Dear Mr. Buffet: what an investor learns 1,269 miles from Wall Street.
by Janet M.Tavakoli.
Preface.
In 2003, I moved from London to Chicago, my original hometown, and founded a finance consulting firm,Tavakoli Structured Finance, Inc. Sophisticated financial inst.i.tutions call me when they have trouble understanding complex financial products, and in recent years, the products have exploded in size and complexity. They also call me when they fight with each other over these products. As a result, my firm is a lightning rod for the myriad problems facing the credit markets. My client list is short and elite, and in one way or another, most of my business comes from my former employers.
I created a niche business at the right time. Structured finance birthed a plethora of new products with acronyms such as ABS, MBS, CDO, and CMO, among other alphabet combinations. Reporters and television networks frequently ask me to make sense of market madness. I"ve made repeat television appearances-CNN, CNBC, BNN (Canada"s Business News Network), CBS Evening News, Bloomberg TV, CBS Evening News, Bloomberg TV, and and First Business Morning News First Business Morning News-on where I"ve frequently predicted problems long before the market or even the Federal Reserve acknowledged them. I"ve been quoted in major financial publications including the Wall Street Journal, Wall Street Journal, the the Financial Times, BusinessWeek, Forbes, Fortune Financial Times, BusinessWeek, Forbes, Fortune and and Investors Dealers" Digest Investors Dealers" Digest (among others) in which I was often the first to publicly and specifically challenge major financial inst.i.tutions, the Federal Reserve Bank, and the major rating agencies: Moody"s Corporation (Moody"s); Standard & Poor"s (S&P), part of the McGraw-Hill Companies, Inc.; and Fitch, owned by France-based Fimalac SA. (among others) in which I was often the first to publicly and specifically challenge major financial inst.i.tutions, the Federal Reserve Bank, and the major rating agencies: Moody"s Corporation (Moody"s); Standard & Poor"s (S&P), part of the McGraw-Hill Companies, Inc.; and Fitch, owned by France-based Fimalac SA.
Beginning in 1985, I worked for various Wall Street firms in New York and London. These included Salomon Brothers (now part of Citigroup), Bank One and Bear Stearns (both now part of JPMorgan Chase), Goldman Sachs, Merrill Lynch, and others. I chiefly worked on trading floors, and most of my colleagues were men. My career travels took me to New York, j.a.pan, continental Europe, and England. I traded, structured and sold complex financial instruments. Although I often held management jobs, I was chiefly a hired gun; I took the jobs others considered too new or too difficult.
I wrote finance books well known to users of esoteric financial products with tongue-twisting names such as credit derivatives credit derivatives and and collateralized debt obligations. collateralized debt obligations. Ten years ago, these products were limited to a small group, but now these products pose hot-b.u.t.ton issues for investors ranging from very sophisticated banks to near-retail clients including local governments, small pension funds, and condominium a.s.sociations. I wrote articles for major financial publications explaining problems in structured finance and warned that it would not end well. I predicted the mortgage meltdown, the global credit bubble, and the collapse of investments backed by unwise mortgage loans. I warned about the risks of hedge funds using leverage including Long-Term Capital Management (LTCM).While the rest of the financial community tripped over themselves to extend LTCM credit (and later regretted it), I recommended cutting their credit. Along the way, I acquired fans and a few groupies. At a Washington D.C. conference, a woman approached me in the ladies room to ask me to sign a blank sheet of paper, just to have my autograph. At a New York conference, an attendee from the Netherlands asked me to sign an extra book he had packed for his absent colleague, a fan who could not make the trip to New York. As I was finalizing paperwork at my doctor"s office in Chicago, a man standing at the counter said: "Tavakoli? Are you the lady who wrote the credit derivatives book?" Ten years ago, these products were limited to a small group, but now these products pose hot-b.u.t.ton issues for investors ranging from very sophisticated banks to near-retail clients including local governments, small pension funds, and condominium a.s.sociations. I wrote articles for major financial publications explaining problems in structured finance and warned that it would not end well. I predicted the mortgage meltdown, the global credit bubble, and the collapse of investments backed by unwise mortgage loans. I warned about the risks of hedge funds using leverage including Long-Term Capital Management (LTCM).While the rest of the financial community tripped over themselves to extend LTCM credit (and later regretted it), I recommended cutting their credit. Along the way, I acquired fans and a few groupies. At a Washington D.C. conference, a woman approached me in the ladies room to ask me to sign a blank sheet of paper, just to have my autograph. At a New York conference, an attendee from the Netherlands asked me to sign an extra book he had packed for his absent colleague, a fan who could not make the trip to New York. As I was finalizing paperwork at my doctor"s office in Chicago, a man standing at the counter said: "Tavakoli? Are you the lady who wrote the credit derivatives book?"
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I stumbled upon a career in finance. My parents met near the end of World War II, during which my mother"s brother was killed after parachuting into Normandy. My Wisconsin-born father was chief of surgical services tending wounded soldiers in the Central Europe and Rhineland campaigns. My mother, who hailed from Buffalo, nursed burn victims in England. They met through mutual friends and returned to Chicago to raise a large family. My father had worked his way through medical school at Jesuit-run Loyola University during the first half of the last century, when well-educated adults were expected to be well-read polymaths. He died when I was 12, and during the summers of my teenage years, I read his collection of books, including texts about medicine, mathematics, Greek philosophy, history, and poetry. My father had read the Wall Street Journal Wall Street Journal every day, but after he died, my mother had not kept up the subscription. I was interested in finance, but I did not yet know much about it. every day, but after he died, my mother had not kept up the subscription. I was interested in finance, but I did not yet know much about it.
I graduated with a B.S. in chemical engineering from the Illinois Inst.i.tute of Technology, and got married five days after graduation. I worked as a chemical engineer, and a couple of years later (in 1978), I moved to Iran with my Iranian (and now ex-) husband. Our timing couldn"t have been worse. Six months after we arrived, Iranians deposed the Shah, and the Ayatollah Khomeini returned to lead an anti-American, repressive theocratic government. I returned to the United States carrying one suitcase of clothing and $1,000. My husband remained in Iran with his wealthy family. He returned to the United States a few years later to start a business with his father"s help, but by then, he was my ex-husband. I had lost my possessions and savings, but my true wealth is portable and remained on my shoulders. I worked as an engineer by day and received an MBA from the University of Chicago"s Graduate School of Business night program, where I later taught derivatives part time.
Just because one is an expert in complicated financial products like derivatives, it does not mean one is good at value investing. (But it doesn"t mean one is bad at it, either.) Although I had read a lot on the subject of value investing, I had not really absorbed it, and I had not diligently practiced it when making investments for my personal portfolio. Then I took a trip to a city 1,269 miles from Wall Street, and my perspective changed.
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Harry Truman once said: "The only thing new is the history you don"t know." I thought I knew a lot, until I met Warren Buffett. In June 2005, I received a letter from Warren Buffett inviting me to visit him in Omaha. A few years earlier, I had sent him a copy of a book I wrote on credit derivatives with a letter stuffed between the pages. It was a pleasure to receive his invitation; but I delayed in responding to him, even after learning that lunch with Warren Buffett went for $202,000 in 2004 and $351,000 in 2005 in charity auctions on eBay (the winning bid in 2008 was $2.11 million, and the proceeds benefit the Glide Foundation, a charity dedicated to helping the poor and homeless get back on their feet1). I am glad I didn"t delay our meeting longer because when I finally met Warren Buffett, I came to realize that I still have a lot to learn. Truman is right that we can learn a lot from history (Buffett"s annual letters to Berkshire Hathaway"s shareholders), but Warren Buffett also taught me that I can learn new things about evaluating the present to improve the odds that the future will be better.
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This book is about my meeting with Warren Buffett on the eve of the greatest market meltdown in history and how meeting him subtly changed the way I look at the global financial markets. I already knew the principles, but meeting Warren encouraged me to think about all financial products in a Benjamin Graham-style framework.
I also changed the way I invest. I have no illusions that I am in the same league with Warren Buffett, but I improved after I met him. Buffett"s successful track record spans a half century, so you"ll have to check back with me in fifty years to see how well I performed to use him as a benchmark. But you will have to do the measuring. I don"t measure myself against benchmarks any more than Buffett does. Instead, I focus on value.
Benjamin Graham was Warren Buffett"s mentor. Over time, Buffett applied and interpreted Graham"s framework to his own unique investment style.This book is not about Graham"s ideas or Buffett"s ideas, it is about my reinterpretation of my own ideas about the financial markets as I looked through the lens of the value framework of Benjamin Graham and Warren Buffett.
My ideas and conclusions are my own and may differ somewhat from Warren Buffett"s. No two people think exactly alike; that is what makes a market. that is what makes a market. But in areas where we may disagree, I should also point out that Warren Buffett has more experience and a much better track record, and I am still learning. Like him, I consider myself a life-long learner. But unlike Buffett, I have so much more to learn. But in areas where we may disagree, I should also point out that Warren Buffett has more experience and a much better track record, and I am still learning. Like him, I consider myself a life-long learner. But unlike Buffett, I have so much more to learn.
Monetary wealth is just one measure of value, however. Steven F. Haward, in writing about Winston Churchill, noted the characteristics that set him apart from other men: "candor and plain speaking, decisiveness, the ability to balance attention to details with a view of the wider scene, and a historical imagination that informed his judgment." 2 2 I could say the same for Warren Buffett. But I have to add that he has a genuine affection for the human race, and a generous desire for everyone to get as much from life as he does. He shared that with me, and now I am sharing it with you. I could say the same for Warren Buffett. But I have to add that he has a genuine affection for the human race, and a generous desire for everyone to get as much from life as he does. He shared that with me, and now I am sharing it with you.
In the interest of full disclosure, I own Berkshire Hathaway stock (BRKA).
Acknowledgments.
I would like to thank the many people who offered comments, encouragement, and suggestions, especially Arturo Cifuentes, Ph.D., managing director, R.W. Pressprich & Co.; David Kuenzi, head of Risk Management and Quant.i.tative Research at Man Glenwood; Lee Argush, cofounder and executive managing director of Concord Wealth Management; Jim Rogers of Rogers Holdings; Hilary Till, cofounder, Premia Capital Management, LLC; Carl Schuman; Costas Kaplanis; Kenneth Brian Brummel, who made tactful comments on an early draft; Greg Newton, founding publisher, MAR/Hedge; Michael Siconolfi, senior editor at the would like to thank the many people who offered comments, encouragement, and suggestions, especially Arturo Cifuentes, Ph.D., managing director, R.W. Pressprich & Co.; David Kuenzi, head of Risk Management and Quant.i.tative Research at Man Glenwood; Lee Argush, cofounder and executive managing director of Concord Wealth Management; Jim Rogers of Rogers Holdings; Hilary Till, cofounder, Premia Capital Management, LLC; Carl Schuman; Costas Kaplanis; Kenneth Brian Brummel, who made tactful comments on an early draft; Greg Newton, founding publisher, MAR/Hedge; Michael Siconolfi, senior editor at the Wall Street Journal Wall Street Journal; Eric Gleacher, founder and chairman of Gleacher Partners; Stephen Partridge-Hicks, cofounder of Gordian Knot; Suzette Haden Elgin, Ph.D. (for decades-old encouragement-you may have forgotten, but I have not); and Edward Stone, Nancie Poulos, Fred Watson, Julian Tyacke (for the question), Andrew Tobias, Osamu Yamada, J.Allen Meyer, Mary Anna Evans,Allen Salter, Rita Ilse Guhrauer, Teresa Brinati, and Libby h.e.l.lmann. I would also like to thank the many people who did not wish to be named but who acted as mutual sounding boards.
My ma.n.u.script benefited from constructive comments from the editors of John Wiley & Sons, namely Pamela van Giessen, who took a special interest in this project and gave developmental suggestions; Emilie Herman, who removed many speed b.u.mps; Kate Wood, who facilitated; Todd Tedesco, senior production editor; and James Reidel, who copyedited.
Finally, I would like to thank Warren Buffett, chairman of Berkshire Hathaway, who told me to "keep writing."
No opinions or theories presented in this book necessarily represent those of the people I have thanked. I am responsible for any errors, statements, interpretations, or conclusions.
Chapter 1.
An Unanswered Invitation Be sure to stop by if you are ever in Omaha and want to talk credit derivatives . . .
-Warren Buffett in a letter to Janet Tavakoli, June 6, 2005
It was August 1, 2005, and I was rereading a letter in my correspondence file dated June 6, 2005.The letter was from Warren Buffett, the CEO of the gargantuan Berkshire Hathaway conglomerate. I had not yet responded and had no explanation for the delay save for a little awe. For the several years prior, Fortune Fortune listed Warren Buffett as either the richest or second richest man on the planet. He and Bill Gates annually jousted for the top spot, with the outcome depending on the relative share prices of Berkshire Hathaway and Microsoft. listed Warren Buffett as either the richest or second richest man on the planet. He and Bill Gates annually jousted for the top spot, with the outcome depending on the relative share prices of Berkshire Hathaway and Microsoft.
Several years earlier, I had sent Warren Buffett a copy of my book, Credit Derivatives & Synthetic Structures Credit Derivatives & Synthetic Structures. In his letter Buffett wrote that he had been looking at the book again and had just found a letter I had tucked between the pages, "Please accept my apologies," he continued, "for not replying to you when I first received it."1 He invited me to stop by if I were ever in Omaha. I looked up. After all this time, I could not remember what I had written in that old letter. I did know that I had not expected a response. But certainly now a response was needed from me, a belated one."Dear Mr. Buffett," I began. He invited me to stop by if I were ever in Omaha. I looked up. After all this time, I could not remember what I had written in that old letter. I did know that I had not expected a response. But certainly now a response was needed from me, a belated one."Dear Mr. Buffett," I began.
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I am an investor in Berkshire Hathaway "A" shares, but Mr. Buffett would have no way of knowing that since I hold shares in brokerage accounts. Perhaps Mr. Buffett had a bone to pick with me, but I had warned about the risk of credit derivatives and the hidden leverage they created. I was so persistent in exposing the flaws in the financial system that BusinessWeek BusinessWeek called me the "Ca.s.sandra of credit derivatives." called me the "Ca.s.sandra of credit derivatives."2 But most journalists overlooked a much more important derivatives quote in Mr. Buffett"s 2002 shareholder letter. Berkshire Hathaway invests in multinational businesses with a variety of complex operations, and that means that investments have to be hedged or entered into in ways that create tax or accounting advantages. Mr. Buffett had also written:"I sometimes engage in large-scale derivatives transactions." But most journalists overlooked a much more important derivatives quote in Mr. Buffett"s 2002 shareholder letter. Berkshire Hathaway invests in multinational businesses with a variety of complex operations, and that means that investments have to be hedged or entered into in ways that create tax or accounting advantages. Mr. Buffett had also written:"I sometimes engage in large-scale derivatives transactions."3 Yet I dithered and had not responded to his letter. Yet I dithered and had not responded to his letter.
In 1998, Berkshire Hathaway acquired General Reinsurance. Warren Buffett initially called it his "problem child,"4 and its General Reinsurance (Gen Re) Securities unit was its problem sibling. Even before the acquisition, both Warren Buffett and Berkshire Hathaway vice-chairman Charlie Munger realized that the value of Gen Re Securities derivatives transactions was overstated and vainly tried to sell it. Some of the contracts were for 20-year maturities, and the operation would take years to wind down. Furthermore, the models valuing the derivatives give poor approximations of the true and its General Reinsurance (Gen Re) Securities unit was its problem sibling. Even before the acquisition, both Warren Buffett and Berkshire Hathaway vice-chairman Charlie Munger realized that the value of Gen Re Securities derivatives transactions was overstated and vainly tried to sell it. Some of the contracts were for 20-year maturities, and the operation would take years to wind down. Furthermore, the models valuing the derivatives give poor approximations of the true mark-to-market mark-to-market value-the price at which the derivative can be bought and sold in the market-of some of Gen Re Securities" esoteric derivatives contracts. There was no real market. Instead, the derivatives contracts were priced or value-the price at which the derivative can be bought and sold in the market-of some of Gen Re Securities" esoteric derivatives contracts. There was no real market. Instead, the derivatives contracts were priced or marked marked based on model valuations known as based on model valuations known as mark to model. mark to model. Buffett wrote that in extreme cases, it was a "mark to myth." Buffett wrote that in extreme cases, it was a "mark to myth."5 In his 2002 letter to Berkshire Hathaway shareholders, Buffett wrote that it sometimes seemed "madmen"6 imagined new derivatives contracts. His pique was prompted by the multiyear-long hangover of losses from derivatives, chiefly credit derivatives, in the GenRe Securities unit. It showed a loss of $173 million, partly due to restating faulty, but standard, derivatives accounting from earlier years. The loss inspired Buffett to call derivatives "financial weapons of ma.s.s destruction." imagined new derivatives contracts. His pique was prompted by the multiyear-long hangover of losses from derivatives, chiefly credit derivatives, in the GenRe Securities unit. It showed a loss of $173 million, partly due to restating faulty, but standard, derivatives accounting from earlier years. The loss inspired Buffett to call derivatives "financial weapons of ma.s.s destruction."7 His viral sound bite quickly circled the globe. After reading Buffett"s quote in the financial press, one investment banker joked that my book on credit derivatives is "the manual on how to blow up the world." His viral sound bite quickly circled the globe. After reading Buffett"s quote in the financial press, one investment banker joked that my book on credit derivatives is "the manual on how to blow up the world."
Warren Buffett"s letter to me arrived in June 2005, a hectic month. One of my clients was a law firm representing a large money center bank as plaintiff in a securities fraud case involving another large money center bank. The defendants" lawyers had hired a former chairman of the U.S. Securities and Exchange Commission (SEC) as their expert witness. Earlier, I had written both my expert opinion report and a report reb.u.t.ting the former SEC chairman"s point of view. I prepared to give a two-day-long deposition to discuss my opinion in the case in which hundreds of millions of dollars had been lost.The defendants had read my work, knew they faced serious trouble, and subsequently changed their strategy. In fact, they sent their most experienced litigator to depose me.
I put Buffett"s letter in my purse to remind myself to respond to it. The morning of the deposition"s first day, I saw the letter and felt a glow of confidence. I am not a superst.i.tious person, but I couldn"t help thinking of the letter as an auspicious sign. I put it in my pending correspondence file and forgot about it again.
The deposition came and went, and the plaintiff "s lawyers were delighted."Everyone gets b.l.o.o.d.y in a battle, but you slaughtered them." The defendants" arguments fell apart in the face of the facts, and the case never went to trial. Shortly thereafter, the defendants came to a settlement agreement to the plaintiff"s satisfaction.
At the end of June, I reviewed my correspondence file and read the letter again. Client business would not take me to Omaha, and I was fairly certain Warren Buffett did not need my help.
July 2005 was another busy month: I had focused so much on the securities fraud case that I had a backlog of business, so I took a much-needed week-long vacation to decompress. At the end of July, I reviewed my pending correspondence file, and it contained only one item: the letter.
After rereading the letter on August 1, I wrote a letter in reply and offered three dates, with August 25, five days before Warren Buffett"s 75th birthday, being the earliest of the three:
It is my turn to apologize for being so late getting back to you. . . . . Business isn"t taking me in that direction anytime soon, but I would be happy to fly in for the day-just because I would enjoy doing it . . .
On August 3, I received an e-mail from Warren Buffett through his a.s.sistant stating that August 25 would work:
If you can make it for lunch, I would be glad to take you to a place with no decor but good food.
Everyone in the global financial community knew Warren Buffett by reputation, and his name continually popped up in the financial press, but I operated in specialty niches of the industry, and he was just part of the background noise of my world. I hadn"t read any of the books about him, and I hadn"t read the many articles about Warren Buffett, the man. But I had read many of Berkshire Hathaway"s annual reports including Mr. Buffett"s shareholder letters, which I enjoyed very much.
Warren Buffett was already a billionaire at age 60.That in itself was an achievement beyond the reach of all but a miniscule percentage of humans, but his future success dwarfed that accomplishment. Due to the benefits of continued compounded growth off of a greater base of wealth, the bulk of Buffett"s wealth acc.u.mulated after the age when most men retire to spend their money.
Throughout my career, I worked with people who eventually met or did business with Warren Buffett. It was as if we attended the same university and he were a popular senior and I a freshman. I was well respected in my field, and was a self-made woman; but Warren Buffett was a financial legend superlatively superlatively good at making money for himself and for his shareholders. good at making money for himself and for his shareholders.
In 1987,Warren Buffett and Charlie Munger rode to the rescue of John Gutfreund, the CEO of Salomon Brothers. Their "white knight" investment of $700 million of Salomon Inc."s convertible preferred stock enabled Gutfreund to fend off Ronald Perelman"s hostile takeover. Perelman, a famous, colorful cigar-loving corporate raider with a reputation for ruthlessness, had already swallowed up Revlon, Sunbeam, Panasonic and other companies in the 1980s. In contrast, Buffett and Munger were not well known, and their lifestyles didn"t provide salacious material for the media frenzy that surrounded corporate raiders.
Initially, Salomon"s preferred stock was an ideal Berkshire Hathaway investment. Buffett never supplied management; he looked for good honest managers, and he thought he had found one in Gutfreund. Things changed in 1991. Paul Mozer, a trader on the Arbitrage Desk, pleaded guilty to felony charges after a government bond trading scandal. John Meriwether, the head of Salomon"s Arbitrage trading desk, told Gutfreund that Mozer had confessed to him. Their failure to immediately come forward compounded the scandal, and neither of them survived the fallout. Buffett was compelled to protect Berkshire Hathaway"s investment. In the summer of 1991, he became Salomon"s reluctant CEO for 10 months. Mr. Buffett"s leadership and reputation for integrity salvaged Salomon"s business, which rapidly recovered. The convertible bonds outperformed the fixed income securities that Berkshire Hathaway had sold in their place, but by 1995, the option to convert to common shares of Salomon stock was worthless. In 1997, Buffett off loaded the investment on Sandy Weil, and Salomon eventually became a part of Citigroup.
I had joined Salomon Brothers" summer 1985 training cla.s.s lampooned by my cla.s.smate Michael Lewis in his book, Liar"s Poker. Liar"s Poker. Unlike Lewis, I was one of the trainees actually paying attention at the front of the cla.s.s, but by the time Mr. Buffett served his brief time as CEO, I was no longer working at Salomon Brothers. Unlike Lewis, I was one of the trainees actually paying attention at the front of the cla.s.s, but by the time Mr. Buffett served his brief time as CEO, I was no longer working at Salomon Brothers.
After almost 20 years working for Wall Street firms in New York and London, I made my living running a Chicago-based consulting business. My clients consider my expertise the product they consume. I had written books on credit derivatives and complex structured finance products, and financial inst.i.tutions, hedge funds, and sophisticated investors came to me to identify and solve potential problems.
Although I was an experienced finance professional, I did not focus on value investing.The University of Chicago was steeped in the myth of efficient markets and leaned to theories put forth by eminent economists.Warren Buffett had earned his MBA at Columbia Business School. He became a friend and disciple of Benjamin Graham, and later worked for Graham"s hedge fund. I had read Security a.n.a.lysis Security a.n.a.lysis by Graham and David Dodd in 1985, but I had not actively practiced its principles for my own investment portfolio. Around the same time, I read John Burr Williams" by Graham and David Dodd in 1985, but I had not actively practiced its principles for my own investment portfolio. Around the same time, I read John Burr Williams" The Theory of Investment Value, The Theory of Investment Value, and the fourth edition of and the fourth edition of The Intelligent Investor. The Intelligent Investor. My edition includes an introduction by Warren Buffett with a tribute to the late Benjamin Graham as well as Warren Buffett"s 1984 commencement address at Columbia University t.i.tled "The Superinvestors of Graham-and-Doddsville." I remembered both the tribute and the address and reread them in preparation for meeting Mr. Buffett. My focus was chiefly on derivatives and complex securities. While I applied many of the principles of value investing to my a.n.a.lysis of complicated financial products, I did not yet focus on it for my own investments or as a way of looking at the global markets as a whole. My edition includes an introduction by Warren Buffett with a tribute to the late Benjamin Graham as well as Warren Buffett"s 1984 commencement address at Columbia University t.i.tled "The Superinvestors of Graham-and-Doddsville." I remembered both the tribute and the address and reread them in preparation for meeting Mr. Buffett. My focus was chiefly on derivatives and complex securities. While I applied many of the principles of value investing to my a.n.a.lysis of complicated financial products, I did not yet focus on it for my own investments or as a way of looking at the global markets as a whole.
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Derivatives are financial bets that something will or will not happen. Any financial investment involves a bet, but derivatives are leveraged bets. leveraged bets. For very little money down-sometimes no money down-you can make gobs of money (or lose gobs of money). The part about losing gobs of money is something most investors try hard not to think about. Sometimes investment banks selling the products help investors achieve this goal by putting the part about gobs of losses in very fine print buried in hundreds of pages of doc.u.ments. For very little money down-sometimes no money down-you can make gobs of money (or lose gobs of money). The part about losing gobs of money is something most investors try hard not to think about. Sometimes investment banks selling the products help investors achieve this goal by putting the part about gobs of losses in very fine print buried in hundreds of pages of doc.u.ments.
Leveraged bets are so popular that there is more money at risk in derivatives than in stocks or bonds. The problem with leverage-driven binge banking is that everyone tends to disgorge a.s.sets at the same time, depressing market prices. Financial leverage sometimes moves global markets, and if allowed to get out of hand, leverage can theoretically trigger a global market Chern.o.byl.
Warren Buffett disproved the theory of efficient markets that states that prices reflect all known information. His shareholder letters, readily available through Berkshire Hathaway"s Web site, told investors everything they needed to know about mortgage loan fraud, mispriced credit derivatives, and overpriced securitizations, yet this information hid in plain "site."
I knew the financial markets were at great risk-like children playing with matches in a parched forest-but those thoughts were far from my mind on that hot summer morning in 2005 as I boarded the plane for Omaha. I was about to meet a financial legend, the greatest investor who ever lived.
Chapter 2.
Lunch with Warren Thanks for sending along the . . . link, which I had not seen.The next guy will probably name his company Buffett, Bernanke and Tavakoli.
-Warren Buffett to Janet Tavakoli, August 27, 2007
The day was sunny and clear, and the flight from Chicago only takes a little over an hour. I wondered how a man with Warren Buffett"s enormous wealth would behave. The late Howard Hughes suffered from paranoid schizophrenia attributed to brain damage suffered during self-piloted plane crashes.According to popular legend, he once roared: "I am not a paranoid deranged millionaire. G.o.dammit . . . I"m a billionaire billionaire." A sense of humor is indispensable if one is insanely insanely rich. rich.
My flight got into Omaha two hours before my appointment. I wanted to be on time for lunch.When I told the cab driver the address, he looked confused. I a.s.sumed that every taxi driver in Omaha would know the location of Mr. Buffett"s office, but I was wrong. He asked another cab driver for directions, and we were on our way. It was a short ride.
The taxi dropped me off at an unremarkable buff-colored office building. I opened the door and entered what appeared to be a hallway instead of a lobby. A lone security guard sat at a small desk. He seemed to be expecting me, telling me to go right on up to the 14th floor. An elevator was already on the ground floor, and there was no one else in the lobby. I rode up alone.
The elevator doors opened to a vacant hallway. As I stepped off the elevator, I was startled to hear a friendly female voice say: "Janet, make a right and then another right, and go straight ahead." I quickly looked around. There was no one there, and I didn"t see a camera or a speaker. I did a quick mental review of my actions since entering the building and was relieved I hadn"t adjusted my skirt on the elevator. The voice repeated the instructions, and this time I followed them.
One of Warren Buffett"s a.s.sistants sat to the right of the small reception area. There was no one else there. I told her I had arrived early, but I planned to read Paul Erdman"s book Tug of War Tug of War about the global currency crisis in the mid-1990s. She offered me beverages, and I accepted a gla.s.s of water. I had barely taken a sip, when Warren Buffett appeared. He gave me a quick look and said energetically:"Oh, Janet"s here. Show her right in." about the global currency crisis in the mid-1990s. She offered me beverages, and I accepted a gla.s.s of water. I had barely taken a sip, when Warren Buffett appeared. He gave me a quick look and said energetically:"Oh, Janet"s here. Show her right in."
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Warren Buffett was taller and trimmer than I expected. He later told me he works out with a trainer three times per week. His famous eyebrows were trimmed-unlike an old Internet photo-and his skin glowed as if freshly scrubbed. He wore a light gray suit and looked as if he dressed for comfort and appropriateness rather than to impress.
He invited me to sit on a sofa while he took a neighboring chair. Plump beads of sweat rolled down my water gla.s.s, and I looked around his coffee table in consternation for a coaster or an ash tray. I didn"t want to be known as the person who left a blistering water ring on the smooth surface. Oh that? A calling card from Janet Tavakoli Oh that? A calling card from Janet Tavakoli. Noticing my hesitation, Warren retrieved the Wall Street Journal Wall Street Journal from his desk. He set it down, and said I could put my gla.s.s on his paper. I looked down at the paper knowing I was about to make a mess of it. It looked so smooth.Warren Buffett had worked as a paper boy for the from his desk. He set it down, and said I could put my gla.s.s on his paper. I looked down at the paper knowing I was about to make a mess of it. It looked so smooth.Warren Buffett had worked as a paper boy for the Buffalo News Buffalo News and identified the and identified the Washington Post Washington Post as one of the great bargains of the twentieth century for Berkshire Hathaway"s investors. Warren"s love of newspapers is well known, and for more than half a century he has been a loyal reader of the as one of the great bargains of the twentieth century for Berkshire Hathaway"s investors. Warren"s love of newspapers is well known, and for more than half a century he has been a loyal reader of the Wall Street Journal Wall Street Journal. My heart sank at the thought of making a mess of his paper. Had he finished reading it? Had he finished reading it? I looked up, and to my complete surprise, Warren Buffett appeared nervous. He wouldn"t feel comfortable until I accepted his offer of hospitality; he couldn"t relax until I relaxed. I rested my gla.s.s and sat down, smiling inwardly. I looked up, and to my complete surprise, Warren Buffett appeared nervous. He wouldn"t feel comfortable until I accepted his offer of hospitality; he couldn"t relax until I relaxed. I rested my gla.s.s and sat down, smiling inwardly.
Then I blundered. In an awkward attempt to lighten the moment, I said:"Some days that is all the Wall Street Journal Wall Street Journal is good for." is good for."
His head snapped around and he gave me a sharp look. A few seconds pa.s.sed."I agree," he finally said.
But I knew he didn"t mean his comment, and I hadn"t meant mine. What"s more, he knew I didn"t mean it, and I suspected he knew that I knew he didn"t mean his. Judith Martin, the Washington Post"s Washington Post"s etiquette columnist, maintains etiquette has been given a bad name by strangers using fake familiarity to make demands on our time, our privacy, and our resources. Genuine etiquette is a useful social tool designed to make others comfortable without sacrificing one"s own rights. Months later, Warren wrote me that he didn"t think he had "studied her advice sufficiently," but I thought he graduated etiquette columnist, maintains etiquette has been given a bad name by strangers using fake familiarity to make demands on our time, our privacy, and our resources. Genuine etiquette is a useful social tool designed to make others comfortable without sacrificing one"s own rights. Months later, Warren wrote me that he didn"t think he had "studied her advice sufficiently," but I thought he graduated summa c.u.m laude summa c.u.m laude.
The Wall Street Journal Wall Street Journal sparked a discussion of how the news media has changed. Stock price quotations are almost instantaneous. There is more financial news today than ever before originating from a wider variety of sources including the Internet. sparked a discussion of how the news media has changed. Stock price quotations are almost instantaneous. There is more financial news today than ever before originating from a wider variety of sources including the Internet.
Warren loves newspapers, recognizing that newspaper ownership confers status and influence out of proportion with economic gain, yet run properly there is also a lot of economic gain to be had. As he talked, Warren mentioned Kay. Kay? Kay? My mind raced. My mind raced. Who is Kay? Who is Kay? Fortunately, I quickly realized that Warren meant the late Katherine Graham, president and publisher of the Fortunately, I quickly realized that Warren meant the late Katherine Graham, president and publisher of the Washington Post Washington Post. Warren said she was "great lady," a "remarkable woman," and recommended I read Personal History Personal History, her Pulitzer Prize-winning autobiography.
With Kay"s sponsorship and his substantial ownership position, Warren became a board member of the iconic Washington Post Washington Post. He said she was the least confident person he had ever met, a curious fact given her privileged life, social standing, and accomplishments. In Personal History Personal History, Katherine Graham expresses admiration for Warren and expresses her grat.i.tude to him for the tutelage he gave her in financial matters. She relied on him for both professional and personal support, and his mentor-ship was a source of strength, giving her confidence. The otherwise all-male board was initially wary of their friendship and she noticed some s.e.xism: "Tom Murphy [another member of the Washington Post Washington Post"s Board of Directors] could consult Warren and no one questioned him, but if I consulted him, it seemed to be something threatening and sinister."1 Often, when men and women have a close business relationship, it is characterized as a Mephistophelean bargain, but when men form a close business relationship, it is just business. Ms. Graham also noticed: "As Warren and I started to spend more and more time together, people"s eyebrows shot up, and I was young enough then for our relationship to become quite an issue." Often, when men and women have a close business relationship, it is characterized as a Mephistophelean bargain, but when men form a close business relationship, it is just business. Ms. Graham also noticed: "As Warren and I started to spend more and more time together, people"s eyebrows shot up, and I was young enough then for our relationship to become quite an issue."2 Even a woman of Katherine Graham"s stature and maturity-she was 13 years older than Warren-could not escape petty innuendo; but she did not let it deter her from taking advantage of Warren"s expertise or spoil her appreciation of their friendship. Even a woman of Katherine Graham"s stature and maturity-she was 13 years older than Warren-could not escape petty innuendo; but she did not let it deter her from taking advantage of Warren"s expertise or spoil her appreciation of their friendship.
I could well imagine Warren"s companionable appeal to Katherine Graham, and Warren lights up when he reminisces about Ms. Graham. He seems to enjoy women without enjoying them too much. It is the difference between spending time with an art connoisseur and a cat burglar. One makes you feel as if you are a national treasure; the other makes you feel as if you are about to be s.n.a.t.c.hed and stuffed in a bag, never to be heard from again. For his part, Warren says he admired Kay"s courage and persistence.
Warren recognizes that the news business had changed. He said the Wall Street Journal Wall Street Journal threw away a golden opportunity to dominate Internet business news. Internet financial news is both instantaneous and less reliable. Newspaper and magazines-even the online versions of legacy print media-often lag behind blogs and certain specialty new services. There are a handful of Internet financial journalists who are every bit as good as the best reporters in the print media, but they are scattered all over the Internet. threw away a golden opportunity to dominate Internet business news. Internet financial news is both instantaneous and less reliable. Newspaper and magazines-even the online versions of legacy print media-often lag behind blogs and certain specialty new services. There are a handful of Internet financial journalists who are every bit as good as the best reporters in the print media, but they are scattered all over the Internet.
Matthew Currier Burden wrote a book about this phenomenon: The Blog of War The Blog of War. The military is having difficulty containing sensitive information as soldiers pour out their stories over the Internet.The day after our lunch, I sent Warren an article written by John Hockenberry, "In Iraq for 365," from Wired.com. Warren wrote back that he found the blogs on Iraq particularly interesting along with "the potential that it has for changing journalism."
The blogs of soldiers in Iraq are much more informative than any state-side news media, including television, radio, newspapers, magazines, and other Internet news sources. Warren is keenly interested in that.Traditional channels of information are being bypa.s.sed and pa.s.sed up by direct information from the front lines, something that had never happened before the Internet Age.The accounts from soldiers are more compelling and informed than the so-called "professional" reportage from mainstream media.
I mentioned that Comedy Central"s The Daily Show with Jon Stewart The Daily Show with Jon Stewart often has better news a.n.a.lysis than what tries to pa.s.s as news shows on other channels. Warren hadn"t watched the program, but asked if he should. I said Stewart"s interviews of leading world figures might be of interest, and later occasionally sent a link. Warren had not yet gotten around to getting a TiVO. Neither had I. often has better news a.n.a.lysis than what tries to pa.s.s as news shows on other channels. Warren hadn"t watched the program, but asked if he should. I said Stewart"s interviews of leading world figures might be of interest, and later occasionally sent a link. Warren had not yet gotten around to getting a TiVO. Neither had I.
Warren displays an open mind to all new ideas. Warren and I both love our newspapers, but we love news news more, wherever we find it. The challenge is to find more, wherever we find it. The challenge is to find reliable reliable news. I was about to discover that some of the information I had read about Warren Buffett was incorrect, and the coming years would reveal more inaccuracies. news. I was about to discover that some of the information I had read about Warren Buffett was incorrect, and the coming years would reveal more inaccuracies.
Dustin Hoffman once remarked on a story he read about how he and Tom Cruise were holding up shooting because they were a couple of prima donnas. The story was fabricated: "but if I wasn"t making a movie with him and I just picked up the paper, I"d believe it. That"s interesting, isn"t it?"3 There is a reason we call it the "Information Age," not the "Age of Wisdom." There is a reason we call it the "Information Age," not the "Age of Wisdom."
Financial research often ends where the Internet begins. Articles are frequently incorrect, urban legend is sometimes presented as fact, and trivial errors sometimes become viral financial lore. Benjamin Graham, Warren Buffett"s Columbia School professor and mentor, founded a hedge fund in the 1920s. Warren says that Graham"s hedge fund was the earliest as far as he knows, though there may have been another before it. Yet, most media report that the first hedge fund founded in the United States was done so in 1949 by A. W. Jones.4 Financial journalists rarely mention Benjamin Graham"s fund. Apparently there are no Google references to the 1920s. Financial journalists rarely mention Benjamin Graham"s fund. Apparently there are no Google references to the 1920s.
On a televised talk show, Ben Bradlee, vice president and managing editor of the Washington Post Washington Post, held that he didn"t think newspapers would ever be supplanted by the Internet. Some Internet sources are excellent, but it is still unclear if they can make enough revenue to continue putting out quality information, and new compet.i.tors keep popping up on the Web. He is probably correct that there will always be a demand for newspapers; but newspaper revenues are already being partially supplanted as they lose chunks of lucrative cla.s.sified ad revenues to the Internet.
Unlike Bradlee, Warren does not let nostalgia get in the way of a good business strategy. On November 21, 2005, Cathy Baron Tamraz, the founder of Business Wire, a San Francis...o...b..sed distributor of online press releases, sent Warren a letter in which she told him, "We run a tight ship and keep spending under wraps . . ." She describes a business with no secretaries or management layers, and they invest most of what they have to stay abreast of technology. By the time he finished reading the letter,Warren had decided to acquire a business perfect for his investment style: it has dedicated management, eliminates unnecessary overhead, produces a product people need and has huge potential for revenue growth. By March 2006, Warren had closed the deal, making Business Wire, an Internet phenomenon, a wholly owned subsidiary of Berkshire Hathaway.