Buffett Angle Heightens Goldman Mystery, Stakes

3 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

3 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

While well-known to Americans and those who trade in US equities, many non-American readers of this site may not know who Warren Buffett is, so I hope the first group will forgive a SHORT introduction to the man and his importance.

3 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

3 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

While well-known to Americans and those who trade in US equities, many non-American readers of this site may not know who Warren Buffett is, so I hope the first group will forgive a SHORT introduction to the man and his importance.

Buffett is currently listed as the third richest man in the world, and CEO / main shareholder of Berkshire Hathaway,

a conglomerate holding company whose individual shares are worth approximately USD 100,000, largely because the company has never paid a dividend nor split its shares.

He is also considered one of the leading, because most successful, proponents of “value investing,” which he originally defined as “buying stocks at less than their intrinsic value” – at first delineated as “the discounted value of all future distributions.”

Over the last 25 years, however, he has taken the concept even further, to define it as “finding an outstanding company at a sensible price” rather than generic companies at a bargain price. [br]

But, aside from the worship Americans give wealth in general, Buffett is beloved for basically four reasons, and, in the current context, one notable comment in particular.

The first is that, despite his huge fortune, he has not moved to any of the places usually associated with big money – eg, New York, Los Angeles, Miami, Las Vegas etc –

but has remained in his hometown of Omaha, Nebraska, where the winters are freezing and snowy, and the summers revoltingly humid.

The second, consequently, is that he has seemed to retain the personal characteristics of the alleged “homespun” Midwesterner: unpretentious, straight-talking, not a snob, and very accessible to people from all walks of life.

Not that most Midwesterners are actually like that – that’s just the stereotype, and Buffett’s public personality conforms to it perfectly. Whether it’s an “act” or not, no one can say.

Given this, the third reason Americans love him is that, despite all his money, he has continually expressed profound mistrust of – if not contempt for – Wall Street and everything that goes on there.

Fourth, he is an extremely generous philanthropist, whose politics are generally liberal – in the US framework – leading him to be a major donor to all sorts of “do-gooder” groups and activities,

as well as, for example, an early supporter of Barack Obama, which gave the latter a significant blast of credibility in the early stages of the endless American campaign season.

And finally, Buffett has been seen most recently as a fount of common-sense economic wisdom for regularly calling derivatives “financial weapons of mass destruction.”

As a result of all these, Buffett is regularly referred to as “The Oracle of Omaha”, or, as we like to call him “St Warren of Buffett”.

Now, why do we go through all this ???

The reason is that, ever since the announcement of the SEC civil indictment of Goldman Sachs –

generally considered the MOST evil of the many dubious denizens of Wall Street –

Buffett, and the vice-chair of Berkshire, Charlie Munger, have been among the most vocal and forthright defenders of the investment company.

Now given everything that we have said about why Buffett is such a beloved figure, his defense of GS raises a lot of questions, most notably:

If Buffett is so anti-Wall Street in general, then why is he so fond of the company that even people on Wall Street consider – perhaps with envy –

to be the sharpest operator in an environment generally considered “shark-like” at best ???

Even more disturbing:

If Buffett is such a militant foe of derivatives, then how on earth can he be so pro-Goldman when they –

along with the now-defunct Lehman Brothers, as we know from the whole Repo 105 scandal –

have been among the most consistent and earliest users of what he has so famously been quoted as calling “financial weapons of mass destruction” ???

Now part of it is that Buffett is simply defending his massive personal stake in GS:

He got a huge sweetheart deal from them at the height of the panic during Black September 2008, when he gave them five billion dollars,

in return for which he got preferred shares that pay an annual dividend of USD 500 million –

which means he will get his entire investment back in 10 years, whatever happens,

AND he got 43,478,260 – that’s right, 43 MILLION – warrants for common stock at a strike price of $115,

which means he also has a very definite stake in Goldman’s share price maintaining / increasing its value.

So how does all this fit together –

St. Warren of Buffett, the “regular guy”, homespun, Midwestern billionaire exponent of “value investing”, on the one hand,

and, on the other, Goldman Sachs, prime user of derivatives, and the most reviled and hated of the many Wall Street firms,

whose high-level employees have been raking in millions in compensation,

while most of the rest of the world sits mired in The Great Recession ???

Well, not to pat ourselves on the back too much, but we raised this question three months ago, well before the SEC suit –

long before anybody else was even thinking along these lines –

wondering how these two seemingly opposite poles of the US / global financial system could fit together so seamlessly. [br]

The answer we came up with at that time, not surprisingly, was basically a question,

taken directly from the immortal words of Senator Howard Baker, when he asked about Richard Nixon’s involvement with Watergate –

then a scandal that, by today’s standards, would barely raise eyebrows –

namely, “what did he know, and when did he know it ???”

And with the announcement of the SEC fraud suit –

whose legal strength we originally questioned, but which has been strongly endorsed by some informed financial world bloggers –

we MAY have begun to get some answers about how much due diligence St Warren did before jumping into bed with what Matt Taibi has so famously called a “vampire squid”.

And it seems like the answer is, “quite a lot.”

The occasion was Berkshire’s annual meeting in Omaha, where Buffett – to give the man his due –

did NOT shy away from difficult questions coming from either his – admittedly, usually worshipful – shareholders nor the media.

NB: We are including almost all of this piece from the influential Deal Book feature of the New York Times – admittedly with our emphases –

just to reassure our more skeptical readers about our portrait of Buffett and the way in which people view him:

[quote]

The first question asked during Berkshire Hathaway’s 2010 shareholder meeting was unsurprisingly about Goldman Sachs,

which is under fire from the Securities and Exchange Commission for an alleged act of securities fraud.

A bit more surprising is how strongly Berkshire’s head, Warren E. Buffett, is defending the firm.  

He told Bloomberg Television before the meeting that he backed Goldman’s chief executive, Lloyd C. Blankfein, “100 percent.”

Mr. Buffett said that he felt little sympathy for the firms the S.E.C. says were hurt by what the agency calls Goldman’s lack of adequate disclosure.

Of one firm, ABN Amro, Mr. Buffett said: “It’s hard for me to get terribly sympathetic when a bank makes a dumb credit bet.”

What Mr. Buffett thinks about Goldman is something the investment community has been buzzing over for days.

[/quote]

Again, that was a question we raised some three months ago.

[quote]

Berkshire has invested $5 billion in Goldman preferred shares, and Mr. Buffett is notoriously skeptical of Wall Street mores.

[/quote]

As we noted above … at least allegedly …

[quote]

In the case of Goldman, Mr. Buffett and his chief lieutenant, Charles Munger, made it clear they’re on the firm’s side.

Goldman and Berkshire have a long history, with Mr. Buffett relying on Goldman as his longtime investment bank.

He has said that Byron D. Trott, a longtime Goldman banker who left to start his own shop, is one of the few Wall Street bankers he trusts.

According to DealBook’s Andrew Ross Sorkin, who’s one of three panelists asking questions at the meeting,

Mr. Buffett essentially took Goldman’s defense that everyone involved in the deal under scrutiny, Abacus, was a sophisticated investor fully capable of evaluating the risks in the subprime mortgage investment.

Instead of needing to be told that a hedge fund manager who suggested which bonds should form the underpinnings of the Abacus collateralized debt obligation was also short the bonds,

the investors should have relied on their own due diligence, Mr. Buffett said.

“If I have to care who is on the other side of the trade, I shouldn’t be insuring bonds,” he said.

Mr. Buffett added an implicit rebuke of a line of questioning raised by several senators during this week’s Goldman hearings.

An investment bank could very well be short the securities Berkshire is buying, and a buyer like Berkshire should be perfectly aware of that in any case.

Mr. Munger added that were he on the S.E.C., he would not have voted to press charges.

That isn’t to say that Mr. Buffett and Mr. Munger think Goldman is blameless here.

Mr. Munger suggested that there was a difference between breaking the law and behaving unethically — and that simply following the law shouldn’t be the basis of a business’s conduct.

He added that many investment banks had taken on “scuzzy” customers that they shouldn’t have.

[/quote]

Well, scuzzy is as scuzzy does, and this makes pretty clear Buffett knew QUITE A BIT about Goldman before he came in and rescued them in the dark days of Black September 2008,

as is only to be expected, given both his history and, in this particular case, his explicit endorsement of the necessity of due diligence.

Which brings us back to the key question of derivatives and St Warren’s attitude towards them.

And here the story gets even darker.

Another DealBook item from about a week before the one quoted above indicates maybe St Warren no longer feels these “weapons of mass destruction” are as bad as he supposedly thought:

[quote]

As Democrats moved closer to an overhaul of financial regulations, The Wall Street Journal reported that 

Warren Buffett — the man who once branded derivatives as “financial weapons of mass destruction” — has been fighting against the deal.

Mr. Buffett’s company, Berkshire Hathaway, has been lobbying for changes to the overhaul that would prevent his finances from being overly impacted by the bill, The Journal said.

Berkshire would like a provision to the bill ensuring that existing derivative contracts would not be affected by the proposed rules.

Berkshire has $63 billion worth of derivatives on its books, according to Barclays Capital, The Journal reported.

[/quote]

WHAT ???

Financial weapons of mass destruction WORTH USD 63 BILLION on Berkshire’s books ???

Hmmmm …

What does THAT say ???

Unfortunately for St Warren, that effort was rejected, and Democrats included a provision that made charges on EXISTING derivatives contracts part of the “financial reform” bill.

Of course, the fight on that “effort” has just begun, and, from this clip from CNBC –

whose Becky Quick actually had the gumption to mention the “mass destruction” characterization to Buffett as he was leaving the stockholder’s meeting –

it’s clear Buffett is a long way from giving up.

Which probably could also be inferred from the fact that the ONLY Democratic Senator to vote WITH the Republicans and AGAINST his own party on the initial vote on this legislation

was – you’ll never guess – Ben Nelson, from Buffet’s own – apparently in many senses of the word – state of Nebraska.

David Caploe PhD

Chief Political Economist

EconomyWatch.com

President / acalaha.com