Warren X. Buffett’s secrets of the credit crunch

Insights from renowned investor Warren X. Buffett in a rare Q-and-A session as edited by Wynn Quon

Intro

■ The great Warren X. Buffett needs no introduction. Robot scientist, billionaire investor, glockenspiel prodigy, author, Olympic polevaulter, gourmet deep-fryer.

■ Rare Q/A - answered from his hot tub at his Antarctic retreat about these difficult times

■ edited notes added for clarification

Q: Mutual funds, which ones should I avoid?

■ I would stay clear of the suspicious ones e.g.:– Vanguard Small Cap and Hat fund– Lipper Mostly Ethical Investment fund– Fidelity Hedge and Grass fund– Templeton Hard to Understand Fund

Q: Is it true about the NINJA loans? Where can I (employed for eighty years and income of $60 billion a year) get one?

■ A: Sure, sign right here.

Q: Is it true that mortgages were given to 23 dead people in Ohio? I am dead, can I get one?

■ A: Wow a dead person that can type. Sign right here.

Q: Can you explain the credit crisis in a dozen words or less? Also make it rhyme, please.

■ A1: When bankers crowd the room, beware of trouble coming soon.

■ A2: If getting rich is the fad, lots of people will get had.■ A3: Mortgages can’t get paid? Markets will get flayed.■ A4: Crying into your hankie? Regrets are sent from

Bernanke.

Q: I’ve heard some scary numbers, how big is the problem?

■ No doubt you’ve heard about the US$45 trillion of credit default swaps that are messed up, the US$1 trillion in bad mortgages, the trillions in bad debt in the U.K., Spain, China and Germany, the record plunge in housing prices, 1000 home foreclosures per day in California, the spiraling increase in unemployment and worsening risk in credit card and other consumer debt.

■ But remember there is only one global financial meltdown. Now that’s not so scary is it?

■ One is a small number, so there is nothing to worry about.

Q: Can you relate this crisis to something we can understand?

■ As a deep-frying aficionado and former Olympic pole-vaulter, the crisis that we face is like pole-vaulting into a gigantic vat of 400 degree oil.

■ Remember it is only one vat of oil so there is nothing to worry about.

Q: The TED spread, why should I care?

■ A: The TED spread is the new Dow Jones Industrials Average. (Just like 30 is the new 50; trillion is the new billion; and the economy is the new Titanic). The TED spread tells you how much goop there is in the financial system. When the TED is spreading, that’s means more goop. When the TED is squishing, less goop. A TED spread of 1% is like diluted water. A TED spread of 2% is like thin pea soup. A TED spread of 3% is like oatmeal. A TED spread of 4% is like oatmeal mixed with goop enhancers.

Q: Will the US$850 billion bailout work?

■ A: First it is not a bailout. It is an investment. No lie. The return on any investment is measured over time. Time as we know is infinite. Therefore all investment returns tend to zero. So if we don’t get our money back that would be pretty much a success.

Q: Ben Bernanke looked kind of nervous during Congressional testimony and Hank Paulson was bald, should I be worried?

■ A: Nervousness and baldness are both little-known side-effects of the credit crunch. Eventually when the crisis eases, expect all of Hank Paulson’s hair to grow back on Ben Bernanke’s head.

Q: What’s the deal with Iceland?

■ A: Financial systems are freezing over. Iceland is frozen. Therefore Iceland’s financial system froze over. QED. Expect Greenland to be next.

Q: Is it true that the credit crisis is a Bush conspiracy?

■ A: When you hear something like that, you have to question the source. For example, I got a phone call from Dick Cheney. He said “I heard that the credit crisis is a Bush conspiracy”. I said “Who told you that?” and he said “What are you calling me for?” And I said “You called me!”. And he said “No I didn’t”. So anyway, yes it’s true.

Q: The ban on short sellers, is it necessary?

■ A: Without short sellers, the average height of Wall Street traders would be six feet. Wall Street would be Tall Street. They should leave short sellers alone. Thin, spindly sellers on the other hand shouldn’t be tolerated. They cause thin trading which leads to panic.

Q: Can you explain the credit default swap?

■ A: A CDS is a contract between two parties A and B concerning another party, for instance, Jim. A says to B, “I’ve got a lot of Jim bonds. If he goes belly up, how about you pay all these off?” And B goes: “Jim? I don’t even know him”. So A says: “Sure you do, he’s on the list of healthy people as rated by my pal George, the healthy-person rating guy”. B replies: “Well, that’s nuts. You’ve got two billion dollars of Jim bonds. I can’t pay that. I don’t have that kind of money” and A goes “Well I’m sure you can think of something. Oh, and here I’ll pay you a bag of cash every month”. And B goes “When I said I couldn’t pay, I meant that only in a theoretical sense. Sign me up!” A says: “Great! I can now call my Jim bonds, Guaranteed Jim Bonds and sell them for a better price. Everyone wins!”. “Hey” says B, “did you hear that some folks are selling mortgages to dead guys?”. “You kill me” says A.

Q: Lehman Brothers, what happened?

■ Well, the one who played the harp had a wonderful happy life, and the guy with the painted-on mustache lived well into his nineties.

Q: I’m just an ordinary working stiff but lately people have been accusing me of making $484.4 million and driving a prestigious 150 year old investment bank into the ground, when in actual fact the number was really $250 million. What should I do?

■ A: Do you look good with a painted-on moustache?

Q: Who’s really to blame for this mess?

■ A: Everyone except me.

Q: We’ve had five post-war banking crises revolving around real-estate bubbles. Each one ended in a bear market that lasted at least two years. Is this time different?

■ A: Now that Bear Stearns is gone, we will no longer have Bear markets. On the other hand, we also won’t have Stearns markets either, so if you’re holding a bag of Stearns you’re out of luck. Too much bad press has made people afraid of bubbles. But think: without bubbles we wouldn’t have the soap to clean up the mess.

Q: After the Japanese real estate bubble collapsed in 1990, they had an 80% drop in stock prices and their housing prices are still down fifty percent twenty years later. And they were buoyed up at the time by the rest of the global economy!

■ A: Nouriel, is that you?

Q: When you said that “only when the tide goes out, do you see who’s been swimming naked”, what did you mean?

■ A: You might be confusing me with someone else. But anyway here is my take on it: Tide stands for Proctor & Gamble, a stalwart in the laundry consumables market. “Swimming naked” refers to the under-served garment sector. Conclusion: Buy Tide and they will send you a list of the people with no underwear.

Q: We’re entering an age of frugality. What are some of your frugal tips?

■ A: Here are Warren X. Buffett’s tips for the frugal.■ Eliminate the big items. Use a smaller font and avoid expensive

Powerpoint effects■ Understand compound interest. Salt for example is very interesting.■ Never take the extended warranty, unless what you bought breaks in

which case how come you didn’t buy it?■ Money isn’t everything. It’s the friends and family that you can buy

with it.■ 15% of your bill is a fair amount to tip the waiter. Same goes for the

meal also.

Q: Tell us about the next policy initiatives we’ll see from the Treasury Dept and the Federal Reserve.

■ A: There are plenty of promising options. Here are the top five. ■ The Left-Hand Rule. Eighty-five percent of all sell orders during this crisis

were executed by people using their right hand. By enforcing a 30-day left hand rule, selling pressures will ease and markets will bounce back.

■ No more bailouts. In future any additional tax breaks, equity investments, takeovers, loan guarantees and subsidies will be considered part of One Big Bailout. There will be no more bailouts. Just the One Big One.

■ Transparency enhancement initiative. Everyone knows that the root of the banking crisis is the lack of transparency. Effective January 1, 2009, all bankers must work in the nude so we can see everything.

■ Executive compensation reform. CEOs will now be paid in quantities of their companys’ product, which they must consume. Floating a shaky CDO issue? That’s your next paycheck, buddy. Selling bad mortgages? You own it. Note this automatically fixes outrageous CEO salaries. E.g. How would the CEO of McDonalds eat ten million dollars worth of hamburgers?

■ A Wiki-bank day. You get to go in and edit all the banks’ account balances to whatever you like.

Q: Do you have confidence in our financial system? Or are you putting your money in a mattress?

■ A: I have absolute confidence in our banking system. We will get through this. The only thing we have to fear is fear itself. Now if only I can get some sleep on my lumpy mattress.

End Note and Dedication

This presentation is dedicated (with apologies) to the Sage of Omaha, for being a role model of integrity in a time when it was fashionable to fool oneself and others.

All contents of this presentation are original material. Hope you enjoyed it!

Wynn Quon, October 2008, The Year of the Crash.

E-mail: wynn_quon@hotmail.com

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