Saturday, February 28, 2009

The Oracle of Omaha

Once a year, Warren Buffet, the so-called Oracle of Omaha, writes a letter to the shareholders of his company, Berkshire Hathaway. Unlike other corporate executives that often pepper their writing with corporate-speak difficult to decipher, Buffet tells his shareholders the story in straight-forward prose, with quite a few funny gems sprinkled in. Even if you don't own Berkshire Hathaway stock--and given that Class A shares trade at $76,800, while class B shares trade at $2,564, you probably don't--his letter is worth reading. Which brings us to the the one he wrote this year.

As you can imagine, much of the new was pretty grim.

The table on the preceding page, recording both the 44-year performance of Berkshire’s book value
and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for
corporate and municipal bonds, real estate and commodities. By yearend, investors of all stripes were bloodied
and confused, much as if they were small birds that had strayed into a badminton game.
As the year progressed, a series of life-threatening problems within many of the world’s great financial
institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned
non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was
young: “In God we trust; all others pay cash.”
By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a
paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have
never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback
cycle. Fear led to business contraction, and that in turn led to even greater fear.


Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a
gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie
Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our
usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will
be in shambles throughout 2009 – and, for that matter, probably well beyond
– but that conclusion does not tell
us whether the stock market will rise or fall.

That said, Buffet also had some encouraging words for Americans.

Amid this bad news, however, never forget that our country has faced far worse travails in the past. In
the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or
so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of
the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of
Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the
real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones
Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which
humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic
system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it
will continue to do so. America’s best days lie ahead.

It's good to know that he thinks it, but it will be more important to have people to buy in. Although we're taught that people are always rational actors in Intro to Econ, it's clear that's not really the case. Things are bad, but there's no reason half of American should be worried about losing their job. Whatever your thoughts on fiscal policy, it's clear that we need to do something to make people less fearful so that the downward spiral does not become a self-fulfilling prophecy.

Friday, February 27, 2009

Datapoint of the Day

Really, it's the 6.2% decline in fourth quarter GDP, but that's too depressing to think about. This tidbit from the Wall Street Journal today was also pretty astounding:

On Thursday, U.S. mortgage titan Fannie Mae, which the government took over last year, reported a larger-than-expected $25.2 billion loss for the fourth quarter, as losses on home loans piled up. The company's full-year loss of nearly $59 billion exceeds its net income for the preceding 17 years.


It's Always Been Our Money

Like any good financial crisis, the current economic downturn has given populists a number of examples of corporate greed at which they can direct their fury. Outraged citizens have used barrels of ink (or, perhaps, megabytes of data) to condemn incidents of corporate excess like John Thain's $1.22 million office renovation, AIG's $440K trip to a resort, and Citi's now-canceled purchase of a $50 million corporate jet. Given all these firms have received government bailouts, it come as no surprise people were upset about those spending sprees. My bigger question, though, is why people care about it now that it's their tax dollars, yet for years allowed executives to spend the money the people invested in them in much the same way.

With the vilification of many large corporations as evil entities, it's often easy to forget that a company is just a legal structure that exist to allow pools of investors to share ownership in an enterprise. And although some might have you think otherwise, the largest shareholders of the biggest companies aren't some devious old men hellbent on using their control to destroy the environment and exploit workers, but rather large institutions like mutual and pension funds that invest for regular folk like you and me. When a company moves jobs overseas to cut cost, we're the ones that, in theory, benefit from the better earnings. On the other hand, when companies spend their money to pay traders millions in bonuses, send employees on lavish trips, or to buy those luxury suites at sporting events, we've always been the ones that have essentially paid--even if it seems like they're just charging it to some faceless corporation. It's shareholders that foot the bill for your salesman friend with the huge expense account.

Although some of it is likely related to the fact people didn't care as long as their stock portfolios went up year-after-year, I suspect a big  reason people never really got as upset until now is that they simply didn't know how absurdly these financial institutions rewarded some of their employees, whether through huge salaries and bonuses* or perks like black car service to and from work. The public, after all, has gotten angry in the past over things like Dennis Kozlowski's $6,000 gold shower curtains and Robert Nardelli's $210 million golden parachute. Unfortunately, these sorts of details rarely become public, because despite being publicly-owned corporations these companies reveal very few details about their actual operations. When they do report to shareholders about their compensation agreements, it's often clouded in obscure language and technical details that only an expert can parse. And there's certainly no line on any income statement a shareholder would ever see that details how much money was spent to sponsor another golf tournament and entertain employees and clients with performances by Sheryl Crow and Chicago

*As a sidenote, if the business media couldn't get the public upset about something straight-forward like the skewed compensation schemes that rewarded traders with millions for short-term gains without any punishment for long-term losses, how could we expect them to warn the public about the danger lurking behind the complex structured finance and derivate products?

Although people have recognized for years that employees' interests must be aligned with shareholders', no one has created a good system for doing it. As taxpayers are now learning, corporate boards and new compensation schemes have clearly failed us once again. Even if shareholders didn't know they were endorsing it, at some point they elected directors who allowed these contracts and severance packages to get signed. Maybe people didn't care about it enough to do anything about it when it was their savings, but now that it's their taxes, hopefully they will.