Month: September 2011

Hero or Hypocrite? “The Buffett Rule” Then and Now

Post author By jeff matthews
Post date September 27, 2011
22 Comments on Hero or Hypocrite? “The Buffett Rule” Then and Now

“The first rule is not to lose. The second rule is not to forget the first rule.”

—Warren E. Buffett, quoted by Carol J. Loomis, Fortune Magazine, 1988

Having recently celebrated his 81st birthday, Warren Buffett is not going softly into that good night. He is, in fact, going quite noisily ahead, making new friends—and new enemies—along the way.

His most visible friend, of course, is President Obama, who has gone so far as to name a new tax proposal after him (“The Buffett Rule”), following the Oracle of Omaha’s August 14 op-ed piece in the New York Times calling for higher tax rates for the rich, as follows:

“I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more…I would suggest an additional increase in rate.”

Buffett’s most visible enemy, now that his long-submerged but never denied personal brand of liberal Democrat politics has burst, full blown, into the open, is a collection of bloggers, politicians, political commentators and billionaires taken to excoriating Buffett for his high-minded, highly visible, and, they say, highly misguided stance on tax policy.

The centerpiece of the criticism is pretty straightforward: if Buffett feels so strongly about paying higher tax rates in the interest of fairness, nothing is stopping him from setting the example by voluntarily cutting a bigger check to the U.S. Treasury.

Buffett’s comeback is, and always has been, likewise straightforward: he simply follows the rules, he says, and the rules currently tax his earnings from dividends and capital gains at a lower rate than regular income.

It’s the kind of by-the-book self-justification that drives those who see Buffett as a rank hypocrite out of their minds, and reassures those who see Buffett as a hero in the current policy wars.

All this is unfortunate, because Warren Buffett, Political Guy had, until yesterday’s unprecedented share-repurchase announcement, largely wiped from the public mind Warren Buffett, Investment Guy—the supremely rational, highly quotable steward of Berkshire Hathaway whose track record for the last four-plus decades is, in fact, unequaled.

How “unequaled” is Warren Buffett’s track record, you may ask? Well, he literally turned his own personal investment of $100—that’s one hundred dollars—into a current net worth of close to $40 billion (and $62 billion at its peak, before he started giving it away).

To see exactly how he accomplished that unequaled feat, you can read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” (available at Amazon.com, here)which explains in plain English what made Buffett the Investor unique while also exploring the upsides and downsides of his extremely risk-averse management style…but we’ll provide one big clue here.

That clue is the original “Buffett Rule,” quoted above, which had nothing to do with raising taxes on the wealthy and everything to do with investing, and is worth repeating:

“The first rule is not to lose. The second rule is not to forget the first rule.”

So well did Buffett adhere to this rule of investing that in his first 46 years managing Berkshire Hathaway’s investment portfolio, Buffett had exactly two losing years (the stock market had 11 in that time), thus allowing Berkshire’s net worth to compound at slightly over 20% a year—an astonishing rate of growth, never duplicated.

But it is a track record that is increasingly underappreciated, because the old “Buffett Rule,” about investing, has been replaced by a new one, about taxing the rich.

The irony here, for anyone who has studied Berkshire Hathaway and Warren Buffett, of course, is that Buffett is as savvy in the taxpaying department as he is in the investing department.

His recent, high profile $5 billion investment in Bank of America, for example, was structured to minimize taxes on the dividends Berkshire will receive (insurance companies can deduct a large portion of dividend income, unlike mere mortals). This drives some bloggers crazy, but the fact is, Warren Buffett, as CEO of a publicly traded company, would be remiss if he did not attempt to maximize the after-tax benefits of all Berkshire’s activities. Shareholders expect and deserve nothing less.

Besides, Warren Buffett himself has always recognized the benefits of paying taxes at lower rates—via the same kind of low capital gains rates he currently criticizes. Indeed, he long ago wrote to his own investors the following:

“I am an outspoken advocate of paying large amounts of income taxes – at low rates.”

—Warren E. Buffett, July 10, 1963

The quote is lifted, verbatim, from a letter Buffett wrote to investors in Buffett Partnership LTD (the hedge fund Buffett managed, prior to taking control of Berkshire Hathaway) and it was Buffett’s way of telling his investors that he would not make investment decisions based on the cost basis of stocks in the portfolio, but, rather “on the basis of the most probable compounding of after-tax net worth with minimum risk,” as he also wrote in that letter, which you can read here.

(We’ve read all of Buffett’s early partnership letters, at least those available on that wonderful tool, the Internet, as well as every one of his Berkshire Hathaway letters, and advise any aspiring investor to do so as well.)

Buffett thus early on identified the minimization of taxes as a key to maximizing long-term investment success, and knew the way to do that was to generate wealth through investments that were held long enough to be taxed at lower capital gains rates—a benefit “The Buffett Rule” would attempt to end—and anyone who has studied his methods knows this.

Unfortunate as the uproar caused by Warren Buffett, Political Guy, has been by blotting out the accomplishments of Warren Buffett, Investment Guy, said uproar is especially unfortunate because it comes at a time when Warren Buffett, Investment Guy, has been busy on many productive fronts.

The Bank of America investment—a no-lose deal in the classic Buffett vein—was just one front. Another was his recent selection of a second investment manager, Ted Weschler, of whom we’ve heard nothing but good things (“a great, smart, smart guy” in the words of a former co-worker). And a third front—yesterday’s share buyback announcement—is literally unprecedented in Buffett’s 46-plus years at the helm of Berkshire.

But the most unfortunate aspect of all, in our view, is this: the original, no-nonsense, invaluable “Buffett Rule” has been replaced, in many investors’ minds, by a new, politically-oriented (and therefore vaporous) “Buffett Rule.”

And that first Buffett Rule was one any investor, no matter what his or her politics might be, ought to have memorized.

So much so we’ll repeat it here, for old time’s sake:

“The first rule is not to lose. The second rule is not to forget the first rule.”

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

The content contained in this blog represents only the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

NOTE ON COMMENTS: We abide by one rule on the comment pages here, and that is NO “Yahoo Message Board-Type Language.” So whatever you write and whether or not you agree or disagree with something, spell it correctly and keep it clean, and no personal stuff. And if you think we won’t enforce that, well, we have over 300 comments that never appeared because they were sloppy, obscene, or personal. —The Management

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Ben Bernanke and “The Costanza Effect”

Post author By jeff matthews
Post date September 23, 2011
22 Comments on Ben Bernanke and “The Costanza Effect”

“This is found money. I want to parlay it. I wanna make a big score!”

—George Costanza, of Seinfeld, on interest income

We were having a back-and-forth via Twitter this morning with a friend of this blog, a very smart reporter who had taken issue with our non-economist-trained view that Ben Bernanke was not saving the U.S. economy by suppressing interest rates at near-zero levels: he was, rather, pushing the U.S. into a depression by killing the interest-rate spread on which the very banks that circulate the life-blood of the system live.

Interest rates, we argued, were not, as Bernanke has believed, too high for the good of the country, they were too low.

Logically, our friend responded that if credit were really as underpriced as we claimed, “Savers would surely use underpriced credit to snap up inflating assets and goods. They’re not.”

And he is right.

However, the reason savers are not jumping out of no-longer-interest-earnings savings accounts and into risky asset pools is not that rates have been too high. We think it is a function of the fact that, at a certain point, low interest rates become counter-productive: they make savers more cautious, not less. Interest rates are, we think, too low.

After all, if you’re not earning anything on the money you have in the bank, your instinct is not to take it down to the track and go bet the whole bundle on Greased Lightening, as Tony Curtis’ character did in “Some Like It Hot.”

No, you’re going to sit tight.

Now, this behavior probably has some fancy economist-type label, but we will hereby declare it to be a reverse-manifestation of “The Costanza Effect,” after George Costanza of Seinfeld fame.

In one episode, George, upon receiving notice of an old passbook savings account with accumulated interest, chooses not to keep the money in the bank, but to gamble it away.

George: “The State Controller’s Office tracks me down. The interest has accumulated to 1,900 dollars. 1,900 dollars! They’re sending me a check!”…

Jerry: “Why don’t you put it in the bank?”

George: “The bank? This is found money. I want to parlay it. I wanna make a big score.”

Jerry: “Oh, you mean you wanna lose it…”

We think “The Costanza Effect” illustrates that people are more willing to risk found money than earned money, and thereby explains precisely the Bernanke dilemma, whereby interest rates have dropped to zero and yet savers have reacted with exactly opposite the intended result.

Far from, as our friend wrote, “use underpriced credit to snap up inflating assets and goods”; they have chosen to sit on what they have.

Kramer for Fed Chairman, anyone?

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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UBS, Connecticut, and The Reverse Protection Syndicate Racket

Post author By jeff matthews
Post date September 18, 2011
4 Comments on UBS, Connecticut, and The Reverse Protection Syndicate Racket

I went back to Ohio

But my pretty countryside

Had been paved down the middle

By a government that had no pride…

I said, A, O, way to go Ohio

—Chrissie Hynde, The Pretenders

Well UBS is in the news again, this time for a “rogue trader” who spent three years losing $2 billion of UBS’s hard-earned money before UBS figured out the money was gone. Good thing the Swiss banking giant has friends in government to support it.

We’re thinking specifically of the State of Connecticut, our home state, which agreed to pay UBS $20 million to stick around Connecticut for five years.

That’s $20 million in cash the state’s taxpayers are paying to a company that just tossed $2 billion out the proverbial window.

Now, the reason Connecticut is paying UBS $20 million doesn’t strictly relate to the rogue trader, who was actually located in London: it’s because the state has become so unattractive to business that our governor has to pay companies to stay.

We are not making this up. Here’s how Reuters carried the story recently:

NEW YORK – UBS AG will receive a forgivable $20 million loan for deciding to stay in Stamford, Connecticut, for five years instead of moving some investment bankers to the World Trade Center complex in New York City…

“This project [emphasis added] will retain at least 2,000 high-quality, high-paying jobs in the state, spur capital investment and reaffirm the state’s reputation as a leader in financial services,” Connecticut’s Democrat Governor Dannel Malloy and UBS Group Americas Chief Executive Officer Phil Lofts said in a joint statement.

Now, this is the first time we have heard a bribe described as a “project.” But never mind that quibble: we have a bigger one: calling it a “loan.”

After all, the term “loan,” when preceded by the adjective “forgivable,” renders the thing not a loan, but a flat-out contribution, because if you think UBS has any intention of paying back a forgivable “loan,” you are either a good-government type who firmly believes that the machinations of local politicians are intended to produce something higher and more useful than gainful long-term revenue for those politicians and their friends, or you haven’t talked to an actual businessperson who has received such a “forgivable” loan.

We have talked to actual businesspersons who’ve gotten forgivable “loans” similar to the UBS deal, and those “loans” are not viewed as “loans” by actual businesspersons, they’re viewed as capital that has been invested in their business in return for short-term promises—such as not moving that business to another state or another country for a certain period of time.

And while UBS will, we have no doubt, honor the terms of the “loan,” UBS will also, we expect, do nothing above and beyond the specifics of the deal. Nor will it pay back the $20 million—especially now that the firm just lost the equivalent of one hundred $20 million investments at the hands of a trader who, bright though he may be, looks like he just got out of high school.

Furthermore, the $20 million contribution by Connecticut taxpayers to UBS’s pockets will certainly not “spur capital investment” in the state, since any business that was planning to invest capital in Connecticut will see straight through this sort of Reverse Protection Syndicate Racket (in which companies are not coerced into making payments for protection, but are paid to be protected) and ask themselves, and their elected officials, what cash can be extracted in return for threats to leave.

Nor do we see how it will it “reaffirm the state’s reputation as a leader in financial services,” since the deal made it clear to the world the only reason UBS agreed to stay in Connecticut for another 60 months was that the governor paid it to stay.

In fact, Connecticut’s “reputation” is less “as a leader” and more “as a hard place to do business.” It ranks 47th in the Tax Foundation’s State Business Tax Climate Index; carries the third highest per-capita tax burden of the 50 states; and is notorious for making local businesses wonder why they bother…so much so that UBS was, at the time of its “loan,” preparing to flee Connecticut for New York, which is not much less difficult, business-running-wise.

Nevertheless, Connecticut must be getting something for its $20 million “forgivable loan” to UBS, and indeed, according to the governor, Connecticut will preserve, for the five years of the deal, as much as $70 million a year in tax revenue that could have been lost if UBS had left the state.

Now, probably that figure is an exaggeration. Back-of-the envelope calculations of income taxes, sales taxes and corporate taxes attributable to 2,000 high-earning UBS employees max out at closer to $50 million, even using generous assumptions.

But, so what, you say? Spending $20 million over five years to save even $50 million annually sounds like a good “return on investment.”

The problem is, that is not an investment. It is a bribe—a form of reverse protection in which businesses that threaten to leave the area receive cash collected from individuals and businesses that don’t threaten to leave.

As such, it is impermanent, subject to political pressure and favoritism, and short-term in nature. Worst of all, these Reverse Protection Syndicate deals don’t lower the cost of doing business in the state: they raise the cost for all the other businesses.

It’s no wonder that Connecticut has lost half its manufacturing jobs in the last 20 years, and has had no net job growth in that time. And if the UBS deal is any indication, the bleeding in service jobs has just begun.

A, O, way to go…Connecticut.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

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9/11

It doesn’t matter, but here’s my story.

I was swimming laps in the pool in the Ritz-Carlton in San Francisco, and thinking tech stocks, when the first plane hit. I didn’t know what had happened until I came out of the men’s locker room around 6 a.m. PST and somebody—somebody in the hallway—said a plane had hit the World Trade Center.

There was a Bloomberg terminal nearby—this was a tech conference, and the hotel was full of Bloombergs—and checking the top stories, sure enough, a plane had hit the towers.

So I got in the elevator with another guy and we speculated about whether an airline was involved—with not a thought about the human tragedy—because the mentality of this business, sick as it can be, is to calculate how a given event will affect a given stock. And all we knew was a plane had hit the towers, and the first word was it was a small plane.

When I got in my room and turned on the TV, the second plane had hit. So of course everything changed, and I decided to leave. Since they’d closed the airports, this meant driving cross-country. No big deal—I’d had dinner the night before with a bunch of friends, some from the New York area. We’d drive together.

The strangest part came next: leaving my hotel room (it was maybe 6:30 a.m., California time) to walk to the lobby, I saw nobody else—only the newspapers hanging on all the doorknobs—and so I thought, “Am I over-reacting? Am I the only person here who thinks this is as bad as it is?”

I decided I wasn’t. I’d worked at One Liberty Plaza, across the street from the towers, early in my career, I’d been to meetings at Windows on the World, I’d watched the tall ships from offices in the towers, shown our two daughters the view from those floor-to-ceiling windows. I had to get home.

The hotel lobby was weirdly quiet. I went to the concierge, told him I wanted to rent a car, he said “Certainly, where will you be returning it?” I said “Connecticut,” and he didn’t bat an eye. I waited for him to call and book the car, and then made him make clear that the car was going to get to the hotel, and I was going to get the car no matter what. Then I checked out.

I packed while calling people to tell them I was driving. At the same time I realized I didn’t know where anybody else was staying in San Francisco, so I’d be driving alone. A West Coast trader trying to be helpful told me the market opening would probably be delayed, and I told him he his was out of his mind and this was the worst thing to happen in our lifetimes and the markets wouldn’t open for a week, and I was going to drive home…but I used really bad language.

I left the room and now the hotel lobby was pandemonium, total pandemonium, hotel people rushing around, phones ringing, people talking. A young woman was on her cell phone trying to locate a friend who worked in the towers. I regretted checking out before the car arrived, because there was a line at the concierge desk of people trying to get cars, and the phones at the front desk were now going crazy—people stuck in town by the flight cancellations were looking for rooms.

Waiting for the car, I talked to my wife, our older daughter, friends, while young men and women from the conference huddled together, discussing whether to cancel the day’s events. I couldn’t believe they even thought what they decided would matter: everything was over.

Then the car came—but I remembered Bella.

Bella was my pal who worked in the gift shop. I went in to say goodbye to her: I was driving home. She said, “Do you have water?” I said no. “You need some water,” she said, and went into the back room to get me a bottle of water. It seemed important that day to help others: it was somehow up to her to give me something for the trip. She returned with a bottle and pushed it in my hands, and I gave her a hug and left, got in the car, drove down California Street, turned right and got on Route 80 East and went home.

I drove all day, from darkness to darkness, for three days and never watched TV and never saw anyone I knew. What I heard about 9/11 came from listening to a.m. radio and hearing Rudy Giuliani’s voice, and from calling friends during the day. I bought local newspapers at every stop along the way. There were American flags across every overpass. People were polite, kind, eager to make contact. The drive was easy: nobody tried to cut you off, nobody honked.

On Friday I pulled off Route 80 somewhere in New Jersey, and went to a church for the noon service that was being held everywhere at that time. And that’s when I really saw what it meant: the church was packed, and when the priest called for names to pray for, the names went on and on and on. A woman in front of me who reminded my of my mother-in-law called out, in an anxious, quavering voice, two names, “Ken and Dan.”

A couple hours later I pulled into my office and then stopped by the Greek diner next door to see how everyone there was doing. A friend was standing at the cash register, waiting to pay. Just by the expression on his face he was devastated. I said, “Ed, who did you lose?” He said, “Jeff, we lost our whole New York office.”

When I think of that week, I think of Bella pushing the bottle of water into my hands, of the young woman trying to track down her friend by cell phone from a hotel lobby in San Francisco, of Ed’s face, and of “Ken and Dan.”
God bless them all.

JM
9/11/11

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Major Major Major Major: A Book Love Story

Post author By jeff matthews
Post date September 5, 2011
7 Comments on Major Major Major Major: A Book Love Story

The laziest column being written in the Mainstream Press these days has to be the “Even Though I Own a Kindle/iPad/Nook I Still Like Print Books Better” lament.

Generally written by an aging Baby Boomer, the columns always start with a nod to the convenience of eBooks and the wonder of having thousands of different eBooks at hand with the tap of a button at all times (“I’m with it, I’m hip,” you can hear Dr. Evil insisting).

Having established “street cred” the columnist then moves on to lament the loss of the tactile nature of a paper book being held in one’s hands; the inability to dog-ear pages and underline sacred passages; and, most of all, to reclaim the time and “space” (a revoltingly overused word in these things) the reader occupied when he or she first discovered a particular book, because digital books don’t possess the nostalgic combination of visual and olfactory clues that paper books provide.

“It was ’63 and I was reading On The Road…” is how the last sentence usually begins.

Teeth-grinding and unpersuasive they may be, but these columns are so prevalent that a conspiracy theorist might suspect a concerted rear-guard effort by the doomed printing industry to create a counter-trend among us Baby Boomers’ children and grand-children such that old-fashioned books appear cooler/hipper/trendier/more worthwhile than the electronic kind.

And while I do read the print version of the Wall Street Journal cover-to-cover for the serendipity of finding interesting stories that can be overlooked on the Journal’s iPad app, and have, in fact, published an actual old-fashioned print book, the “Why I Still Love Print Books” stuff strikes me as more like the grumpy manifestation of a certain demographic seeing their lives flash before their eyes than anything else.

After all, the digitization of words is, to our times, what Gutenberg’s printing press was in his times: a radical reduction in the cost of shared knowledge.

That’s because the printed book business has to be—and this is from experience, not casual observation—the least efficient form of production ever created outside Soviet Russia.

Here’s how print book publishing works in the real world:

1. A book publisher bets on a bunch of books in the form of advances to various authors whose book proposals have passed muster: the bigger the advance, the more confident the publisher is in the ultimate payoff—the distorting effects of which will be felt at the time of publication, for reasons that will be made clear later on here;

2. The authors set about writing their books, with the help of editors, meeting or missing various deadlines along the way;

3. Meantime, the book covers must be printed because the publisher has to line up production slots ahead of time, so even though the books are not finished, and in some cases are not even mostly written, blurbs praising the books must be obtained (think about that next time you read a blurb on a brand new book);

4. All during this phase, the publisher’s sales force is running around trying to interest various book sellers in its books based mainly on the authors’ reputations and short summaries of what the books will say, none of which matters anyway because none of the book sellers can take risks on a book whose author they never heard of;

5. The books continue to take shape through a series of edits and corrections, none of which will prevent mistakes or typos from getting into the final printed copies because of the back-and-forth nature of the work;

6. The book is finished, but a year or more has gone by, and publishers discover that the world has changed: stuff has happened, national moods have changed…and while you would think publishers would adjust marketing plans based on which books now seem more timely than they did a year ago, the fact is publishers hate to do that because they are mainly interested in recouping the advances they already paid to the authors (the larger the advance, the more marketing the book will get, no matter what); thus the books will be published and marketed based mainly on the basis of how much of a sunk cost each book represents;

7. The books are printed, the covers are added, and the finished product is boxed and shipped to stores based on orders that have no bearing on the likely demand for the books given the swings in national moods, current events etc.;

8. Oh, and the books, which have been printed after a maddening series of corrections and edits, nearly always have typos and errors in the final copy anyway.

That’s just the way it works. It’s amazing great books by then-unknown authors (classics like Catch-22 and A Confederacy of Dunces, to name just two that almost never saw the light of day) ever make it into the hands of a single reader.

Now, this is not a criticism of the individuals involved in the book publishing industry. For one thing, they universally love language, and they know good writing when they see it.

And they really, really love books—printed books. They care about what the cover looks like, how the text appears on the page, and what the final product feels like in their hands.

But their business model is the functional equivalent of going down to the track and placing bets on a bunch of horses that won’t race for a year, in track conditions that nobody can imagine yet. (In fact, it’s more like placing bets on horses that haven’t even been born, because most advances are paid before the books have actually been written.)

So along comes the eBook model, which not only democratizes the demand for books by making them available to anybody with an Internet connection, but also democratizes the supply by lowering the cost of production and speed to market.

In fact, an eBook (a good one, on a meaningful topic—not one of those “Death of a Legend” hurry-up books that get churned out after some Hollywood star gets killed by a drug overdose) can be conceived, written, edited and published—mistake free, because it costs nothing to correct the text—in one tenth of the time, start to finish, of an equivalent print book, merely by reducing the friction of the printed book process.

So, yes, I’ve kept the old blue paperback English Lit 101 copy of Catch-22, which I re-read every few years just to get to the Major Major Major Major bit (“I have named the boy ‘Caleb,’ in accordance with your wishes…”) not to mention a cool, thin, beautiful Great Gatsby and a fat, funny Confederacy of Dunces, plus my first Thurbers and all those Dave Barry collections.

But I have ‘em all on the iPad, too, just in case I want to read one of them, wherever I happen to be.
I love books, period.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com