Don't Miss This! - Buffet's important/intriguing points

Today we take a break from clips of deals that may or may not happen and look under the hood, behind the curtain or whatever idiom you prefer for attempting to be thoughtful rather than reactive.





#1  Buffet's Big Points


This month's Fortune magazine has a cover story on Bill Gates and Warren Buffet's bid to get billionaires to give away half of their assets. Below is a sample from Warren Buffett's piece in Fortune this month. He is discussing his philanthropic pledge and intentions:

"...all of my Berkshire shares will be expended for philanthropic purposes by 10 years after my estate is settled. Nothing will go to endowments; I want the money spent on current needs."

Sidebar: I had an interesting debate a few years ago on a non-profit board on which I served at the time. We were discussing annual spending versus reserves - this group had what I consider the ridiculous habit of  keep two years' operating expenses as reserves, which really amounted to job security for the staff more than a desire to be conservative with regard to the mission. Anyway, we digressed to the point we were discussing whether, in the face of a truly enormous need (say, a 9/11 in Southern California; or a 2nd Great Depression) we would spend our reserves on current needs rather than holding them in reserve or endowment. My thought was met with a resounding hammer. 'Never spend the corpus...,' they chimed in unison?

What leads to the notion that one would apparently let people die in the street so that people in the future could benefit? Are those future people more deserving? Are current lives less so? Is it job security? Habit? The quest for immortality?

Buffett's notion seems to have an underlying assumption that there are more than enough current needs to absorb all of his wealth, so what point is there in holding it. Thoughts?

More from Buffett:

...My wealth has come from a combination of living in America, some lucky genes, and compound interest. Both my children and I won what I call the ovarian lottery. (For starters, the odds against my 1930 birth taking place in the U.S. were at least 30 to 1. My being male and white also removed huge obstacles that a majority of Americans then faced.)

My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well. I've worked in an economy that rewards someone who saves the lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect the mispricing of securities with sums reaching into the billions. In short, fate's distribution of long straws is wildly capricious."

Sidebar: Buffett's humility here is as staggering as it is honest and rare. A mentor to my wife always reminds people who are upset about something they've missed or jealous about someone else's good fortune that "they've already won the lottery" by being born in the United States. They aren't dying in the third world, oppressed in the 2nd or having to risk their lives and freedom moving to have a better chance to provide for their families. Further, Buffet hints at an important point: compensation is not tied to productivity in anywhere near the linear way many people assert. Did the $500,000-a-year unemployed Circuit City salesperson-turned-mortgage-broker of 2007 really get an appropriate pay for his/her economic impact when compared to, say, a $90,000-a-year career engineer at Caterpillar, or a $130,000-a-year pharmaceutical scientist? Of course not. 

 

View the whole piece here: 

http://money.cnn.com/2010/06/15/news/newsmakers/Warren_Buffett_Pledge_Letter.fortune/index.htm

#2  Municipal Bonds


A much more pedestrian pursuit here, but one worth considering. Some clients and prospects have been listening to Henny-Pennyisms with regard to municipal bonds, particularly those in California. 


The question of the safety and return of munis, like anything else, needs to be looked at in context and in consideration of alternatives.


For example, let's say a California resident is concerned that the whole state is going to fail. Does that mean you don't buy munis? Perhaps. More precisely, however, it probably means the avoid California munis. Sure, you will have to pay the state 10% income tax on, say, South Dakota bonds, but you still avoid the 38% federal hit. 


That said, given the huge advantage for taxable investors,do the math. Before avoiding municipal issues, do the math and determine how much would have to fail before it becomes disadvantageous to own them, and then research the likelihood of exceeding that threshold.  


Further, municipal bonds are not all created equal. Those issued on behalf of a coportation or in support of a project default at higher rates than tax-backed munis. The rate for the latter, according to a 2003 study, was 0.25%, or $1 per $400. What's more, they had a recovery rate of nearly 70%. 






#3  California - Deficit Hype


Not to defend the sorry state of fiscal affairs in California, but Time magazine had an interesting analysis a couple of weeks ago in looking at the 2010-11 budget deficits by state. Although California is routinely lambasted in the national press for being a financial train wreck, the fact is that the state is underfunded by 9.1% of its annual budget -- which is inline with less press-worthy places like Kansas (9.1%), Missouri (9.3%), South Dakota (9%), Kentucky (9.1%), Nebraska (9.7%), Michigan (8.8%), Alabama (8.2%), Virginia (8.2%) and Indiana (9.9%).


In contrast, the real train wrecks are Nevada (56.6%), New Jersey (37.4%), Arizona (35.3%), Maine (32.1%), Illinois (36.1%), Connecticut (29.2%), Vermont (31.1%), Colorado (21.2%), Wisconsin (25.3%), Minnesota (26.4%) and Florida (22.2%) Even Texas, which is continually held up as a model of government restraint, has a 12.8% deficit.


So who is NOT in trouble? North Dakota, Alaska and Montana are facing a surplus (what to do with the money??) , Arkansas is at breakeven and West Virginia (3.5%) has a very modest deficit.








#4  Underappreciated Enablers: Convenient Capitalism




Interesting story in the New York Times last week about hedge fund manager Andrew Hall, who spun off from Citibank last year. Hall's fund has been hurting. Here's what the story says:


"Money managers say life within a bank sometimes can be easier than in the hedge fund world. With large balance sheets that can absorb losses, banks sometimes allow a trader more leeway for bets, such as providing additional capital, and can help traders absorb losses.


"Mr. Hall was 'incredibly successful but his strategy has volatility, and at a bank there's an implicit or explicit backing of your activity, whereas a hedge fund has a finite amount of capital,' says Charles McNally of Lyster Watson & Co., which invests in hedge funds."


Hall was the target of criticism last year for a $100 million payday when he was part of Citi, which arguably wouldn't exist were it not for taxpayer-funded bailouts. 


So the question is this: If a company's explicit or implicit backing makes huge earnings possible, doesn't that negate the idea that someone "deserves" a huge portion of the profits they make for a company? The idea that traders deserve huge chunks of the profits they generate is an essential component of the Wall Street mentality, but the fact of the matter is that the reason those traders are at banks is because - without the backing of huge financial institutions -- they wouldn't generate those huge profits. 


The massive payday are nothing but convenient capitalism. Traders argue that they deserve a lion's share of profits because they made the money, but the reality is much more complicated and owes much more to a complex system in which the trader is one important piece, but is far from an island of profitability. Like entrepreneurs, traders should make money when their capital is at risk, not when it's OPM. 


Traders have been playing shareholders and the public for fools, demanding -- and getting -- paid for using other people's money at a fixed game, where if you make big bets and win, you get $100 million, but if you make huge bets and lose, you have to scrape by on a $500,000 salary for that year -- but then can try again next year with a fresh pool of other people's cash. Those people? They are the teachers and engineers and artists and accountants whose pension funds provide the capital.