Outside the Herd

Buffett says “Economic Pearl Harbor”

8 Responses to “Buffett says “Economic Pearl Harbor””

1. 
   FN
   10, 5, 2008 at 9:40 pm

   Nice Post! I saw that interview and thought it was great. It’s interesting in the same way that Fareed Zakaria’s interview with Bill Gates was interesting. Couple of thoughts/questions:

   (1) According to the Federal Reserve total value of real estate held by US households is about $22 trillion. I would think that absorbing a $4 trillion loss would be painful, but not fatal. That’s like 2000 level values. How is that a disaster?

   (2) Some folks point out that the loss is closer to $6 trillion when you factor in the falling value of the dollar. I’m not sure that matters so long as inflation is low. If inflation takes off, then watch out.

   (3) 60 Minutes had an interesting piece today talking about credit default swaps. These are derivative products that are basically insurance against default on mortgage products (they can’t call them “insurance” because that would trigger government regulation). What I didn’t realize is that this CDS market is estimated to be “$50-60 trillion” according to 60 Minutes. Further they go on to say that 94% of mortgage holders continue to pay as agreed but that the CDS market was primarily insuring the 6% who are now in default. So my question is: how can you write $50 trillion in insurance on $1 trillion in sub-prime mortgages?

   (4) I find it interesting that the richest people in the world (Buffett, Gates) are pro Obama. Watch the Gates interview and he points out that he should pay a huge estate tax (if he doesn’t give it away) because he benefited from the public infrastructure (schools, roads, legal system, etc.).

   (5) I’ve been reading and thinking about this “mark to market” controversy and have concluded that it’s absurd to relax this rule. If low valuations cause companies to de-lever, so be it. Transparency is our friend. I’ve never heard of too much transparency in markets causing problems. Think about it. Would we be better off if Paulson, Bush, Frank, Dodd, et al told us 6 or 12 months ago (when they saw the data) that things were off kilter?

   Good stuff.

   FN

   Reply
2. 
   FN
   10, 5, 2008 at 9:47 pm

   One more thing, remember Buffett has a lot of horses in this race. He benefits by a bail out as he has a bunch of insurance companies and other firms (not to mention $5 billion in Goldman Sachs) that deliver billions (literally) to his bottom line.

   I don’t think he really cares personally (heck he’s giving away his own money) but somehow he can’t help himself from making money from his investors.

   Reply
3. 
   Edward
   10, 7, 2008 at 11:27 am

   On the $50 trillion in insurance for $1 trillion in assets…that’s the really fun part of derivatives. No regulation (thank you Senator Phil Gramm, now Vice Chairman UBS I believe – no payback there, honestly) means that you don’t need insurable interest, i.e. no need to own the thing you are insuring. It’s not just mortgages. I read somewhere that only 4% of the multi-trillion dollar commodities derivatives market is linked to delivery of the underlying asset. The rest of it is financial engineering.

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4. 
   Edward
   10, 7, 2008 at 11:43 am

   Also, I didn’t see the 60 minutes episode so I’m not sure what exactly the “CDS market” refers to but most CDS instruments aren’t related to mortgages, it’s bonds. So that would account for a good deal of the difference between the CDS market size and the mortgage market.

   Reply
5. 
   FN
   10, 7, 2008 at 1:09 pm

   Good point on CDS market insuring more than just mortgages. That said, and I confess I know very little about this, aren’t the derivative products zero sum? Seems like we should be able to just unwind the damn things and call it even.

   The lack of regulation in these markets is criminal in my view. The fact that there were no cops on the beat is absurd. It’s also obvious, listening to the congressional hearings, the congresspeople are way over their head in trying to probe this stuff. It’s like the family of a deceased patient holding a trial of their doctors and medical staff…oh, and the family members have to use a chess clock when asking questions.

   Reply
6. 
   Edward
   10, 7, 2008 at 2:56 pm

   Unwinding theoretically would work if you could rationally manage the entire $60 trillion market in a singular, orderly, and rapid fashion. But the reason why Buffett called these things “weapons of mass destruction” is that these things are carried on the books at a certain – perhaps unwarranted – value. He unwound a very small position at General Re in an okay market and took a small hit to the tune of $400 million. The act of unwinding in a collapsing market would mean balance sheets wouldn’t just deflate, they’d implode. Thus you have the government looking at AIG as one massive domino.

   Reply
7. 
   edaciuk
   10, 7, 2008 at 3:06 pm

   The market may be flat less the original bonds being insured but any given participant is not. You’d have to net everyone simultaneously so you didn’t see the netting process play out across balance sheets. This is why SEC and Fed are talking to the clearing firms. Theoretically if everyone simultaneously moved to a clearing firm the market, in effect, would net itself because the clearing firm would be able to act as the “netter” across the market.

   Reply

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