Buffett and Munger Support Regulation and Consequences – For Others

Tuesday, May 4, 2010

Berkshire Hathaway Chairman Warren Buffett and Vice-Chairman Charles Munger made some prepared and impromptu statements at last weekend’s annual meeting and press conference. Some of those comments give us an unexpected – and disappointing – look into their thinking.

Buffett, in his annual shareholder letters, has made many observations about two subjects (among others):

  1. Pushing for stronger derivative regulations
  2. Criticizing Wall Street’s sales tactics

In his 2000 annual report letter, he had this to say about Wall Street and mortgage securities:

“But a pin lies in wait for every bubble.  And when the two eventually meet, a new wave of investors learns some very old lessons:  First, many in Wall Street – a community in which quality control is not prized will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest.”

The resulting mortgages were usually packaged (‘securitized’) and sold by Wall Street firms to unsuspecting investors. This chain of folly had to end badly, and it did.”

Given this is how things work, what is Buffett’s solution?

  1. Create a derivatives “central bank” regulatory structure to prevent a destructive chain of collapse
  2. Make leaders pay the consequences when they harm their companies or the financial system by their mistakes

You would expect, then, that congress’ work on derivative regulation and the SEC’s lawsuit against Goldman Sachs for improper sales disclosure would be high points for Buffett. Instead, he is complaining about each.

About derivatives regulation – Congress, working on a better regulatory structure, wishes to require collateral to mitigate the risk that counterparties might not be able to pay. Buffett has highlighted this problem in the past. However, now he is lobbying to keep Berkshire from having to put up collateral on its $63 billion in derivatives, arguing that Berkshire doesn’t represent a danger to the system. That may be true, but as a wise and respected leader who has made a multi-year campaign to fix up the derivative industry, Buffett now is saying, in essence, he meant the other guys.

About Wall Street mistakes – The SEC has identified an area where Goldman Sachs may have stepped over the line. But, instead of supporting this action, Buffett is defending Goldman, saying it did nothing wrong. “I haven’t seen anything in Goldman’s behavior that makes it any more subject to criticism than Wall Street generally.” He said Goldman was caught up in the “mania that prevailed throughout the investment world.”

So, he is excusing any improper behavior because Goldman is part of Wall Street. (A kind of psychological bailout.)

Worse is his turnabout from criticizing Wall Street’s aggressive selling behavior towards “unsuspecting investors.” He called the Royal Bank of Scotland, which lost about 90% of its $1 billion investment in the suspect Goldman deal, “dumb.” (“Dumb” means stupid. I assume he meant “ignorant” – i.e., uninformed. And who kept the knowledge from them? Goldman, according to the lawsuit.)

Munger takes on a pit bull role

Charlie Munger gave us more insight into their thinking with unvarnished remarks. (Source: “Buffett Warns on Derivatives Legislation,” Financial Times, by Jeremy Lemer, May 2)

“Berkshire Vice Chairman Charlie Munger said he believes Goldman is the nation’s best investment bank in terms of morality and competency. He said vilifying Goldman won’t solve the problems created by what he called faulty government regulation of the financial industry.

“’Our problem is that our commercial banks and our investment banks have been regulated with a combination of permissiveness and stupidity,’ Munger said.

“Munger compared the bankers that have caused problems to tigers that escaped from the circus and ran amok. ‘When the tiger gets out and starts creating a lot of damage, it is insane to blame the tiger.

‘It’s that idiot tiger keeper that didn’t do his job,’ Munger said. ‘The government regulatory system has utterly failed us.’”

Munger can certainly believe that Goldman Sachs is “best” in terms of “competency,” but “morality?” He is saying that when Buffett and he roasted Wall Street firms’ questionable behavior, they meant the other guys.

Now, about his picture of dangerous tigers running loose. If we define “tiger” as a clever, powerful being that tenaciously pursues its desires, that meshes with their past view of Wall Street firms. But his logic now is that these tigers are doing what comes naturally, and so it’s the “idiot tiger keepers” who are at fault.

Then there is that statement, “vilifying Goldman won’t solve the problems….” Perhaps not, but punishing a wrongdoer is never about solving society’s problems. It is about enforcing the laws currently in place.

This is where Munger’s statements double back on themselves. That lawsuit is being brought by an “idiot tiger keeper” – the SEC. Would he have them back off? Why? Is it because Berkshire Hathaway owns $5 billion of Goldman Sachs securities or because Warren Buffett says there is no problem? Would Munger/Buffett be saying the same thing if Morgan Stanley were the subject of the suit? Just where and when does he want the tiger keepers to do their job? And, with his grade of F- (utter failure) for the government’s current regulatory system, why are they lobbying to weaken the proposed improvements? Is it because the rules apply equally to Berkshire – and not just the other guys?

So… While Warren Buffett retains his reputation as a sage investor, his status as an unbiased, high-minded champion of a sound financial system has a blemish. Very disappointing.

Additional Investment Directions Reading:

Goldman Sachs Could Win Its Case but Lose Its Clients” (April 19)

Goldman Sachs’ Public Relations Strategy Raises Questions” (April 20)

Banks to Congress: “Don’t Fence Us In” – $20 Billion Derivative Revenue at Stake, but Not Future of the Business” (April 28)

Disclosure: No positions in Berkshire Hathaway, Goldman Sachs or Morgan Stanley

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