Comment by miked | Hacker News Reader

Comment by miked | Hacker News Reader

From http://seekingalpha.com/article/97158-goldman-sachs-buffett-... :

"In the news yesterday, Goldman Sachs (GS) announced that Berkshire Hathaway (BRK.A), Buffett's investing vehicle, will purchase $5B worth of perpetual preferred shares with a 10% dividend being paid in return for exclusive use of this capital injection. Not only does Berkshire get a dividend nearly double that of Canadian bank issued perpetuals, but the holding company also receives warrants to purchase $5B of common stock at $115 during the next five years."

So let's put it together.

* Buffett and Munger buy tons of stock in the above mentioned "casino".

* The casino loses big.

* Casino gets huge tax bucks from you and me to cover its loses and pay huge bonuses to itself.

* The tax money flows back to Berkshire via the holdings listed above, and form thence to Buffett and Munger.

* Munger writes folksy article damning "casino gambling".

For those who weren't aware, Buffett was a director of Goldman for many years. You know, the years when all this latest crap was happening. The years when he and Munger must have talked at least once a week. Those years.

EDIT: Buffett is the largest individual investor in GS, and was apparently asked (on that basis) to join the board, but apparently never did. My bad. On the other hand, his involvement in TARP is even worse that I knew:

From http://www.mcclatchydc.com/2009/04/05/65496/buffett-champion... :

"Buffett's company, Berkshire Hathaway, hasn't received any of that federal aid, but Berkshire, based in Omaha, Neb., owns stock valued at more than $13 billion in the top recipients of TARP funds, including Goldman Sachs Group, US Bancorp, American Express and Bank of America, which analysts all thought were in deep trouble before TARP was approved in October."

I'm a huge believer in economic freedom, i.e., the free market. I only wish that most large businesses were. It's so much easier for them to rent-seek.

All absolutely true, but note the lack of derivatives and hedges. The Goldman transaction was a straight equity deal, with a big emphasis on dividends. In a nutshell, it was a chance to squeeze one of the 'casinos' hard, while still staying out of the whole CDO/default swap/derivative mess.

Both Munger and Buffett have a habit of stealing your wallet while telling you you're an idiot for letting them do it. The article and the Goldman deal are reflections of that attitude.

"The Goldman transaction was a straight equity deal, with a big emphasis on dividends."

No. They were derivatives. Goldman was to pay those heavy dividends by executing credit default swaps they had purchased from AIG. Trouble is, the securities underlying the swaps were overcommitted, meaning the swap prices would be driven way down in an open market. And Goldman didn't own the securities. And the securities hadn't necessarily defaulted. And AIG had no money.

This was solved by the Munger/Buffet helping arrange for the taxpayer to pay off AIG's gambles at 100% without Goldman even delivering the securities underlying the swaps.

Make no mistake, the Goldman deal was a naked derivative play combined with brazen government corruption.

There's no question that Goldman had to pay off those dividends with some kind of shenanigans. IIRC, they were up to their eyeballs in default swaps and CDOs, both of which were beyond toxic at the time. That 10% payout was going to have to come from somewhere.

However, my understanding was that from Berkshire's perspective, it was a straight equity investment for preferred stock. They didn't really care where the dividend cash came from, so long as they got paid. So, if it was a derivative play, it was an indirect one. Berkshire never had those default swaps on its books.

That's how I remember it going down, at least. It's entirely possible that I got some of this wrong.

The Berkshire and Goldman deal was, but Goldman plays in derivatives. Where are the fundamentals there? Or when is Goldman going to announce their new business model?

You'd hope someone like Buffet, with his cache and savvy could suggest some reasonable ways to end "too big to fail." All things right now make me think we'll have another bust in a couple years, nothing is fundamentally different.

You cannot avoid playing in derivatives. Do you have a bank account? Do you own U.S. currency? Is all of your wealth in gold? In any of these cases the price is set by the market and strongly effected by derivative trades. You need to understand derivatives just to do a reasonable job avoiding them.

Warrants are derivatives.

Actually depending upon how the warrant is structured it's most likely a pseudo-derivative, not a pure play on pricing action.

If you classify options as derivatives, then you're right. However, if you use that definition then the Berkshire/Goldman warrants are the simplest derivative that I've ever seen.

The Goldman warrants are an option to purchase an additional $5 billion of stock at $115 per share, any time in the next 5 (now 4) years. Basically, they're a plain vanilla call option.

What's really interesting about those warrants is that they behave identically to an equity purchase, only without the downside. Berkshire literally can't lose money. Plus, if the warrants are ever exercised, then Berkshire simply gets more equity. It never gets tarted up with default swaps and tranches and triggers and all that crap. The deal is the complete opposite of the 'casino' mentality that Munger is decrying.

So, yeah, you might be technically correct. However, you've also got to look at the spirit of the thing.

Buffet was never a director at Goldman. Berkshire did not loan the $5 billion and receive the options until well after the financial mess, after Goldman's stock dropped over 50%. The article talks about casinos dealing "financial derivatives" which are completely different from equity securities, and which were the primary investment vehicle that led to the collapse in 2008. Munger is dead on.

Buffet was never a director at Goldman.

Thanks for the catch. See my edit above for more.

Berkshire did not loan the $5 billion and receive the options until well after the financial mess...

This is effectively wrong, since the TARP funds were issued after the investment. See the link at the edit above.

Sure they were, but he didn't make the loan until well after everything collapsed. In fact the U.S. Treasury was practically begging for him to make these investments and he said he would only do a deal with Goldman because he knew they were the only bank left that was financially sound. EDIT: And Wells Fargo. He bought into Wells Fargo huge.

In any case, I think that if there anyone who has demonstrated an immense understanding of the American economy for the last 50 years, it's Warren Buffet and his partner Charlie Munger. There is no one/duo that has been more successful at investing and predicting long term economic scenarios over this time period.

Yeah, given that he stayed out until things collapsed, then swooped in and bought at the bottom, I think it's pretty hard to tag him with "involved in the collapse".

It's also worth noting that Buffett occasionally likes to take a turn at being the house. Between 2005 and 2008, he sold a notional $40 billion of puts on various equity indexes. This is basically a highly leveraged bet that the market would go up 5% a year for the next 15-20 years, entered into at the height of a bull market.

It also backfired on him at the height of the credit crunch. While he was smart enough to write the contracts in such a way that he didn't need to post collateral, he didn't account for the way that someone looking to hedge their counterparty risk with him would behave. When the market collapsed, the buyers of the puts proceeded to short both the equity and debt of Berkshire to protect their investment. http://crookery.blogspot.com/2008/11/valuing-large-options-i... and http://crookery.blogspot.com/2008/05/warren-buffetts-vega-ga... have some of the technical details, and http://www.portfolio.com/views/blogs/market-movers/2008/11/2... has a good general explanation of what went wrong.

Buffett may not have been in the casino all the time, but he had plenty of side bets that could have wiped him out.

BH could have paid 40 billion today let alone in 10+ years from now so it's not highly leveraged. Highly leveraged for BH would have been placing a 4,000+ billion bet. If you read up on this deal BH maximum risk is a small fraction of their projected net worth and they can’t be forced to pay up early. They would need to lose ~90% of their value today and never recover for this to be an issue. At the same time to be on the hook for the full 40 billion the indexes would need to be at zero (at which point the company would have already failed).

PS: Leverage means making money from money you don't have ex: loan on rental property. But to classify as highly leveraged you need to risk 10x or more money than you actually have.

Buffett has been more prudent than much of the rest of the financial industry, and he should be commended for that. However, the primary business for Berkshire Hathaway is reinsurance. As such, other insurers pay them to take on the risk that claims will exceed a certain level. If New York got nuked, the reinsurance contracts that Berkshire has written with the property and casualty insurers of the area would be invoked and Berkshire would be forced to assume the bulk of their obligations.

The "money you don't have" part of the definition of leverage isn't necessarily money that you must pay back like a loan or bonds; it can also be money that you may have to pay under certain conditions. Writing naked puts and selling reinsurance is the latter.

From http://community.reinsurance.org/Data/Leverage/Und%20Lvg%202... , we can see that Berkshire's 2005 leverage ratio was 143%. That's fairly low for a reinsurance company, and Berkshire is not highly leveraged.

However, I'm still going to maintain that the marginal increase in leverage from the specific derivatives deal I mentioned was rather high. Most insurance companies have noncyclical liabilities (e.g. the mortality rate doesn't increase in recessions) and procyclical assets(e.g. stocks and bonds that fall in recessions). The sale of puts added a procyclical liability, increasing Berkshire's leverage at the margin.

I don't like casinos much either, but I wouldn't mind owning one. The preferred shares in a profitable company shows the usual skilled negotiating that Buffet uses to get large pieces of large companies in deals with a high margin of safety. Here, he gets a solid dividend on his investment with the possibility of upside. The problem that Berkshire Hathaway have is size : they are running out of profitable places to invest $5 billion dollars. Their primary responsibility is to invest well for their shareholders, so that's what they are doing.

The parable is designed to highlight the folly of having 25% of your GDP devoted to what is essentially gambling. I don't think the story is weakened by the author having invested money in one of the 'casinos'.

I'll bet it's not part Goldman's normal business model to borrow money at 10% to fund operations. Perhaps Buffett was just taking advantage of their weakness to extract some cash from the beast and invest it into more sound vehicles in the future.

From what I have read, investing in Goldman was Buffet's idea. Are the any articles that list Munger talking about the equity stake in goldman as well?

You can disagree with the scheme of things while exploiting it. Buffet thinks his taxes are too low but he doesn't offer to pay extra unless he is forced to.

I think it's hard to criticize the man on those grounds since he has pledged to give the "bulk of his fortune" to the Gates Foundation. That's arguably more productive than donating money to the government.

http://www.washingtonpost.com/wp-dyn/content/article/2006/06...

I was disagreeing with the original commenter.

I was arguing it's possible to not agree with the way the world works, but still exploit it. Of course buffet shouldn't pay taxes until the laws are changed. Hs's publicly argued many times that taxes are too low on rich people, just as he argues derivatibes are net destructive to society - it desn't mean he should not deal in derivatives if he sees an opportunity.

Wouldn't voluntarily paying extra taxes be akin to donating money to the government? Say what you will about Buffet, but I don't think you can criticize him for not writing a few extra zeros on his tax check.

EDIT: Fixed duplicate words.

Sure you can.

Also, Buffet advocates higher taxes that the won't pay and that he benefits from.

Consider the estate tax. He pushes it, but his estate will never be taxed. He also makes quite a bit of money selling insurance to help people pay estate taxes.

Yes, he benefits directly from estate taxes.

Why will his estate not be taxed? Because he's going to give most of it away before he dies? That makes him some kind of tax cheat?

The estate tax doesn't even kick in unless the inheritance is over something like 2 million dollars. That is one "anti tax" issue that I seriously don't understand. Seems like that should be literally the last tax that gets cut, why not cut the income tax if we're cutting taxes?

Family farms and small businesses are often severely hurt by estate taxes. Many of the people who oppose the estate tax are those who want to see a farm or business stay in the family, but tax laws make it incredibly hard to transfer it to their children.

It is often portrayed as something only the super wealthy need to worry about, but plenty of farmland goes on sale in the midwest because taxes can't be covered.

Well, advocate for an exemption, then. Advocating to abolish the tax entirely come across as advocating for only the super wealthy's needs -- let's face it, family farms and small businesses with values over 2 million are a tiny minority of these inheritances, nationwide.

You're missing the point. The estates of the super wealthy aren't subject to the inheritance tax. It only hits family biz because they can't make the necessary arrangements.

marshallp wasn't criticizing him. On the contrary, he was just pointing out that Buffet's actions are morally consistent.

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