 billion wouldn't do it and $30 billion wouldn't do it and $40 billion wouldn't do it. So it got beyond anybody's ability to certainly to do it in a short period of time.
ROSE: There was not enough capital available from the government.
BUFFETT: It's an unknown situation. You have a derivative book called 'AIG Financial Products'. Nobody's ever heard of it, except it was terrific profit center. You could manufacture earnings and do all these things. And I will guarantee you that the top management - and I'm not knocking them for this. I don't think I could have done it. They didn't - they couldn't get their mind around it.
I bought a company called 'General Reinsurance' in 1988 that had a similar but much smaller operation, had 23,000 contracts. And I said, I have to get out of this. It cost me 400 and some million dollars in a benign situation.
But this was not a benign situation. If AIG had tried to unwind the derivative book, I don't know. It would have hit every institution in the world.
ROSE: And there was no private capital to come in and do that?
BUFFETT: Not big enough.
ROSE: Not even Berkshire Hathaway?
BUFFETT: No, not even Berkshire Hathaway. If I thought 5 or 10 billion would have bought me a good deal, and I could have done it, I'd have done it.
(CROSSTALK)
ROSE: $10 billion was within reach, but $85 billion might not have been.
BUFFETT: And the Feds structured that thing very, very well. I mean, they have put themselves in a position where they are very likely to get their money back, maybe more. They participate 80 percent. They drove tough terms. I mean, I want to hire the guy that made that deal. He would fit in well at Berkshire.
ROSE: A lot of people look at you and Goldman Sachs and GE saying I want to hire the guy that made that deal for you.
BUFFETT: Tim Geitner did a better job on this one.
ROSE: So we've come down to the close of this conversation. And you have been warning us about certain kinds of things. I hear from this conversation, too, this plan is essential now, otherwise we're in a very, very difficult place. And each week we go beyond not doing something, we get deeper and it becomes more irreversible.
BUFFETT: And, yes. Whoever said, you know, an ounce of prevention is worth a pound of cure understated it. A pound of cure is delayed another six months, you need a ton of cure later on. I mean, it would be crazy not to do this. It will not produce dramatic results, though, in the economy.
That's what people have to understand. You're going to see unemployment go up. You're going to see lousy earnings in many businesses.
ROSE: You're going to see people unemployed.
BUFFETT: You're going to see more people unemployed. But the difference, Charlie, if we bottom this thing out at 7 percent unemployed versus 9 percent, that's 3 million people. That's 3 million people that, if we do it wrong, you know, lose their jobs unnecessarily, in my view.
You know, I have never been unemployed. I have never been very fully employed either. But just think of what it's like to go home with a mortgage payment and kids and everything else. My dad had that happen to him in the early 30s. You don't want to create 3 million people more - unnecessarily. But I don't think -
ROSE: That's the depression.
BUFFETT: It really is, and you can't help some increase from this point. I don't want any viewer to go away thinking a magic wand exists in Congress. So they're going to see some more bad news. But if we do this, we're doing the right thing. And the system will work over time. There's no question, and we've got a wonderful system.
ROSE: Okay, I'm going to come to that in the end. Do we need to do anything about the system, beyond the urgency of the moment, come January, about the system? Lots of talk about regulation, as you know, and finding the right balance. Lots of talk about whether government involvement is an idea we need more of rather than less of, rethinking sort of what President Reagan brought to fore.
BUFFETT: Once we get the athlete back, we can tell him to change his diet a little or exercise a little more. We can do all of that sort of thing. If I have any good ideas out of that, or I think they're good ideas, I'll be glad to contribute them. But the system will probably overdo some other things.
The nature of democracy is such that when there's - there'll be this revulsion, obviously, towards - that's never going to happen again. So we will probably attack it in various ways that don't make sense.
But I'm - that's what Congress is for and that's what advisers are for. And I'm all for getting the best minds to get to work on that kind of thing. Like I said, I don't think it will be done perfectly.
Maybe we'll end up with a little bit better system at the end. We had a pretty good system over time. When we went crazy, and we did go crazy on residential real estate, it set things in motion that just - the dominoes started toppling.
ROSE: Thank you for coming.
BUFFETT: Thank you, Charlie. Enjoyed it.
ROSE: Good to see you. Warren Buffett. We're in San Diego. My thanks to the people at KPBS here. A conversation here about the crisis that we all face and hearing from a man that a lot of people want to hear from. And I'm pleased that we were able to join with him here. Thank you for joining us. See you next time.
***END OF TRANSCRIPT***
Subscribe to:
Posts (Atom)
