Stephen H Baum Leadership

When Warren Buffett speaks, listen. He makes complicated situations understandable, puts them in current context and historical perspective and encourages a balanced, unemotional mindset. 

This is my impression of what he said about the economic crisis to Charlie Rose last evening in an interview on PBS:

1. No matter how the economic crisis befell us, it is urgent first to enact and execute a rescue plan

2. What we are rescuing is the American economy

3. What we are rescuing it from is a seizure, a lack of the liquidity and credit that keeps business and consumers going (example: commercial paper that fuels business short term expansion is very scarce even for worthy borrowers)

4. We are also rescuing it from a breach in the confidence and trust that we all place in the system; you take it for granted when you have it and it is all you think about when you lose it; Treasuries are paying 1/20th of 1% because people don’t trust the financial institutions

5. The plan will work if and only if the price paid for the distressed securities is at market: let the seller sell some of it on the open market, then let the Treasury buy the rest at the market price. The debate tonite should be between each candidates proposed Secretary of the Treasury – a more important position than VP unless something happens to the President. <note: this is counter to Bernanke’s suggestion that the distressed securities be bought at a premium)

6. Once we are executing the plan, expect the credit markets to unfreeze and stabilize; but expect the economy to be worse until it gets better. If we are lucky, unemployment will reach its maximum at perhaps 7% rather than 9% (a difference of 3 million unemployed). You can also expect some inflation as the money supply is expanded. 

7. Then expect that the amazing American economy will revive. It may take 2 or more years, but it will revive. In the past 100 years, despite a depression, two world wars and more, our standard of living rose seven fold, more than any other country in history. 

8. Cash is king. But the king cannot just sit on the throne. He is no good unless he knows when to act. And there are opportunities to put cash to work now at reasonable prices (Buffett just bought a piece of Goldman Sachs, General Electric and a battery company in China). Buy into companies whose business model you understand, whose management is trustworthy and has a good track record and whose price is now reasonable. 

9. How we got into this crisis was a repeat of history. Think Tulip-mania of 400 years ago in Holland. Or the internet bubble. Or any number of other bubbles in our history with a frenzy of buying at rising prices. 

10. Greed is human nature. We see our neighbor with a better house or car and we want one too. We see our neighbor making money by investing and we feel left out and pressure to do likewise. Never mind the risk. 

11. The sequence is innovators first, then imitators, then idiots who enter just before the bubble bursts.

12.This crisis flowed from extreme leverage added to the greed. If you are smart and can always pay your bills, you get wealthy. If you are smart and borrow too much, one mistake and you can be wiped out. 

13.This crisis also flowed from adding an investment vehicle that defies understanding. I bought a company that had a derivatives division, failed to understand it and sold off the division. I lost 400 million in the process but avoided much larger losses. 

14.There was no regulatory oversight to retard the leverage and risk-taking that the greedy pursued or raise the supporting capital requirements. And such oversight might have been ineffective anyway since the financial people usually find ways around the regulations as they did. <Note: this applies not only to Wall Street but also to home buyers who bought houses they could not afford with mortgages they could not afford with 10% or less down). 

15.If AIG had not levered so much and taken on so much of the derivatives, it would be healthy today. 

The private sector tried to step up after the failure of Bear Stearns, but discovered that the pit of capital required would be almost bottomless. Only the U.S. Treasury has the ability to raise so much money at a low borrowing cost and the staying power to wait for returns on its investment.

And the $700Bn or more the Congress is weighing is not spending. It is an investment. And it may see as good a return as past such efforts (there have been at least two analogs of reconstruction finance and rescue in our history). 

So, when Warren Buffett speaks, listen. That’s my view.