Come on, Buffett!
Donald Ruffkin works at an equity-oriented investment fund.
~~~
General
Buffett has come out once again, offering his view of the market and where we stand. I thought his comments provided a useful platform with which to engage what are ultimately the 2 most important questions:
- What is our problem?
- What should we do about it?
In the first couple sections of this, I offer rebuttals to some of Buffett’s statements. I use this as a lead-in to answer those 2 most important questions.
To put it simply, I believe we need the following:
- More manufacturing
- More savings
- Less debt
- Less speculation and leverage in our banking system
- More transparency and honest dealings in our financial system
Will this be painful? Yes, it will be really, really painful. But the path we are going down will make this all the more painful. If, as I am claiming, the problem is too much for the government to prop, all the resources committed to that endeavor will have been wasted.
Let’s get ready for the future, instead of bankrupting ourselves trying in vain to bring back an unsustainable past.
Buffett’s comments
This is Part 1 (source). He says we are in an economic Pearl Harbor, mirroring comments he made 6 months ago. The economy has “fallen off a cliff” and the consumer is “changing their behavior like nothing he has ever seen.” There has been a reset in people’s minds. He says the level of spending we are seeing is due to their being “fearful”. He says that fear is contagious. He says that we have a great leader and we should follow his prescription. In wartime, you need to follow the leader. Now is not the time to ask questions or have internal dissent. Now is the time to follow what he says.
My comments
I had a few:
- I noted then, as I will now, that it is disingenuous at best for Buffett to be calling this an “Economic Pearl Harbor”. (1) There is no external aggressor. (2) We are more like a drug addict or an alcoholic than a populus being attacked. (3) His metaphor implies we are not at fault – we just need to fight back against the force which is fighting us. In many, many ways this is not an appropriate metaphor. I understand that he is trying to convey a sense of urgency, and a need to put aside our differences to reach a good solution. But the gaping holes in the metaphor are so large that I am left with the impression that he is simply trying to scare us into following the prescription of Obama.
- The majority of people fundamentally disagree with Geithner’s plan. Many people, including myself, Paul Krugman, Nouriel Roubini, Simon Johnson (former IMF Chief Economist), Richard Shelby, Lindsay Graham, Chris Dodd, KS Fed Chief Thomas Hoenig (source), Calculated Risk, Barry Ritholtz, John McCain, Nassim Taleb, Chris Whalen, Elizabeth Warren (head of Congressional Oversight Panel), Josh Rosner, Alan Greenspan, Gordon Brown, Nancy Pelosi, Nassim Taleb, Joseph Stiglitz and Todd Harrison, believe the plan put out by Tim Geithner is FUNDAMENTALLY FLAWED. Warren Buffett is basically saying that we should shut up and do what Obama says. However this plan is, to our belief, fundamentally flawed and could bankrupt this country. This is not some trivial minority. In fact, it appears the majority OPPOSE the “private public” toxic asset purchase plan proposed by Geithner. “Private public partnership” is a euphemism for “subsidize hedge funds with low cost 9-to-1 non-recourse loans to bail out the banking system”.
- The People versus The Oligarchs. Former chief of the IMF Simon Johnson takes it one level further and believes we have been and continue to be ravaged by the business elites in the US (source). I agree with his assertion, as do many other people. They look askance at the large number of Goldman alumni occupying positions of political power. At the backdoor bailouts to Goldman via the capital injections into AIG. At the fact that PIMCO, Blackrock and Goldman Asset Management are 3 of the biggest consultants helping the Fed and the Treasury manage their bailouts – conflict of interest? At the fact that Goldman was the biggest individual beneficiary of the AIG bailout. At the fact that Wall Street, in aggregate, got paid 2004-level bonuses in 2008. 2004 level bonuses? Are you kidding me? They would not exist if it was not for bailout money. We have privatized gains, and socialized losses.
- US consumer spending is NOT irrational. The Savings Rate was 1.4%, 2.6%, 3.1%, 3.9% and 5% in September 2008, October, November, December and January (see chart). Yet we began seeing Depression-level spending in December (source 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11). How much of this lack of spending is due to “fear”, and how much is due to a simple reversion to the sort of savings rate we are *supposed* to have? As we can see from this chart, our savings rate structurally was north of 5% from 1929 to 1994 and went down to 0% and below. As can be seen from this global comparison of savings rates, a 10% savings rate is normal. I agree with him that spending has fallen off a cliff, but I completely disagree with his implicit assertion that there is someting irrational about how much we are spending. We have seen 1 single month of an uptick in saving, and we are already moaning and crying about it.
Buffett’s comments 2
This is another part of his interview (source). Many, many times he refers to his war analogy. This is war! He mentions that the banks should be able to “earn their way out” of this downturn. He noted that Wells Fargo’s cost of funding is now extremely cheap, and earnings spreads have never been wider. When Betsy Quick retorts, asking why the banks should be able to do this and get huge bailout checks from the government, he responds that in wartime, no one ever questioned shipbuilders and the excess of profit they made during those times.
My comments 2
- Why do you keep saying war over and over again, in this manner?
- The banks are arguably the ones who goofed up the MOST. They are NOT like shipbuilders in a war. The shipbuilders didn’t instigate the war in the 1st place!
- The banks are insolvent because they extended far more loans than will get paid back, and losses far exceed the capital base of these firms.
- Why should we save the equityholders of insolvent banks? Why should the taxpayers bail out the debtholders of insolvent banks? I understand that we need to protect depositors. But there is a BIG DIFFERENCE between protecting customers, and protecting speculators. Protecting debtholders is what one would expect not under democracy, but KLEPTOCRACY. We cease being a market system. There are pros and cons to everything, but I just hope we are clear what market system we are operating in.
My belief – not a war, but a drug addiction that began in earnest in 1980
I wrote a few pieces earlier which convincingly argue that our real problem is simple – too much debt.
- 15%+ of aggregate demand (GDP) in the US in 2007 was from growth in debt (source) alone. It is as if I spent all of $100 in income, and then borrowed another $15 to spend it. When debt growth simply goes flat, that 15% of GDP will vanish. Debt goes flat when it gets way too large, and borrowers pull back. That is what is happening as we speak.
- We foisted all this debt on the mistaken belief that housing prices, globally, were worth far more than they were actually worth (source). We then foisted a bunch more debt on a bunch of other things, like our corporations (source). Now that asset appreciation is going away.
- We repealed Glass Steagal, which separated speculation from traditional banking, and which imposed leverage limits on our banks – leverage limits that had been place since the era of the Great Depression. Old restrictions capped us at 12x leverage. We ended up with 33x leverage (and higher!), leaving us vulnerable to even the smallest of shifts in valuation (source).
- We had a global debt bubble – we can see this clearly in Japan (source), in Australia (source), in the UK (source), in Ireland (source), in Switzerland and Belgium (source), in the OECD as a whole (source).
Debt is in many ways like a drug. It provides an up front “high” (cash) at the expense of the future (interest payments). At the beginning its impact is a lot stronger than it is later after repeated use. It can create addiction, where later on, doses are required simple to remain “even” (if you borrow interest over time, debt continues to rise, requiring debt simply to pay off the interest payments). If the dosage gets high enough in the blood stream it can be fatal.
A person making $1000 per year can support $300 of debt a lot easier than $1000. But we are way worse than that. There are 116M households in the US, generating average income of $68k per year. We have $52T of total debt in our country. This is $450k per household. $68k supporting $450k of debt is extremely high, and is larger than we have ever had before (source).
The picture is clear – we are spending too much, and working too little. And that this really began starting in about 1980.
- Secular shift out of manufacturing started then (source)
- Real Industrial production peaked in 1975 (source)
- Domestic non-financial debt / GDP began spiking in 1980 (source)
- Imports began consistently outstripping exports in 1975 (source)
- Savings rate secularly shifted from 10% to 0% in 1980 (source)
- Financial sector profits rose from 5% of total US corporate profits to about 40% (source)
Solution – Reversing the problem
We are now trying to nurse our banks back to health by putting them on extremely expensive life support systems. The patient is going to get badly damaged anyways. Let’s not bankrupt the USA trying to support what is unsustainable. The pain is coming regardless. Let’s focus on getting back to our roots, to what made us a strong country to begin with.
- Let’s manufacture more. People warn that protectionism is evil. I agree. China has been pursuing protectionist policies in spades, especially starting in 2000. Just have a look at their Treasury holdings (source). We have systematically routed our unions, halved our real industrial production, outsourced it to foreign countries, routed our manufacturing workforce (source), borrowed to pay for imports, and made up the difference via financial services jobs. Let’s manufacture more – do some real work.
- Let’s save more. Let’s remain at 5%+. Too much debt got us into this mess. Weaning ourselves off of the drug, even if we must do so slowly, is the way to get out of the mess.
- Let’s forbid banks from engaging in excess speculation and leverage. It got us into trouble in the Great Depression. We then put in place rules to stop that in the future. We then repealed those rules recently. We then re-created a huge mess of leverage and speculation. Here we are. We learned our lesson. Re-institute Glass Steagall.
- Let’s let financial services shrink back to a suitable size.
- Let’s re-impose rules to create transparency and stability in our marketplace. Ban naked short selling. Clean up the CDS market. Break up the banking and ratings monopolies. Enact position limits in the commodities market. Bring back the uptick rule. Replace Goldman Sachs alumni with capable individuals with fewer conflicts of interest. Enforce policies promoting disclosure – let us know who AIG’s counterparties are, instead of dragging your feet and then having that information leaked “through the grapevine”.
Will this be painful? Yes, it will be really, really painful. But the path we are going down will make this all the more painful. If, as I am claiming, the problem is too much for the government to prop, all the resources committed to that endeavor will have been WASTED.
All those resources can be used on the reconstruction efforts mentioned above. Change is coming, whether we want it or not. Let’s get ready for the future, instead of bankrupting ourselves trying in vain to bring back an unsustainable past.
Addendum – Want a risk free 4-6% return? I have a solution for you
Pay off your mortgage.
These are conventional mortgage rates from 1972 to 2008 (source). Your money is probably sitting in a money market account right now, earning less than 1%. As Buffett himself had said, Wells Fargo had a cost of funds of around 1.4% last year. That is because Wells is paying YOU 1.4% on average.
Instead of putting what little you have remaining in the stock market, you might want to consider paying down your mortgage.
- Mortgage rates have remained above 6% so this is likely around the rate you are paying. Even after accounting for mortgage interest deductibility, paying off your mortgage is a risk free return well in excess of what you would get elsewhere.
- Obama is considering hacking away at mortgage interest deductibility for couples earning north of $250k per year. Even the interest deductibility might be going away (source).
- One of our problems, as an economy, is too much debt. This will lower our debt.
Just something to consider.
March 9th, 2009 at 3:56 pm
I already have a paid-off mortgage. Now where is there any risk-free return in this mess, besides CD’s?
March 9th, 2009 at 4:51 pm
At last! Someone with a modicum of authoritativeness saying the same things I’ve been saying to anyone who would listen to me for the last thirty years! (Of course that was a very small number of people.) Between the assault on government regulations and the almost complete cluelessness of the American public, the Super Rich managed to drag us back to the 1920s, and now, again into the 1930s….. “The Empire Strikes Back” is not just the name of a Star Wars movie…..they really did it! The idea that Obama, or any other Washington politician, can fix what ails us is an exercise in wishful thinking. To paraphrase the late, great Paul Harvey, “Good luck, America!”
March 9th, 2009 at 5:03 pm
Dean,
All of ur money are belong to us!
THX,
USG
PS. we’ll always have breakfast at Tiffany’s.
March 9th, 2009 at 5:32 pm
I couldn’t agree more with your comments, analysis and conclusion. Buffett is loosing his marbles. Assuming he ever had any marbles to begin with.
March 9th, 2009 at 7:49 pm
great comments.
1- The Treasury and the Fed have been focusing on INSTITUTIONS rather than the INSTRUMENTS (CDS) that have caused the problem.
A- we still don’t have a central comprehensive data base of all the derivative instruments, i.e. what’s in each tranch and where are they located?
2- What is wrong with a slowdown in purchasing on credit?
3- a focus on developing automation in manufacturing, especially in assembly, would permit our design and manufacturing base to prosper. Look at Japan’s growing high tech manufacturing base. They keep the R&D high
tech core and export the low tech manufacturing.
Here GE walks away from appliances just when appliances begin to incorporate intelligence and a whole new industrial cycle.
Boeing becomes an integrator and gives away the keys to the kingdom, i.e. knowledge on wing construction to China.
Is GE going to do the same with jet engines?
Most of the composites in the new planes are manufactured and assembled abroad.
If the US doesn’t have a vibrant manufacturing base then we will ultimately go the way of the UK, which is exactly what the Financial Service industry has wanted and continues to want.
They (Paulson, Rubin…) have always fought for open access for financial services but never for manufactured products.
4- Buffetts last two major purchases (not investments) were manufacturing companies: Iscar and Marmon.
What am I missing??
March 9th, 2009 at 7:55 pm
Funny that all the bad habits and trends kicked in between 1975 and 1980, when the hippie generation began transforming into the yuppie generation.
So the old coot GI generation was right when they said that those dirty hippie baby boomers would amount to no good and destroy our country!
I think when the final draft of this era in American history is written, the baby boomer generation will be dubbed The Selfish Generation.
March 9th, 2009 at 9:51 pm
“This guy has the right idea. I would go further. If there’s one thing the financial crisis has taught us, it is that private interests are every bit as bad as government in running things, particularly in the finance and insurance sector. We’re bailing both of these sectors out. It’s time to stop the nonsense and let the government take them over. They could run them cheaper and more fairly. Anything else is just blowing smoke and making excuses for speculators and parasites. Only productive industries that actually create useful goods and services and are not to big to fail should be private. Get on with the job!”
March 9th, 2009 at 10:17 pm
The most wondrous thing of the piece is that after rereading, have NO idea of whether the author is a Dem or a Republican…THAT says a lot, and he does have some superb thoughts!
March 9th, 2009 at 11:24 pm
Where are all the free traders when we need them? Come on folks. I know you’re out there. Tell us again how it’s good to give up our manufacturing jobs. Tell us again how we’ve moved up the ladder and making things is so old school. I’m from Detroit and I can round up 50,000 engineer with masters degrees to move on up that ladder.
March 10th, 2009 at 12:52 am
It’s not that I don’t agree with you but I don’t agree that it’s that easy. I am no genius in finance but I easily saw this coming 3-4 years ago. I smartest minds didn’t,..I call bullshit. This is just not that bubbly simple. There is a Gorilla in the room we are not paying attention to.
China had us by the balls, period. A pusher per say Barry. Go cold turkey, could die? I think we are getting a little Methadone to the banks so we don’t. I’m sure there are various ways of doing this but I think we all agree there needs to be some short term support. Plus the pusher is going,..what the fuck…your my best customer, you can’t quit…or else. Notice the pusher has been fucking with us in the South China Sea all of a sudden. Probably not real happy with our new ideas to save ourselves.
Sure there is plenty of blame to go around but the people running the show are not stupid. This revision of the mean in this country is going to be long and painful and in my mind just beginning. A decade? L-shaped in my mind for sure. With the Baby Boomers too, Sweet! Socialized health care too, awesome. Earth to socialist, we are broke now. I would almost guarantee the so-called experts like Buffet will be no where in site when the middle class is pulling themselves up by their bootstraps. Money goes to money, that’s not considered being a genius. I say just give him some money to shut the fuck up. He didn’t see this coming? My ass, the biggest fleecing of the American Taxpayer ever. He should be ashamed of himself.
March 10th, 2009 at 12:58 am
Agree with comments totally, as does most everyone in the country except the oligarchs. Fascinating. They are going to do what they are going to do. We have to learn to accept it.
@l_emmerdeur: Funny you would call the Boomers the selfish generation. Your time frame just about corresponds to the time when Boomers started indulging their children, conditioning them to take for granted everything the Boomers did not have. If I were to pick the clueless generations they would be the spoiled ones that followed the Boomers. The anger toward the Boomers is merely a reflection things are so bad they may not be able to continue to spoil all the young people quite so thoroughly. And the younger generations are pretty much at sea what to do when Dad turns the spigot off.
So you baited people and it worked. Guess that makes you feel pretty smart.
This is not a generational issue. Sure some of the worst bad players are Boomers. But for every one of the bad players, there are a million Boomers that can’t get a job. So I guess that makes them selfish.
What say you brilliant one?
March 10th, 2009 at 3:45 pm
Buffett is still wrong:
http://network.nationalpost.com/np/blogs/francis/archive/2009/03/10/buffett-is-still-wrong.aspx
I don’t think he is necessarily wrong. I think he is just towing the party line to keep all the sheeple from bolting…or revolting. He is playing the role of the judas sheep perfectly. His ‘job’ is to maintain the economic status quo which is why he sounds so far out of alignment. A lot of credibility is crashing and burning in this pullback
March 10th, 2009 at 3:48 pm
@usphoenix Says:March 10th, 2009 at 12:58 am
The boomers have the majority of the power and a majority of what is left of the wealth right now. So, for the most part, I’d say they own it
March 10th, 2009 at 9:18 pm
@How the Common Man Sees It: See, you’ve got the same problem. “Boomers” is not an adequately accurate social term except as a target for your Angst.
Yeah, I suppose the 1% is more concentrated in the Boomers than elsewhere. But the elsewhere is about to inherit it.
The fact is, the Boomers with all if it are an incredibly small % of the Boomers. It’s the Boomer with all of it that are the problem. Boomers are far more fractured. There are the successful incredibly wealthy, some financially secure after several years of working and saving, and more that can’t find work.
You also have to remember a lot of Boomers have what they have because they were frugal and saved. They didn’t need $5 lattes to and from work. They were lucky to be able to afford a hamburger once in a while.
So do you think it’s particularly fair or brilliant to spread the blame over all the Boomers?
To say they own it? Maybe you’re right. Maybe there are too many of them that can’t relate. But I don’t hear them criticizing the later generations and arguing against a fairer society.
OTH. Maybe you have a better grasp. I am not a Boomer with a lot of money or a lot of power. And neither you nor I should speak about a subject we have such a poor understanding of.
You insult me by inclusion.
March 11th, 2009 at 12:48 am
I have a pretty good understanding of it. I have been following in the boomer’s wake all of my life so I know the path of destruction they left
March 11th, 2009 at 1:10 am
The Boomers left no path of destruction.
You are an ungrateful. You see things through your eyes. You have no concept.
Go ahead and whine. That’s your generation’s way. It’s someone else’s fault.
You don’t like it, change it. But pay your own way. You have not done that yet.
March 11th, 2009 at 4:22 am
“You see things through your eyes.”
Better than seeing things through a greedy banker’s (CNBC) eyes.
“You don’t like it, change it. But pay your own way.”
Unfortunately there are too many old people/idiots to change it enough. I don’t have the option of not paying for the Iraq war. Oh but all the oil there was supposed to pay for our invasion… What happened to that? We don’t have to pay our own way, we’re just going to inflate away all your debts and devalue your savings. Medicare will still survive, and as an unfortunate side effect so will you.
March 11th, 2009 at 10:07 am
@usphoenix Says:March 11th, 2009 at 1:10 am
I’m not going to argue with you. The facts speak for themselves and this is not the post to do it at. You are one of the many who are entering the denial phase of your mortality and will take it out on anyone that challenges your generation’s legacy. The desperate boomer thrashing is about to start for all to see. You guys are going to meet your maker whether you like it or not
As for paying my way, I’ve been paying my way for 25 years and owe no man anything. I may not have much, but what I have is paid for….after taxes
March 11th, 2009 at 8:10 pm
Thanks for this. I would go further. Shrinking the financial services industry basically means not giving them your money. It means you have to look at all the ways they’ve cooked up to control your money (mutual funds, money market funds, 401K funds, etc.) and cash out. Hold cash outside of the banking system; use community banks instead of national banks. Don’t use credit cards; pay cash (how much do they make in fees?). Pay off debts. Don’t run up new debts. Starve the beast. The regulators won’t do it. The industry won’t do it. We have to do it.
March 12th, 2009 at 4:14 am
like this is all obama’s fault. there is no other solution. To let the banking system fail would be utter mayhem for decades. with all the stimulus, this is as soft as it gets. And it feels like we missed the pool and landed on the cement. Fear is great and irrational. I’m a buyer in this market with what little I have. If you were really learnit, when studying the GD, you would have noticed that the market bounced prior to peak unemployment. US equities is the best asset right now hands down. This will not be the next great depression because the money supply is flexible. We are also not suffering from a dust bowl causing mass starvation. Debtless money is abound right now. It is a myth that rising commodity prices is a result of demand. But this kind of inflation will never spin out of control because the higher price will cause demand destruction due to the higher price. So this is not the kind of inflation I fear, nor is it ever a problem. The inflation I fear is money supply growth that can spiral out of control. It is not self regulating. Whether this money is backed by debt is meaningless because debt can be defaulted on and the money lent is merely entries in an accounting ledger transferred electronically. If you though we had high inflation in the seventies and eighties, you ain’t seen nothin’ yet.