Warren Buffett’s new letter to shareholders is out. One passage in particular reveals just how much government is the problem rather than the solution.
Warren Buffett’s new annual letter to shareholders is out. You can find it (and all letters previous) on the Berkshire Hathaway Web site.
I read it over the weekend (sitting at the poker table, of course). There were a number of nuggets and insights in Buffett’s letter worth commenting on. I’ll probably discuss those later in the week when I write to Safe Haven Investor readers... today, though, I want to focus on just one passage.
But first, some background.
A Financial Fortress
Berkshire Hathaway (BRK.A) (Buffett’s investment vehicle) is like a “Rock of Gibraltar” in the Oracle’s own words.
It is one of the most, if not the most, financially sound corporations in the world. Off the top of my head, the only other outfit that comes close is Exxon (XOM)... and Exxon’s lifeblood comes from a single industry, oil and gas. Berkshire, on the other hand, owns a famously wide and diverse variety of businesses. Those businesses throw off many collective billions in cash, with very little (if any) leverage or debt.
In times like these, a “fortress balance sheet” is a huge asset. And what the world needs now, more than ever before, is not love sweet love but rather strong entities with the ability to lend and invest wisely. Berky (as some holders affectionately call it) is one of those entities.
The trouble is, the government’s attitude towards the “zombie banks” – Citigroup (C) chief among them – is holding back investors like Buffett and screwing up the recovery process in general.
The following passage makes that truth painfully clear:
Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal.
Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.
This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.
Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.
That last sentence is the killer: “At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.”
This is exactly backwards from how the process is supposed to work. It is backward from the way free markets work, the way evolution works, and even the way basic logic works.
The virtue of the “creative destruction” process is that, when the business cycle goes through a downturn, capital is transferred from weak hands to strong hands.
Failure is a vital aspect of the free market because if failed experiments are not shut down, the experiments that work will not have the resources needed to expand. Without failure, the market has no way to reorganize and revitalize itself.
In more concrete terms, think of it from the perspective of a business owner. Imagine your business has two divisions and a general manager for each division. One of those managers is hard-working, savvy, and consistently profitable. The other is a complete idiot.
So... do you punish the smart successful manager for his success, and reward the idiot for his failure, by pouring more funds into the flailing division at the expense of the one that’s working? Of course not. No sane business owner would do that.
But if your name is Tim Geithner, and your title is Secretary of the Treasury, and the idiot in question happens to be an old Wall Street pal, then that is exactly what you do.
And when successful outfits like Berkshire find their opportunities constrained by the likes of the government propping up Citigroup – a ship of fools if there ever was one – the above is roughly what happens. The idiots get continued funding, while the diligent and prudent get punished for their wise stewardship.
As a result, the market does not heal itself. Money does not flow to where it will be best treated and best allocated. Instead it gets dammed up in stagnant pools, good for little more than attracting mosquitoes and leeches. Bad behavior is rewarded; good behavior is ignored or worse yet punished. Brain-dead politicians, seeing their initial dose of medicine is not working, then call for a bigger dose of the same.
Buffett Versus Pelosi
Here is another way to ponder it. Berkshire had a very tough year last year – the company’s worst year ever in fact. But it should still be rather easy to answer the following question:
“Who would you rather have manage your money... Warren Buffett or Nancy Pelosi?”
When we sign up for letting the government expand its budget dramatically, we give a vote to the likes of Pelosi and Reid over Buffett and Munger. And it really is an either / or type vote to a large degree. When times are tough and people are scared, government-backed debt competes with private debt and private investment opportunity in the general marketplace.
So if Uncle Sam is able to put out a couple trillion in new government-backed securities and find buyers for all that paper, well, then bully for him. But that flood of government securities winds up crowding out smarter managers in the marketplace – guys like Buffett – and reducing their scope of opportunity. Good opportunities go begging and the recovery gets delayed that much more.
Getting Worse, Not Better
The situation is depressing because it seems to be getting worse, not better.
We are making no headway with the banks. Geithner’s “stress tests” are a complete joke. The government can’t be bothered to fire any of the executives who got us into this mess. AIG is opening its massive maw to swallow up another $30 billion.
And the new Obama budget has been deemed “very, very good” by NYT’s liberal uber-columnist Paul Krugman... which means in all likelihood it is a fiscal nightmare.
Meanwhile, most Americans still don’t seem to understand what’s happening, or what to do about it. For instance, a recent Gallup poll produced the following nonsensical results:
Poll question 1: Do you favor or oppose the federal government temporarily taking over major U.S. banks in danger of failing in an attempt to stabilize them? 54% favor / 44% oppose / 3% no opinion.
Poll question 2: Do you favor or oppose the federal government temporarily nationalizing major U.S. banks in danger of failing in an attempt to stabilize them? 37% favor / 57% oppose / 6% no opinion.
The public doesn’t understand what the word “nationalize” means. Nor do they understand that the U.S. taxpayer already owns the zombie banks – or at least should own them, at any rate, given the hundreds of billions that have been pumped in. We have de facto nationalized, but we are still paying off the private parties who should have been wiped out as a logical consequence of their enabling this fiasco.
Management has proven grossly inept on all sides, public and private. And the biggest stakeholders in this whole mess – American taxpayers – have proven too uninformed or too unmotivated to realize how badly they are being screwed.
If ever proof existed for the twin assertions “ignorance is dangerous” and “government doesn’t work,” that proof is now staring us in the face.
Go Forth and Trade
So what can be done about this?
As far as Washington goes, your humble editor throws up his hands. I will no longer expect anything but foolishness and incompetence and deceit from that town from here on out. (Some of you will say, “What took you so long?” To which I say, “better late than never.”)
As for me, I’ll stick with Deng Xiaoping’s late-in-life observation: “To get rich is glorious.”
If our government is going to be resolute in making dumb decisions, propping up losers at the cost of winners, and generally going about the business of making things worse, then there’s really only one thing to be done in my view: make the most of a bad situation by making money off it.
In volatility we trust. As I told Macro Trader members last week, if government involvement in markets ranges from 1 to 10 over the course of the long-term cycle, right now we are close to “10” and may well remain near the “10” level for years.
That means uncertainty and volatility are here for the duration... and that’s a world where trading dominates.