Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street Part 8

Yet, just as with the August 2007 liquidity bailout of Countrywide, the Fed extracted no concessions when it aided JPMorgan's purchase of Bear Stearns and when it handed out ma.s.sive liquidity to highly leveraged investment banks in the first quarter of 2008. It opened the national purse and let investment banks reach in.

In early April 2008, Fed Chairman Ben Bernanke testified before the U.S. Senate's Committee on Banking in a speech devoid of inflationary language. His reason for the Federal Reserve's agreement (in consultation with the Treasury Department) to provide funding to Bear Stearns through JPMorgan Chase was "to prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe consequences for market functioning and the broader economy."7 What happened to the $30 billion in Bear Stearns' mortgage-backed products that the Federal Reserve bought through JPMorgan? From March to June 2008, it lost more than more than $1.1 billion in value; it has already eaten through JPMorgan's $1 billion "cus.h.i.+on" and is now eating into taxpayer dollars. It is a sticky bomb, sticky bomb, as dangerous as the makes.h.i.+ft explosives stuck to tanks during World War II. In June 2008, the Fed admitted that it priced the a.s.sets as if we were in an "orderly market." as dangerous as the makes.h.i.+ft explosives stuck to tanks during World War II. In June 2008, the Fed admitted that it priced the a.s.sets as if we were in an "orderly market."8 But we are not in an orderly market, so the price should be lower, meaning we do not know how much taxpayer money is at risk. Who is helping the Fed price these securities since it cannot price the sticky bomb itself ? Blackrock. Blackrock lost money when it invested in the Peloton fund that bought overrated and overpriced mortgage backed securities. But we are not in an orderly market, so the price should be lower, meaning we do not know how much taxpayer money is at risk. Who is helping the Fed price these securities since it cannot price the sticky bomb itself ? Blackrock. Blackrock lost money when it invested in the Peloton fund that bought overrated and overpriced mortgage backed securities. They should know all about getting taken for a ride. They should know all about getting taken for a ride. Jamie Dimon claimed he by no means saddled the Fed with Bear Stearns's riskiest a.s.sets. Given the performance of the a.s.sets the Fed took on board, JPMorgan's shareholders may not feel rea.s.sured by Jamie's testimony before the Senate Banking Committee. Jamie Dimon claimed he by no means saddled the Fed with Bear Stearns's riskiest a.s.sets. Given the performance of the a.s.sets the Fed took on board, JPMorgan's shareholders may not feel rea.s.sured by Jamie's testimony before the Senate Banking Committee.

Bernanke seems to think the Bear Stearns bailout did not create a moral hazard problem, because shareholders lost money. Bear Stearns' share price bubble burst, but the Federal Reserve Bank inflated moral hazard. Shareholders in leveraged companies should expect to take risk. Bernanke bailed out Bear Stearns' creditors. creditors. Investment bankers-not shareholders-are the key architects of the mortgage meltdown. Many investment bankers lost money on their own stock holdings, but others sold and diversified their holdings. Some earned high salaries and a significant portion of their bonuses in cash. Investment bankers-not shareholders-are the key architects of the mortgage meltdown. Many investment bankers lost money on their own stock holdings, but others sold and diversified their holdings. Some earned high salaries and a significant portion of their bonuses in cash.

If the Fed feels investment bankers have learned anything from the Bear Stearns debacle, it might consider Jim Rogers's point of view. "You don't see any 29-year-old cotton farmers driving around in Maseratis," he observed,"but you see a lot of 29-year-olds on Wall Street driving around in Ma.s.seratis.This is not the way the world is supposed to work."9 Warren Buffett put it another way: "Wall Street is going to go where the money is and not worry about consequences.You've got a lot of leeway in running a bank to not tell the truth for quite a while." Warren Buffett put it another way: "Wall Street is going to go where the money is and not worry about consequences.You've got a lot of leeway in running a bank to not tell the truth for quite a while."10 The securitization markets presented a high potential for fraud known as the fraud triangle fraud triangle: need, opportunity, and the ability to rationalize one's behavior. Many financial professionals have great needs: the need for a larger house in the Hamptons, the need for a large yacht, the need for a rare Patek Philippe watch, the need for a multimillion dollar annual bonus. Lax oversight provides the opportunity. Intelligent people with broken moral compa.s.ses-can't they afford a new ones?- provide the rationalizations. provide the rationalizations.

SEC Chairman c.o.x testified that the SEC was investigating whether there was unlawful manipulation of Bear Stearns's stock that led to a run on the firm. c.o.x did not refer to earlier statements (early 2007 earnings reports) made by CEOs and CFOs that may have propped up propped up stock prices, but he might want to look into it. stock prices, but he might want to look into it.11 How do we explain the SEC's poor reaction time to the securitization problems at the investment banks it regulates? How do we explain the SEC's poor reaction time to the securitization problems at the investment banks it regulates? Could the SEC's conflicts of interest have anything to do with it? Could the SEC's conflicts of interest have anything to do with it? Former SEC staffers often seem to land very lucrative jobs working for law firms that represent investment banks, working for law firms seeking expert witnesses to defend investment banks, or working for investment banks needing a new general counsel. Some SEC officials often end up affiliated with a huge private equity fund or start a fund of their own with fundraising help from investment banks. I am sure there are many rationalizations for this. Former SEC staffers often seem to land very lucrative jobs working for law firms that represent investment banks, working for law firms seeking expert witnesses to defend investment banks, or working for investment banks needing a new general counsel. Some SEC officials often end up affiliated with a huge private equity fund or start a fund of their own with fundraising help from investment banks. I am sure there are many rationalizations for this.

Warren Buffett is among those that felt the Fed action with respect to Bear Stearns was probably necessary: "Just imagine the thousands of counterparties having to undo contracts."12 I disagree, but I could be wrong, and there is no way to prove this either way since the bailout already occurred. Banks will bid on all or part of a derivatives book. It is a pain in the neck, but it has been done successfully several times in the past. I agreed with Bernanke when he said in testimony: "Normally the market sorts out which companies survive and which fail, and that is as it should be." I disagree, but I could be wrong, and there is no way to prove this either way since the bailout already occurred. Banks will bid on all or part of a derivatives book. It is a pain in the neck, but it has been done successfully several times in the past. I agreed with Bernanke when he said in testimony: "Normally the market sorts out which companies survive and which fail, and that is as it should be."13 I wish Bernanke had stuck to that. I wish Bernanke had stuck to that.

Federal chairmen may not want to bite the hand that may feed them in future. Jeremy Grantham wrote in his April newsletter that a Federal Reserve chairman may find that on the retirement lecture circuit "grateful bailees . . . hire you for $300,000 a pop."14 Charles I. Plosser, president of the Philadelphia Federal Reserve Bank, and Jeffrey M. Lacker, president of the Richmond Federal Reserve Bank, also expressed concern. Plosser said the Fed might be "sowing the seeds of the next crisis." Charles I. Plosser, president of the Philadelphia Federal Reserve Bank, and Jeffrey M. Lacker, president of the Richmond Federal Reserve Bank, also expressed concern. Plosser said the Fed might be "sowing the seeds of the next crisis."15 Lacker said the credit hand-out to financiers "might induce greater risk-taking." Lacker said the credit hand-out to financiers "might induce greater risk-taking."16 Congress embraced The Emergency Economic Stabilization Act of 2008, the bailout bill proposed by Paulson and Bernanke, with weak oversight and no requirement for using market prices. William Poole, the retired president of the St. Louis Fed, finds it "appalling" that the Fed is "a backstop for the entire financial system."17 If the Federal Reserve Bank did not seem like such a pushover, investment banks (and AIG) might have managed their businesses more carefully. Warren pointed out that Wall Street will not worry about the consequences, and I might add that is especially true when an accommodating Fed shelters Wall Street from the consequences of its folly. If Bear Stearns had failed, investment banks, hedge funds and banks might have sat at the table and sorted out their problems.

In September 2008, the Fed let Lehman Brothers (a larger investment bank than Bear Stearns) fail, and helped AIG with a credit line of $85 billion. Were there alternatives? In my view, there were. AIG could have contacted its credit default swap counterparties and asked them for better collateral terms while it was still rated double-A.There is a precedent for this. When ACA, the failed monoline bond insurer (unlike AIG it did not have a diversified business with valuable a.s.sets) needed time, its counterparties gave it a six month reprieve. But that was before the Fed bailed out Bear Stearns's creditors. AIG knew it could run to the Fed, and it initially did, even before it approached JPMorgan Chase and Goldman Sachs for a loan. AIG remained in denial for many months. It worked on a strategic plan instead of acting on its problems, Moral hazard creates opportunity costs, because people with a sense of ent.i.tlement tend to get complacent about managing complex risk. Taxpayers can only hope that AIG's valuable a.s.sets are ultimately enough to cover its liabilities, but it never should have become the problem of U.S. taxpayers.We may have to come up with a new slogan-no taxation without regulation.

The Federal Reserve should have saved its fire power, because we have even more serious problems. Warren's Berks.h.i.+re Hathaway backs Clayton Homes' business. In contrast, Fannie Mae and Freddie Mac are highly (and dangerously) leveraged. They had only a 2 percent core capital requirement; banks hold a minimum of 6 percent in "tier one" capital. The burden of both mortgage giants increased in the past two years. In 2006, they accounted for 33 percent of total mortgage backed securities issuance, and as of the summer of 2008 they accounted for 84 percent. Fannie Mae and Freddie Mac have been pressured to help other lenders out of the mortgage mess. Fannie Mae and Freddie Mac guarantee approximately 40-45 percent of the $11.5 trillion U.S. residential mortgage market. As of March 31, 2008, Fannie Mae and Freddie Mac had combined debt of $1.6 trillion and credit obligations of $3.7 trillion.This is a total of $5.3 trillion, roughly the same as U.S. government bonds. roughly the same as U.S. government bonds.18 The U.S. government took over Fannie Mae and Freddie Mac on September 7, 2007, and this is the problem that will probably cost taxpayers the most.The government is in charge of financing most of the U.S. mortgage market, and the mortgage market is still under-regulated. The U.S. government took over Fannie Mae and Freddie Mac on September 7, 2007, and this is the problem that will probably cost taxpayers the most.The government is in charge of financing most of the U.S. mortgage market, and the mortgage market is still under-regulated. U.S. taxpayers have too many sticky bombs. U.S. taxpayers have too many sticky bombs.

The new regulators and the new CEOs do not inspire me with confidence. James Lockhart is the head of the Federal Housing Finance Agency (which will now also oversee the 12 Federal Home Loan Banks) and he was head of the Office of Federal Housing Enterprise Oversight (starting June 15, 2006, just when effective action seemed most needed), the former regulator for Fannie Mae and Freddie Mac. It had over 200 employees and wrote long after-the-fact reports. As Warren put it to CNBC: "You had two of the greatest accounting misstatements in history.You had all kinds of management malfeasance . . . the cla.s.sic thing was . . . OFHEO wrote a 350-400 page report . . . they blamed [everyone else]."19 This predated Lockhart, but under Lockhart's watch, things went from bad to conservators.h.i.+p. This predated Lockhart, but under Lockhart's watch, things went from bad to conservators.h.i.+p.

Initially, the mortgage giants charged fees to guarantee prime mortgages (up to a specific size) and borrowers made 20 percent down payments. It was a license to print money, which motivated Warren Buffett to make a large investment in their shares in the first place. It is amazing to me that Fannie, Freddie and OFHEO could screw this up, but overreaching has that effect.That is what motivated Warren to sell the shares in 2000.

In June 2008 (before the government takeover), former St. Louis Federal Reserve President William Poole, said: "Congress ought to recognize [Fannie Mae and Freddie Mac] are insolvent, that it is continuing to allow these firms to exist as bastions of privilege, financed by the taxpayer."20 In 2006, U.S. regulators imposed limits on lending for Fannie Mae and Freddie Mac after discovering $11.3 billion of accounting errors. On March 1, 2008, regulators In 2006, U.S. regulators imposed limits on lending for Fannie Mae and Freddie Mac after discovering $11.3 billion of accounting errors. On March 1, 2008, regulators lifted lifted those limits. Meanwhile, the FHA, which provides funding for low-income borrowers, is struggling to abolish future no-money-down mortgages. those limits. Meanwhile, the FHA, which provides funding for low-income borrowers, is struggling to abolish future no-money-down mortgages.2122 In July 2008,Treasury Secretary Paulson obtained broad authority to purchase unlimited shares of the stock in the companies,23 which could mean unlimited tax dollars- which could mean unlimited tax dollars-a completely insane and unsound economic policy. The costs are potentially unlimited, as are the opportunities for looting the treasury by gaming the shares.There is no The costs are potentially unlimited, as are the opportunities for looting the treasury by gaming the shares.There is no quid pro quo quid pro quo except for a goal of reducing the size of the portfolios over time.Yet there is still little discipline for mortgage brokers and many mortgage lenders. If we want to restore confidence in Fannie Mae and Freddie Mac, we need a two-p.r.o.nged approach: (1) support the except for a goal of reducing the size of the portfolios over time.Yet there is still little discipline for mortgage brokers and many mortgage lenders. If we want to restore confidence in Fannie Mae and Freddie Mac, we need a two-p.r.o.nged approach: (1) support the debt debt (not the shares) issued by Fannie Mae and Freddie Mac; and (2) strongly regulate what backs that debt in the first place. In other words, if taxpayer money is used to help, we must enforce sound lending: 20 percent down payments, verified income, low debt loads and more-the traditional standards of sound mortgage lending.There are worse things than renting; for example, piling up crus.h.i.+ng debt that forces you into bankruptcy just as the country sinks into stagflation-that is much worse. (not the shares) issued by Fannie Mae and Freddie Mac; and (2) strongly regulate what backs that debt in the first place. In other words, if taxpayer money is used to help, we must enforce sound lending: 20 percent down payments, verified income, low debt loads and more-the traditional standards of sound mortgage lending.There are worse things than renting; for example, piling up crus.h.i.+ng debt that forces you into bankruptcy just as the country sinks into stagflation-that is much worse.

The Government Accountability Office (GAO) says we have even greater worries. We are $52.7 trillion in the hole based on our fiscal burdens of social security, Medicare, public debt, and more. That number grows $3 to 4 trillion per year on autopilot. The GAO recommends tough tough budget controls, comprehensive tax reform, reform of social security, and reform of Medicare. The U.S. needs to generate more revenues through growth. In the face of this, the only advice one can give is budget controls, comprehensive tax reform, reform of social security, and reform of Medicare. The U.S. needs to generate more revenues through growth. In the face of this, the only advice one can give is don't retire and keep saving. don't retire and keep saving.24 On August 21, 2008, Warren appeared in the doc.u.mentary on our growing debt burden On August 21, 2008, Warren appeared in the doc.u.mentary on our growing debt burden I.O.U.S.A., I.O.U.S.A., a scarier summer thriller than a scarier summer thriller than JAWS. JAWS. Your odds of suffering a shark bite are small, but we are being slowly devoured by our national debt. Your odds of suffering a shark bite are small, but we are being slowly devoured by our national debt.25 [image]

On March 13, 2007, while New Century watched its credit lines disappear and faced allegations of fraud, U.S. regulators complained that the United States investment banks lost business to London. Sarbanes-Oxley requirements became the scapegoat. Hank Paulson a.s.sembled a panel at Was.h.i.+ngton's Georgetown University. Paulson invited several notables in the financial markets, and Mr. Buffett went to Was.h.i.+ngton.26 John Thain, then head of the New York Stock Exchange (later the CEO of Merrill Lynch that arranged its sale), said that only two of 25 IPOs in 2006 were made in the United States. The implication seemed to be that Sarbanes-Oxley, inspired by Enron, Worldcom, and other corporate malfeasance, hampers business. The collapse of Enron and WorldCom led to billions of dollars in losses for investors and cost thousands of people their jobs. Adelphia's former CEO, John Rigas, and his son, Timothy Rigas, the chief financial officer, were found guilty of fraud and conspiracy after hiding $2.3 billion in debt. On June 17, 2005,Tyco's L. Dennis Kozlowski and Mark Swartz, charged with stealing $600 million in unapproved compensation and illicit share deals, were found guilty of criminal counts of securities fraud, eight counts of falsifying business records, grand larceny and conspiracy. Ex-waitress Karen Kozlowski filed for divorce in August 2006 and sought to keep booty paid with loans that Tyco later "forgave," including some of hundreds of thousands of dollars in Harry Winston jewelry. She may be disappointed. Businesses will fund business trips, but you might have to reimburse the company if it funds your ego trips.272829 Warren felt that after such astonis.h.i.+ng corporate malfeasance, it is a "question of restoring trust." He added "American business is working pretty darned well." Although compliance with Sarbanes-Oxley cost Berks.h.i.+re Hathaway tens of millions, he said it might do some good if it restores investors' confidence: "There are worse things than Sarbanes-Oxley."30 Three years prior to Paulson's meeting, Warren attended a conference at which Mikhail Khodorkovsky, the former CEO and owner of AOA Yukos Oil Co., asked him if it would be dangerous to bring an IPO in the United States. Three or four months later Khodorkovsky was imprisoned in Siberia.Yukos went belly-up in 2006 and had back-tax claims exceeding $30 billion.Yukos's a.s.sets were subsequently bought by Russia's largest oil company, AOA Rosneft at bankruptcy auction. Three years prior to Paulson's meeting, Warren attended a conference at which Mikhail Khodorkovsky, the former CEO and owner of AOA Yukos Oil Co., asked him if it would be dangerous to bring an IPO in the United States. Three or four months later Khodorkovsky was imprisoned in Siberia.Yukos went belly-up in 2006 and had back-tax claims exceeding $30 billion.Yukos's a.s.sets were subsequently bought by Russia's largest oil company, AOA Rosneft at bankruptcy auction.31 Sarbanes-Oxley requirements seemed to discourage Khodorkovsky from making an initial public offering of Yukos's stock in the United States.We dodged a bullet. Sarbanes-Oxley requirements seemed to discourage Khodorkovsky from making an initial public offering of Yukos's stock in the United States.We dodged a bullet.

Jeffrey Immelt, chairman and CEO of General Electric Co., also attended Paulson's conference. He complained that regulatory requirements are "just too gosh-darn complex."32 As too gosh-darn complex as the subprime-backed investments that later cost GE $300 to $400 million of dollars worth of write-downs? As too gosh-darn complex as the subprime-backed investments that later cost GE $300 to $400 million of dollars worth of write-downs?33 In contrast, Warren noted that some of Sarbanes-Oxley requirements promoted transparency, and he eagerly reads financial reports: "like a teenager reading Playboy. Playboy."34 Readers of financial reports and Readers of financial reports and Playboy Playboy agree that more transparency is desirable. agree that more transparency is desirable.

Part of the reason we are losing business to London may be that quite a few international investors are concerned about structured financial products they bought from U.S. investment banks. Loans were made to people who would not be able to pay them back, ratings are flawed, and securitization technology is suspect. We are losing business because we were found out. Europeans in particular feel that smart Americans abused securitization technology to fool a lot of people in the short run. In a letter to the Financial Times Financial Times on March 19, 2007, I wrote: on March 19, 2007, I wrote:

Wall Street's former standard: "Your word is your bond, did not mean "Your spin is your s.h.i.+eld." . . . [I]n areas in which we are lightly regulated, our words are unworthy.35 Until recently, I opposed hedge fund regulation. Eric Mindich (formerly of Goldman Sachs) now heads Eton Park Capital Management. When Mindich was a.s.signed to head the President's Working Group a.s.set Managers Project, I volunteered my perspective: "I am a laissez faire capitalist, and do not believe in protecting consenting adults from making informed decisions, even if that decision is to make a blind bet." That was in September 2007, but my point of view is changed, since U.S. taxpayers bail out hedge funds creditors.

The hedge fund business is approximately $1.9 trillion in size, and 87 percent of the money is controlled by fewer than 10 percent of the hedge funds.The larger hedge funds have a lot of clout. Large hedge funds act as if they are investment banks. Often they acc.u.mulate large trades-taking the other side of an investment bank's trade-then call up the investment bank and ask them if they would like to negotiate to close out the transaction. In other words, for some types of transactions a hedge fund is the other side of an illiquid market. In other words, for some types of transactions a hedge fund is the other side of an illiquid market.

Furthermore, when investment banks bail out hedge funds (and structured investment vehicles), these ent.i.ties are not truly off balance sheet. For example, Citigroup took around $9 billion of a.s.sets on balance sheet from Old Lane Partners, the former hedge fund of its CEO, Vikram Pandit.36 Bear Stearns bailed out creditors of two of BSAM's hedge funds, and Bear Stearns was subsequently purchased by JPMorgan Chase with help from the Fed. Since the Federal Reserve Bank supplies liquidity to the banking system, and since the SEC regulates investment banks, hedge funds should be regulated. Bear Stearns bailed out creditors of two of BSAM's hedge funds, and Bear Stearns was subsequently purchased by JPMorgan Chase with help from the Fed. Since the Federal Reserve Bank supplies liquidity to the banking system, and since the SEC regulates investment banks, hedge funds should be regulated.

Bank problems could get even worse. Banks moved a.s.sets off their balance sheet using structured finance. They set up off balance sheet ent.i.ties that owned the a.s.sets and issued debt. Now the banks may have to take $5 trillion $5 trillion in a.s.sets back on balance sheet as if they had never been moved. in a.s.sets back on balance sheet as if they had never been moved.37 Although the vehicles currently pay for themselves (their a.s.sets meet their debt payments), if the a.s.sets' quality falls into doubt, banks might have to bail them out (as Bear Stearns bailed out the creditors in the hedge funds).The banks would have to borrow more money from the Fed. Even if that does not happen, banks' debt to equity ratios will increase, and banks will be less willing to lend Although the vehicles currently pay for themselves (their a.s.sets meet their debt payments), if the a.s.sets' quality falls into doubt, banks might have to bail them out (as Bear Stearns bailed out the creditors in the hedge funds).The banks would have to borrow more money from the Fed. Even if that does not happen, banks' debt to equity ratios will increase, and banks will be less willing to lend you you money. money.

We have too many ineffective regulators: the OCC, Fed, OTC, FHFA, SEC, FDIC, and more. Watching the regulatory system is like watching bad doubles tennis players. No one hits the ball thinking the other guy other guy will get it. Investment banks are not suffering from too much regulation.The global capital markets are suffering from too little competent regulation where it counts most. will get it. Investment banks are not suffering from too much regulation.The global capital markets are suffering from too little competent regulation where it counts most.

The Fed, Congress, the Treasury, and the Bush administration wanted you to believe they have solved the "regulatory problems." On March 31, 2008, a couple of weeks after the Bear Stearns deal, Treasury Secretary Hank Paulson rolled out the "Blueprint for a Modernized Financial Regulatory Structure." The draft of this report was prepared in November 2006, when the Treasury alleged excessive regulation caused the U.S. financial markets to lose its compet.i.tive edge to London in the global financial markets. In other words, it called for less regulation, less regulation, not more. not more.38 At its core, the mortgage lending crisis is no more sophisticated than a schoolyard swindle, and the SEC is the princ.i.p.al. Economists and pundits unhelpfully-and conveniently-focused on the Federal Reserve Bank and retired Chairman Alan Greenspan. Others blame the rating agencies.Yet neither the Federal Reserve Bank nor the rating agencies regulate the securities industry. That job belongs to the SEC. The SEC has broad authority over banks, too. The Office of the Comptroller, the OCC, examines the risk management of the capital markets areas of banks. The Federal Reserve Bank primarily looks at banks at the holding company level.The SEC has broader authority than either the OCC or the Fed for publicly traded companies. It is deceptive securitization practices deceptive securitization practices at the root of the mortgage bubble, and the SEC had the authority to stop Hurricane Ponzi. Instead, it slumbered. at the root of the mortgage bubble, and the SEC had the authority to stop Hurricane Ponzi. Instead, it slumbered.

Wall Street acts fast, and its regulators move at glacial speed. In other words, the existing regulation-even if it demonstrated the will to be proactive, which it did not-is too slow.The system is doomed to repeat its failures, because as Benjamin Graham observed, when things are going well in the financial markets, there is "a strong temptation toward imprudent action."39 As long as Wall Street enhances revenues with leverage to prop up kingly bonuses, as long as there are few personal consequences for CEOs (and board members and other top executives) for shoddy risk management, as long as CEOs are allowed to walk away with millions, nothing will change. The fact that shareholders are wiped out is no deterrent, and moral hazard will live on. I see nothing that will change that in future. In fact, just the opposite. We have handed out hundreds of billions of dollars in taxpayer dollars and have put hundreds of billions more at risk without demanding effective conditions.

Our bailout bills are mounting. The treasury has extended more "temporary" credit lines to the 12 Federal Home Loan Banks, and the government has an additional $90 billion in exposure to the FHA.A new housing bill created a $4 billion fund for local governments to buy foreclosed homes, a $7,500 tax break for first-time home buyers, and a $300 billion insurance fund for refinanced mortgages (but no clear way on how to control the risk of the new mortgages). As of July, there is an 18 month line of credit for Fannie and Freddie to borrow from the Fed, and Bazooka Hank has authority to purchase shares. The FDIC has taken on $39.3 billion of failed bank a.s.sets (as of September 2008, and there is more to come). The Fed created various special financing programs amounting to hundreds of billions of dollars. The Fed took $29 billion (after using up JPMorgan's $1 billion on the original $30 billion) of exposure to Bear Stearns's a.s.sets and gave an $85 billion credit line to AIG. If that were not alarming enough, the Fed relaxed its borrowing standards to allow borrowers to present equities as collateral. Benjamin Graham cautioned that if you have common stocks you "must expect to see them fluctuate in value."40 You You now means the U.S. taxpayer. now means the U.S. taxpayer.

The Treasury issues new debt to fund the Fed's liquidity bailouts along with the hundreds of billions (perhaps running into the trillions) of dollars called for by The Emergency Economic Stabilization Act of 2008 (the Paulson Plan). In other words, the government is printing money like crazy. That is inflationary, and inflation weakens the dollar.

The United States is a nation at war. A handful of financial inst.i.tutions are chiefly responsible for roiling the housing market, the munic.i.p.al bond markets, the economy, and the dollar.Yet, executives may still earn tens of millions of dollars through stock awards. The Paulson Plan does not require market prices for the a.s.sets our Treasury may buy or for the trading books of the inst.i.tutions it is bailing out.Warren and I proposed that market prices (to restore confidence) should be required along with new capital, but someone else gave Congress a bad education.Wall Street is getting what it wants, and U.S. taxpayers are underrepresented in Congress.Thomas Jefferson warned: "A government big enough to give you everything you want is strong enough to take everything you have."

The policies of Was.h.i.+ngton and Wall Street have weakened the dollar. It is unclear whether the United States has the will to pull the dollar up from its tailspin.The United States dollar is less secure in 2008 than it was 10 years ago, and it is weaker than it was 10 years ago. Warren sometimes takes currency positions to hedge this risk. He currently seeks good foreign companies to add operating earnings in foreign currencies. If you know of a good foreign company (understandable business, sound management, favorable prospects, fair price) that is $1 billion or more in size-$5 billion would be even better-please call Warren.

Chapter 13.

The Fogs of War, Religion, and Politics What would happen if Internet communications were disrupted, how would we trade?

-Warren Buffett to Janet Tavakoli, August 25, 2005

While the rest of the world seemed bent on mutually a.s.sured destruction-pursuing wealth through leveraged mortgage loan products, hedge funds, and leveraged buyouts-Warren had already taken steps to do something about the weakening dollar problem for Berks.h.i.+re Hathaway shareholders. He used derivatives to take positions in the relative strength of foreign currencies, and he looked abroad for well-run companies that earn money in foreign currencies.

On October 25, 2005, Warren received a letter from Eitan Wertheimer, chairman of Israel's ISCAR Metalworking, saying: "Berks.h.i.+re Hathaway would be the ideal home for ISCAR."1 On May 5, 2006, Berks.h.i.+re Hathaway used On May 5, 2006, Berks.h.i.+re Hathaway used Business Wire Business Wire to announce it had agreed to acquire 80 percent of the tool-cutting company. Two months later on July 5, 2006, the acquisition was completed. Berks.h.i.+re Hathaway paid $4 billion. to announce it had agreed to acquire 80 percent of the tool-cutting company. Two months later on July 5, 2006, the acquisition was completed. Berks.h.i.+re Hathaway paid $4 billion.2 ISCAR's main plant is located in Israel's Galilee around 7.5 miles south of Israel's border with Lebanon. It does business in more than 60 countries, has a good source of foreign revenues (a hedge against a weakening dollar), and it is a business with products the world needs: cutting tools used with machine tools.The management is in place, and the family is dedicated to the business.

Eitan Wertheimer is the chairman of ISCAR, and 20 percent of the stock remains in the Wertheimer family. Michael Federmann, the Chairman of Elbit Systems Ltd., a Haifa-based electronic defense company, knows Stef "Steffie" Wertheimer, Eitan Wertheimer's father. "Steffie," he later told me, "is the entrepreneur who built the company. Eitan is an administrator and a good steward of the legacy." Stef Wertheimer started in a backyard shed with no funds and worked his way up from there. Michael's enthusiasm inspired me to read more about Stef, and I learned that he was expelled from formal education at age 14 for "slugging a teacher who hara.s.sed a female cla.s.smate."3 On May 8, 2007, three days after the Berks.h.i.+re Hathaway annual meeting, I attended a dinner sponsored by the Jewish American Chamber of Commerce at Chicago's Conrad Hilton Hotel in honor of Eitan Wertheimer. Ralph Gidwitz, a Managing Partner of Capital Results LLC, asked if I would invite Warren, and I did, but he had to decline. Warren attends only one function per year for his senior managers and he had already committed to support one of Eitan's Canadian charities.

I sat at the same table with Eitan and Ariel Wertheimer. Ariel explained that Eitan's father, Steffie, settled in Israel after fleeing n.a.z.i Germany as a 10-year-old boy. Stef Wertheimer seems to focus on hope and how he can improve the lot of others. The company he founded is a large employer of Arab Israelis, and Ariel said it provides intensive training and good working conditions. Ariel's account of Stef reminded me of one of Winston Churchill's maxims: "Live dangerously; take things as they come; dread naught, all will be well."4 Eitan Wertheimer gave a speech detailing his vision for a Middle East renaissance including Arabs in Israel and neighboring Arab countries. Like his father, his belief is that wealth distribution via economic growth is the only viable avenue to produce lasting peace in Israel and the Middle East. His contribution is the stewards.h.i.+p of ISCAR and the creation of a pleasant work environment for the large number of Arab Israelis he employs. As Eitan talked of the goal of lasting peace, we were oblivious that in two months Israel would be embroiled in a b.l.o.o.d.y conflict with Lebanon.

It was not as if tensions were not a concern, but Warren publicly stated that the world in general was a dangerous place and that in the absence of war: "Most of the time Israel is no more dangerous than the U.S."5 Berks.h.i.+re Hathaway's headquarters is located in the Midwest as is Oklahoma City, the site of the deadliest home-grown domestic terrorist attack in U.S. history. In 1995, Timothy McVeigh's bomb attack killed 168 people and injured more than 800 others. Berks.h.i.+re Hathaway's headquarters is located in the Midwest as is Oklahoma City, the site of the deadliest home-grown domestic terrorist attack in U.S. history. In 1995, Timothy McVeigh's bomb attack killed 168 people and injured more than 800 others.6 [image]

Israel during peace time is as safe as the United States, but Israel has tensions with Palestine's Hamas Movement as well as Lebanon's Hezbollah. Iran and Syria back Lebanon's Hezbollah terrorist organization, and although Iran does not actively support Palestine's Hamas (as far as I know), it is sympathetic with its thinking. On June 6, 2006, shortly after dinner with the Wertheimers, but before the war, I sent Warren an e-mail about a Web site (http://iranvajahan.net/english) with a summary in English about international news about Iran. I noted it draws on media sources in English, German, French, and Farsi: "Print media compilations cannot compete with a well-designed Internet compilation."

On June 14, 2006, I sent Warren a commentary I had written about our growing tensions with Iran. The U.S. media seem fixated on Iran's President Mahmoud Ahmadinejad, but he does not control Iran, and he does not have a job for life. Iran's president serves at the pleasure of the Ayatollah. Ayatollah Ali Khameni is the supreme leader of Iran, and his control in Iran is close to absolute. He controls the media, the judiciary, the military, and he effectively controls the legislature.

Iran has been deeply suspicious of the United States ever since we deposed its first democratically elected government. Iran elected Prime Minister Mussaddiq in the summer of 1953. One of his first acts was to force into exile the young Reza Pahlavi, son of a self-proclaimed Shah, a brutal despot and a commoner of nonroyal origins. Mussaddiq wanted to nationalize the British Anglo-Iranian oil company because Iranians were not getting a fair share of the profits. The United States CIA and the UK's MI5 deposed Mussaddiq and reinstalled the young Shah, a foreign-educated dictator who now owed allegiance to both Britain and the United States. At the time, Eisenhower was president of the United States. John Foster Dulles was Secretary of State, and his brother, Allen Dulles, was Director of Central Intelligence. The Dulles brothers were alumni of law firm Sullivan and Cromwell, whose prestigious clients included the British Anglo-Iranian Oil Company.

On June 20, 2006, I sent Warren my concerns about Iran's potential treatment of Israel based on my first-hand experiences living in Iran at the time of the Shah's overthrow and Khomeini's return. At a party shortly after the Shah was deposed, a couple announced they were moving to Canada. My then husband, a Moslem in name only, observed that the wife was wise to leave because her grandfather is Jewish. Her grandfather grandfather? He insisted it might become a problem. As it turned out, he was probably right.

In the summer of 1978, when midday temperatures exceeded 100F, I met Habib Elghanian at the Shahanshahi Club, where Iranian waiters dispensed pastel-colored iced melon drinks to foreign businessmen and captains of Iranian industry. Elghanian, a pleasant man pus.h.i.+ng late middle age, was the third richest man in Iran and a leader in the thriving Iranian Jewish community. He and his two brothers acc.u.mulated most of their wealth in Iran during World War II, and one of his brothers had settled in Israel. Among other things, Elghanian owned a manufacturing company that produced refrigerators. His factories created jobs in Iran and were a major contributor to the Iran's modest industrial progress. My ex-father-in-law imported refrigerators, freezers, stereos, and various luxuries for sale in Iran, and Elghanian occasionally visited his stores to examine the displays of foreign appliances and glean ideas for improvements of his own products.

In May 1979, I remembered Habib Elghanian's pleasant smile with deepening sadness and horror as I watched his televised kangaroo court trial. Facial bruises and swelling showed through heavy makeup. Bearded mullahs dressed in dark cloaks spat questions at him. Before he could answer, a mullah answered the question for him and twisted it into an accusation. Elghanian had no defense counsel and seemed disoriented and unsteady in his chair. He had been accused of being a Zionist spy, and the mock trial served as a warning to those who wanted to oppose the clerics. If this could happen to Habib Elghanian, any Iranian could be arrested for being a collaborator with the Shah, and any foreigner could be accused of spying. The next morning, the newspapers printed a photograph of Habib Elghanian's corpse. He was naked from the waist up and lay on his back in the courtyard of the prison. His execution as a spy was the pretext clerics used to seize his property for the benefit of the Islamic revolution. The Shahanshahi Club was renamed the Revolutionary Club.

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In mid-June 2006,Warren recommended I see The Fog of War, The Fog of War, a movie about Robert Strange McNamara's role in the Vietnam War and the United States' military industrial complex. The Middle East is unstable, and one of the challenges of having a large military industrial complex with powerful lobbyists in Was.h.i.+ngton is that it tends to find a reason for growing, namely a war. I ordered an old VHS copy that arrived in early July, and wrote Warren on July 14, 2006, two days after the war began. McNamara seemed to admit to having floundered his way through the Vietnam conflict. a movie about Robert Strange McNamara's role in the Vietnam War and the United States' military industrial complex. The Middle East is unstable, and one of the challenges of having a large military industrial complex with powerful lobbyists in Was.h.i.+ngton is that it tends to find a reason for growing, namely a war. I ordered an old VHS copy that arrived in early July, and wrote Warren on July 14, 2006, two days after the war began. McNamara seemed to admit to having floundered his way through the Vietnam conflict.

Thank you for your recommendation [to see] The Fog of War. The Fog of War. I watched it twice back-to-back, and I will watch it again in the near future. I was fascinated by Robert S. McNamara's view of himself, and I was startled by what he felt were revelations. I agree that war is chaotic. But in the epic battle, I'd rather have been one of the hundreds of Roman legionnaires than one of the tens of thousands of Queen Boudica's Iceni. I am fond of a good plan. I watched it twice back-to-back, and I will watch it again in the near future. I was fascinated by Robert S. McNamara's view of himself, and I was startled by what he felt were revelations. I agree that war is chaotic. But in the epic battle, I'd rather have been one of the hundreds of Roman legionnaires than one of the tens of thousands of Queen Boudica's Iceni. I am fond of a good plan.

Israel is always in need of a good plan. The 33-day war with Lebanon began on July 12, 2006, when Lebanese Hezbollah, a terrorist organization backed by Iran, sh.e.l.led Israel's border and attacked two Humvees, killing seven soldiers including those killed in a subsequent failed rescue attempt of the two Israeli soldiers captured and spirited into Lebanon. Rockets landed in the ISCAR main plant's industrial park. The plant shut down for several days, but there was no major damage, and business continued as usual after the war. Israel's forceful response included ma.s.sive air strikes, the invasion of ground forces, and the crippling of Lebanon's Rafic Hariri Airport and other parts of the country's infrastructure. As in Turkey's conflict in the 1990s with Kurdish insurgents belonging to the PKK (for Kurdistan Workers Party), in which tens of thousands of Kurds were killed, Lebanese casualties were many times the number of Israeli casualties. There were up to 1,000 civilian casualties. The casualties got much more media attention than the much deadlier Turkish conflict with the PKK, perhaps because the Lebanese conflict was between different religious groups. (The media seems to relatively ignore the misery in Darfur, where Moslems are killing hundreds of thousands of Moslems and displacing millions.7) By August 11, 2006, the United Nations Security Council approved Resolution 1701. Both Lebanon and Israel agreed to the resolution, which included troop withdrawals and, among other things, the disarmament of Hezbollah. Predictably, Hezbollah has not disarmed. Just because you negotiate an "agreement" and obtain a paper with dried ink signatures, it does not mean you necessarily have a deal in the Middle East.

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Meanwhile, the dollar is being weakened by the expense of our poorly planned ongoing Iraq War. However one wants to debate how we got there, one of the reasons we may be quick to enter into a war is because we have the military industrial complex to wage it.

On December 8, 2006, I wrote Warren a note about The Iraq Study Group Report. The Iraq Study Group Report. Despite the fact that we waged war in Iraq for more than three and a half years (at the time), we had recruited few Arab speakers, and we hadn't trained people to speak Arabic. Only Despite the fact that we waged war in Iraq for more than three and a half years (at the time), we had recruited few Arab speakers, and we hadn't trained people to speak Arabic. Only six six of the 1,000 emba.s.sy staff in Iraq spoke Arabic fluently, and only 33 in total spoke any Arabic at all. There were "fewer than 10 a.n.a.lysts on the job at the Defense Intelligence Agency who have more than two years' experience in a.n.a.lyzing the insurgency," of the 1,000 emba.s.sy staff in Iraq spoke Arabic fluently, and only 33 in total spoke any Arabic at all. There were "fewer than 10 a.n.a.lysts on the job at the Defense Intelligence Agency who have more than two years' experience in a.n.a.lyzing the insurgency,"8 and the report didn't make clear if any of them were fluent in Arabic, the language of the people they are trying to understand. Our costs were around $8 billion per month for this war, and we had spent a total of $400 billion. and the report didn't make clear if any of them were fluent in Arabic, the language of the people they are trying to understand. Our costs were around $8 billion per month for this war, and we had spent a total of $400 billion.

The ultimate dollar cost of the Iraq War might reach $2 trillion in addition to lives lost-thousands of Americans, and tens of thousands injured or killed Iraqis. In January 2007, I wrote Warren about another movie, Why We Fight, Why We Fight, a warning about the unchecked growth of a military industrial complex enabled by lobbyists and Was.h.i.+ngton think tanks. The Iraq war has been mismanaged. Besides possible overcharging by Halliburton, there were many reasons to investigate mismanagement of the war. For example, $12 billion, about half of Amba.s.sador Paul Bremer's budget for rebuilding Iraq, simply disappeared. I had to add a Bremer amendment to my theory of everything in finance: a warning about the unchecked growth of a military industrial complex enabled by lobbyists and Was.h.i.+ngton think tanks. The Iraq war has been mismanaged. Besides possible overcharging by Halliburton, there were many reasons to investigate mismanagement of the war. For example, $12 billion, about half of Amba.s.sador Paul Bremer's budget for rebuilding Iraq, simply disappeared. I had to add a Bremer amendment to my theory of everything in finance: What is the probability you have someone handing out shrink wrapped bags of money that disappear from your organization What is the probability you have someone handing out shrink wrapped bags of money that disappear from your organization? I doubt Berks.h.i.+re Hathaway will be tapping Bremer's management expertise any time soon.9 In April 2007, I wrote Warren and sent him a link to an article that appeared in the Was.h.i.+ngton Post Was.h.i.+ngton Post:

When I lived in London, I joined . . . the American Women's Club . . . [T]hey made it their mission to coax me to use my vacation days for bridge, hiking, lectures, short trips to the continent, language lessons and a variety of other activities they creatively planned.They called the club their Disney Land for women. Among the members was Peggy Sheehan . . . John J. Sheehan, Peggy's husband, turned down the "War Czar" job and stated his reasons in a Was.h.i.+ngton Post Was.h.i.+ngton Post article. article.

John Sheehan is a retired Marine Corps general. He turned down the job as White House implementation manager for the Iraq and Afghanistan wars because he thought there is no consensus in Was.h.i.+ngton on strategy. He was also concerned about Iran as "an ideological and destabilizing threat to its neighbors and, more important, to U.S. interests."10 Most important, he felt that Was.h.i.+ngton lacks "a broader view of the region and how the parts fit together strategically." Most important, he felt that Was.h.i.+ngton lacks "a broader view of the region and how the parts fit together strategically."11 Some pundits feel that pulling out of Iraq would allow Al Qaeda to flourish, but Al Qaeda is almost completely made up of Sunnis. The government of Iraq's 25 million people is dominated by s.h.i.+tes. s.h.i.+a Moslems make up around 55 percent of Iraq's population, and Sunnis make up most of the other 45 percent.

Iran already has a foothold in Iraq, and Iran would probably help eliminate the influence of Al Qaeda Sunnis. s.h.i.+tes in Iraq and Iran have strong ties even though they have ethnic and language differences. Khomeini temporarily hid in Iraq when the Shah ousted him, and s.h.i.+a Moslems make up around 90 percent of Iran's population of 68 million people. The greater threat might be that Hezbollah, an enemy of Israel, would find more support if we withdrew from Iraq.

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It sometimes seems to me that Moslems would get along much more easily with Warren Buffett, a good-hearted atheist, than with members of a different faction of Islam. For centuries, the various factions of Islam have quarreled and, at times, have even gone to war.

The birthplace of Mohammed, the founder of the Islam, is Medina, located in Saudi Arabia. s.h.i.+tes believe that Ali, Mohammed's son-in-law, is his successor. The Sunnis believe the Caliphs are Mohammed's successors. All Moslems have ties to Saudi Arabia. Devout Moslems believe that the hajj, hajj, a pilgrimage to Mecca in Saudi Arabia, is required at least once in one's lifetime. Performing the a pilgrimage to Mecca in Saudi Arabia, is required at least once in one's lifetime. Performing the hajj hajj is one of the five pillars of Islam. The other four are professing one's faith, praying in Arabic five times per day, giving alms to the poor, and fasting during Ramadan. is one of the five pillars of Islam. The other four are professing one's faith, praying in Arabic five times per day, giving alms to the poor, and fasting during Ramadan.

One would think those similarities would be enough for people to get along, but Islam is divided among itself, sometimes with sn.o.bbery that makes a British royal appear egalitarian. Most Iraqis are Arabs, but some are Kurds. Kurds consider themselves to be racially distinct from Arabs. Minority populations of nomadic Kurds also live in neighboring countries. Iraqis chiefly speak Arabic, but regional minority languages include Kurdish and Turkmen. Iranians, formerly known as Persians, consider themselves Aryans, but many Persians appear to look Arabic.

When I lived in Iran, an Iranian friend joked that 40 percent of Iranians may have Arabic blood, and 100 percent of them will deny it. Nose jobs are a brisk business among Iranians living in foreign countries. Yet, many Iranians claim they are descended from the prophet Mohammed, who was an Arab. My Iranian ex-husband, who earned his Ph.D. in chemical engineering, had no problem performing the required mental gymnastics to live with this contradiction. This is not that unusual, either. Having been born and raised a U.S. Catholic, I know a few who cannot accept that Jesus was Jewish. Many who do accept it believe he looked like the blond blue-eyed actor Jeffrey Hunter in the King of Kings. King of Kings.

Iran's official language is Farsi (or Persian). It is an Indo-European language (most Westerners find Farsi much easier to master than Arabic), yet it uses Arabic script. All Iranian Moslems pray in Arabic, even if they do not understand the language. (Catholics recite Latin prayers without fully understanding them.) Iran has a small Arab minority and one of its neighbors is Arab-speaking Iraq. The United States has a much bigger language barrier in Iraq than Iran has. Given the large population of s.h.i.+a Moslems in both Iraq and Iran, and given their common economic interest in oil, it is easy to see why Iran's influence is rapidly growing in Iraq.What that would mean for Israel is unclear, but it is a concern.

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Warren invested in ISCAR with his eyes wide open, and he is a long-term investor. One of my British friends complained that Warren's investment in Israel is highly risky. I responded that financial risk is relative, and I saw people making much riskier bets in the mortgage market and in hedge funds for the promise of much less return.

Warren does not ignore risk, but he has a unique perspective.When we first met, Warren asked me what I thought the greatest global risks and surprises might be, and if I think of anything else later, to let him know. He asked what might happen if, for example, global computer communication were knocked out. How would we track trades? I responded that we might exhibit ingenuity. I recall that in Apollo 13, Apollo 13, stranded astronauts and their Houston-based colleagues reached for stranded astronauts and their Houston-based colleagues reached for pencils pencils and and slide rules. slide rules. We sent men to the moon before computers were in every middle-cla.s.s home. It is an unwelcome thought that we would go back to those days, but Warren tries to consider all angles. We sent men to the moon before computers were in every middle-cla.s.s home. It is an unwelcome thought that we would go back to those days, but Warren tries to consider all angles.

While the 33-day Lebanese-Israeli war was still waging, on August 1, 2006, Bear Stearns a.s.set Management launched the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage fund. The fund invited investors with comforting words like "high grade" and "enhanced," and the investors seemed to be persuaded that they were getting a relatively safe and rewarding investment. Yet a terrorist attack would have posed less risk to their investment. Within a year, Bear Stearns told the fund's investors they would probably get nothing. Had the investors put their money in Berks.h.i.+re Hathaway instead, they would have had more than $1.2 million for every $1 million they invested. Furthermore, the hapless investors in the hedge fund will have no peace.They hired lawyers.

Warren looks for companies that create value for consumers. ISCAR continues to thrive, and once he finds value, Warren's favorite holding period is forever. As a result, Berks.h.i.+re Hathaway still owns the major part of a company that creates economic opportunity for both Jews and Arabs in Israel. Perhaps one day, it will be part of a Middle East renaissance. I like to think that Warren's investment has a chance to make the world a better place.

Chapter 14.

Finding Value [T]here was an absolutely open-ended, no-score-kept generosity of ideas, time, and spirit.

-Warren Buffett on Benjamin Graham, 1976

After I met Warren for lunch, I began spending more time on my personal ideas of value. I bought energy and energy-related stocks, a potash manufacturer ripe for takeover, metals stocks, and some value stocks. I kept my Berks.h.i.+re Hathaway holdings, of course.

I could write a long book on valuing Berks.h.i.+re Hathaway. Instead I will offer you my completely unauthorized and lazy shortcut to understanding the value of Berks.h.i.+re Hathaway. my completely unauthorized and lazy shortcut to understanding the value of Berks.h.i.+re Hathaway. You can play around with balance sheets, discount rates, multiples, and the like; but basically Berks.h.i.+re Hathaway invests in sound business that will stick around, and the businesses it owns have growing earnings. You can play around with balance sheets, discount rates, multiples, and the like; but basically Berks.h.i.+re Hathaway invests in sound business that will stick around, and the businesses it owns have growing earnings.

A thorough a.n.a.lysis is hard, but understanding that there is a lot of value in the stock is easy. Getting the annual report brings a smile to my face and I dive in and get right to the action. Warren wrote in the 2007 shareholder letter that investments (about 40 percent financed by insurance float) are worth $90,600 per share. Now you add to that the value of $4,093 per share of a growing stream of earnings from the non-insurance operating businesses. As a long-term investor, you might use a 10-times multiple to earnings (as some long-term investors do) for a combined value-including investments-of $131,530. If you apply a 15 times earnings multiple (as other long-term investors do), you get a value of $151,995. No one knows what may happen in the super-cat insurance business managed by Ajit Jain who runs Berks.h.i.+re Hathaway's reinsurance business, and I did not factor that into the numbers. 2006 was a lucky year and the super-cat insurance business went from red to very black. 2007 was a good year, too. No one can predict what will happen, but the premiums are well invested, and this is only a part of the overall business.

Obviously, this is a gross oversimplification. My point is there is substance behind the numbers. First and second quarter 2008 earnings were down, but Berks.h.i.+re Hathaway's businesses continued and will continue to generate earnings. As noted before, there was an unrealized loss on derivatives, but shareholders know it is unlikely a payment will ever be due, Berks.h.i.+re Hathaway has wisely invested the premium income, and Berks.h.i.+re Hathaway is not leveraged and has lots of cash.This is why Warren Buffett and Charlie Munger are right to call this fluctuation meaningless. Meanwhile, the operating businesses generate earnings, and Warren is on the hunt for more good companies to grow operating revenues.

Intelligent investors revisit the stocks they own periodically, especially as market conditions change, but they do not overreact to a change in market prices. Although one's favorite holding period may be forever, you do not have to hold stocks you no longer favor. If you are a value investor, you won't have to check your portfolio every day, but you should periodically reevaluate your decisions.

Berks.h.i.+re Hathaway may never match the stellar returns of its early years, but it is likely to remain a great steady performer returning 10 percent to 15 percent returns over a five-year period. Even if a prolonged recession hurts returns, I am still likely to be much better off than the rest of the market. Berks.h.i.+re Hathaway's companies make things people use, want, and need. While results may not be as exciting as they were in previous decades, they are likely to be satisfactory in the long run.You will not gasp with delight one day only to gasp for air the next. It is not my only holding, but it is one I do not worry about.

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When we had lunch, Warren encouraged me to use what I know, so I fell back on my engineering background to look for opportunities. For example, in the late spring of 2006, it seemed to me oil pipe replacement orders were not keeping up with stress corrosion cracking and ordinary corrosion. A pipeline at Alaska's North Slope proved the point by leaking oil through a corroded pipe shortly after I bought steel shares. The smaller steel companies were ripe for takeover and produced gains of more than 30 percent.

In December 2006. I wrote Warren that I had rejected a pitch by a California-based hedge fund manager that did not seem to offer anything new and demonstrated some inconsistencies. They strongly believed in the housing bubble, so they did not own their own homes. Yet this strength of conviction did not extend to their personal transportation. They strongly believed energy prices (and gasoline prices) would explode; yet they drove gas guzzling sports cars (except for the salesman, who seemed smug because he said he drives a hybrid). I was already long energy and oil-related stocks. I had bought shares in two steel companies, which produced gains of more than 30 percent when they were acquired by larger companies, and I profited when my shares in a small potash company was acquired by a large chemical company, and I do not charge myself high fees. Warren Buffett takes advantage of these kinds of market opportunities when he finds them. These are called merger and acquisition merger and acquisition (M&A) opportunities, and they are sometimes loosely (and not technically correctly) called merger "arbitrage" opportunities. These are not meant to be long-term holdings, but are a way of taking advantage of a good opportunity when it seems to fall in your lap. Sometimes, however, you can be wrong (it is not a genuine arbitrage) and you fall off your chair. The other problem with merger and acquisition opportunities is that once the acquisition occurs and one pockets a gain (currently a short-term gain is taxed higher than a long-term gain and often these are short-term opportunities), one has to reinvest. (M&A) opportunities, and they are sometimes loosely (and not technically correctly) called merger "arbitrage" opportunities. These are not meant to be long-term holdings, but are a way of taking advantage of a good opportunity when it seems to fall in your lap. Sometimes, however, you can be wrong (it is not a genuine arbitrage) and you fall off your chair. The other problem with merger and acquisition opportunities is that once the acquisition occurs and one pockets a gain (currently a short-term gain is taxed higher than a long-term gain and often these are short-term opportunities), one has to reinvest. What next? What next? It can be exhausting, so I am trying to find more value stocks as long-term holdings. It can be exhausting, so I am trying to find more value stocks as long-term holdings.

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When I sent Warren my old copy of The Intelligent Investor The Intelligent Investor to sign, he returned it with an inscription: "To Janet - With personal & professional admiration." to sign, he returned it with an inscription: "To Janet - With personal & professional admiration."1 He may write that inscription for everyone but I glowed the entire day anyway. In August 2007, during one of several minor market upsets, I wrote Warren: "I've been recommending He may write that inscription for everyone but I glowed the entire day anyway. In August 2007, during one of several minor market upsets, I wrote Warren: "I've been recommending The Intelligent Investor The Intelligent Investor for those swimming for the lifeboats." for those swimming for the lifeboats."2 Warren could have invented the maxim "ponder, and then act. act." His investment style allows him to remain unflappable despite Mr. Market's manic depressive fluctuations. While the a.s.set bubble expanded and exploded,Warren made time for old and new friends.

Warren wrote me at the end of May 2006: "I am swamped at present. You will see why in a little while...."3 Even though he was terribly busy, he made time for me. I called Warren in June 2006 to ask his thoughts on my nephew selling his business. It is a business too small for Warren (but very substantial), and my nephew is a young man. While Warren's advice was the same as mine, Warren agreed my nephew would more readily accept advice from "the voice of authority." Even though he was terribly busy, he made time for me. I called Warren in June 2006 to ask his thoughts on my nephew selling his business. It is a business too small for Warren (but very substantial), and my nephew is a young man. While Warren's advice was the same as mine, Warren agreed my nephew would more readily accept ad