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Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street Part 7

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How could one value Merrill Lynch, Lehman, or any of the other investment banks? How could anyone trust their numbers?

Lehman announced a probable loss for second quarter 2008 of $2.8 billion, the first loss since going public in 1994. It came as no surprise when Lehman said it might boost its Level 3 a.s.sets. It raised $12 billion in new capital between February and the end of May, and said it would raise $6 billion in new equity diluting shareholder equity by 30 percent. Through sales, it reduced leverage from 31.7 times to 25 times. It sold $130 billion in a.s.sets (but it did not specify how it sold all of those a.s.sets so quickly or to whom).35 Richard "d.i.c.k" Fuld, the 62-year-old then CEO, was a Lehman lifer. In December 1983, when Fuld was chief of trading operations, he made a presentation to Lehman's board as it met over lunch to a.s.sess capital needs. Richard Bingham asked Fuld how he had made money in his trading operations the previous five years and how he would make it the next five. Fund responded: "I don't know how I made it over the last five years."36 Fuld added he had hired people "to study how we're going to do it over the next several years." Fuld added he had hired people "to study how we're going to do it over the next several years."37 An appalled Bingham asked how long that would take. Fuld responded: "Two years." An appalled Bingham asked how long that would take. Fuld responded: "Two years."38 I wonder if Fuld completed the study. I wonder if Fuld completed the study.

The SEC quickly moved to give the appearance it was on top of things. After all, we wouldn't want another debacle like Bear Stearns, would we? The SEC said it would require Wall Street to report its liquidity levels and its capital starting later in 2008.The SEC wants disclosures "in terms that the market can readily understand . . ."39 Oh, really? About that letter the SEC sent in March. . . . Oh, really? About that letter the SEC sent in March. . . . That ship has sailed. After financial inst.i.tutions stuff tens of billions of dollars worth of a.s.sets into a black box (Level 3 accounting buckets), how is the market supposed to readily understand? The Federal Reserve Bank, the new liquidity provider for Wall Street, seemed to have no idea of what was going on, either.The American taxpayer should ask for a refund for the money allocated to keep the SEC in operation. It makes one wonder just what it would take to get Christopher c.o.x booted out and have a thorough housecleaning at the SEC. That ship has sailed. After financial inst.i.tutions stuff tens of billions of dollars worth of a.s.sets into a black box (Level 3 accounting buckets), how is the market supposed to readily understand? The Federal Reserve Bank, the new liquidity provider for Wall Street, seemed to have no idea of what was going on, either.The American taxpayer should ask for a refund for the money allocated to keep the SEC in operation. It makes one wonder just what it would take to get Christopher c.o.x booted out and have a thorough housecleaning at the SEC.

I do not as a rule weigh in on quarterly earnings statements, but I will occasionally volunteer my views just to keep making the point. I had publicly challenged AIG's writedowns in August 2007, Merrill's in early October 2007, and challenged Citigroup's reported numbers in January 2008. I told the Wall Street Journal Wall Street Journal that Citigroup might need $3.3 billion more in write-downs on its "super safe super senior" positions to reflect market prices. That would have increased Citigroup's overall write-down due to subprime from $18 billion to $24 billion. Citigroup raised new capital that diluted shareholder equity by 10 percent. In the new world of financial topseyturveydom, that Citigroup might need $3.3 billion more in write-downs on its "super safe super senior" positions to reflect market prices. That would have increased Citigroup's overall write-down due to subprime from $18 billion to $24 billion. Citigroup raised new capital that diluted shareholder equity by 10 percent. In the new world of financial topseyturveydom, diluting shareholder equity was touted as a good thing. diluting shareholder equity was touted as a good thing. 40 4041 Warren aims to Warren aims to preserve preserve shareholder value. shareholder value.

Oppenheimer's bank a.n.a.lyst Meredith Whitney wrote a report on October 31, 2007, saying that Citigroup's dividend exceeded its profits, saying, "it was the easiest call I ever made."42 Since that Halloween day in 2007, Wall Street has been paying closer attention to Meredith Whitney's reports. It seemed to take more than a month before other Wall Street a.n.a.lysts woke up to the problem. Bear Stearns' bank a.n.a.lyst David Hilder thought her concerns were overstated. He was wrong, of course. Since that Halloween day in 2007, Wall Street has been paying closer attention to Meredith Whitney's reports. It seemed to take more than a month before other Wall Street a.n.a.lysts woke up to the problem. Bear Stearns' bank a.n.a.lyst David Hilder thought her concerns were overstated. He was wrong, of course. Where did Bear Stearns find these guys? Where did Bear Stearns find these guys?

Citigroup's losses continued to mount.As of October 2008, Citigroup's subprime-related write-downs are $60.8 billion.43 Vikram Pandit had been CEO of Citigroup just over a month when the numbers I challenged were reported. Pandit cofounded Old Lane Partners in 2006 and sold it to Citigroup in July 2007 for $800 million. His personal take for his share was $165 million, but he plowed $100.3 million of it back into the fund. By June of 2008, Citigroup shut it down.The Vikram Pandit had been CEO of Citigroup just over a month when the numbers I challenged were reported. Pandit cofounded Old Lane Partners in 2006 and sold it to Citigroup in July 2007 for $800 million. His personal take for his share was $165 million, but he plowed $100.3 million of it back into the fund. By June of 2008, Citigroup shut it down.The Wall Street Journal Wall Street Journal reported the fund "has been dogged by mediocre returns and the loss of its top managers." Old Lane had raised $4 billion from investors and borrowed $5 billion more. Citigroup agreed to take $9 billion of a.s.sets onto its balance sheet after writing down $202 million. Whatever you may think of Pandit's qualifications to lead Citigroup, it seems he knows how to time a sale. reported the fund "has been dogged by mediocre returns and the loss of its top managers." Old Lane had raised $4 billion from investors and borrowed $5 billion more. Citigroup agreed to take $9 billion of a.s.sets onto its balance sheet after writing down $202 million. Whatever you may think of Pandit's qualifications to lead Citigroup, it seems he knows how to time a sale.44 Lehman was not so lucky with its sales; it could not raise cash when it need it. Many questioned Lehman's accounting. David Einhorn of Greenlight Capital had publicly questioned Lehman's first quarter accounting numbers. Lehman reported a $489 million "profit" and only took a $200 million gross write-down on $6.5 billion on its holdings of a.s.set backed securities. Einhorn complained that (among other things) Lehman did not disclose its significant CDO exposure until more than 3 weeks later when Lehman filed its 10Q (a required financial report).45 In October 2008, Lehman and Tishman Speyer engineered a $22.2 billion leveraged buyout of Archstone, an apartment developer. In October 2008, Lehman and Tishman Speyer engineered a $22.2 billion leveraged buyout of Archstone, an apartment developer. Fortune Fortune said d.i.c.k Fuld declined to talk to it for months and it seemed to said d.i.c.k Fuld declined to talk to it for months and it seemed to Fortune Fortune that the Archstone deal had losses almost from the start. that the Archstone deal had losses almost from the start.46 Richard Fuld tried to sell a stake in his separate a.s.set management unit to stay afloat. He was unsuccessful. Lehman Brothers worked during the weekend of September 13 and 14 with a group of potential buyers. Bankers wanted the Fed to partic.i.p.ate, but the Fed refused. Bankers fretted about how they would unwind (sell out) their derivatives trades with Lehman. On Monday, September 15, 2008, Lehman Brothers Holdings Inc., a 158 year-old firm, filed for bankruptcy. It is still alive in the minds of its creditors, since they will not know what they have left until Lehman's a.s.sets are finally liquidated.4748 Hedge funds that used Lehman Brothers as their prime broker found "their" a.s.sets temporarily frozen. Like many other prime brokers, Lehman had provided financing for hedge funds to purchase a.s.sets, and now it was not clear whether Lehman or a hedge fund owned a particular a.s.set. Like creditors, Lehman's hedge fund customers will have to wait until the mess is sorted out. Warren had been correct in warning that the leverage unwind would be painful, and it seemed hedge funds and investment banks failed to imagine all the ways it could cause pain. Hedge funds that used Lehman Brothers as their prime broker found "their" a.s.sets temporarily frozen. Like many other prime brokers, Lehman had provided financing for hedge funds to purchase a.s.sets, and now it was not clear whether Lehman or a hedge fund owned a particular a.s.set. Like creditors, Lehman's hedge fund customers will have to wait until the mess is sorted out. Warren had been correct in warning that the leverage unwind would be painful, and it seemed hedge funds and investment banks failed to imagine all the ways it could cause pain.

John Thain as CEO of Merrill Lynch recognized that a Lehman bankruptcy could have negative implications for Merrill. He and Ken Lewis, Bank of America's CEO, hammered out an agreement, and on September 14, a Sunday night, Bank of America Corp. agreed to purchase Merrill Lynch & Co. in an all-stock deal for $29 per share (at the time of the announcement worth about $50 billion), a premium to its closing price the previous Friday. The combined firm will be a behemoth if the deal closes as planned in early 2009. Bank of America will get a broader global reach; Merrill's huge wealth management business; a huge trading operation; a prime brokerage business; and around half of Blackrock, an investment manager with $1.4 trillion under management. 49 49 The Fed said it did not partic.i.p.ate in a bailout, but it expanded its lending facility just after Lehman declared bankruptcy. It would take a wider variety of securities including The Fed said it did not partic.i.p.ate in a bailout, but it expanded its lending facility just after Lehman declared bankruptcy. It would take a wider variety of securities including equities. equities.

In August 2008, Warren told me he read every page of Lehman's financial report. In March of 2008, Warren told me he had been approached about helping Bear Stearns, but he could not come up with a value in a weekend (and did not have $60 billion in capital). He expanded on that to the students from the University of Pennsylvania when he said that bailing out Bear Stearns "took some guts that I didn't want to match."50 The balance sheets of the investment banks are so difficult to figure out that one cannot tell whether one is getting a good deal. The balance sheets of the investment banks are so difficult to figure out that one cannot tell whether one is getting a good deal.

Pimco's Bill Gross found there is a limit to the Fed's largesse, and his Lehman investment lost money. In March, Bear Stearns, the fifth fifth largest investment bank, was deemed too big to fail, but the Fed refused to help Lehman, the largest investment bank, was deemed too big to fail, but the Fed refused to help Lehman, the fourth fourth largest investment bank. As Jim Rogers predicted, larger investment banks than Bear Stearns had problems, and the Fed had other problems besides investment banks-Fannie, Freddie, and AIG. Pimco's investments were only partially protected by the Fed. The Total Return Fund's return slumped, and it will be interesting to see if Gross ends up a net winner or a net loser as the market struggles for balance. largest investment bank. As Jim Rogers predicted, larger investment banks than Bear Stearns had problems, and the Fed had other problems besides investment banks-Fannie, Freddie, and AIG. Pimco's investments were only partially protected by the Fed. The Total Return Fund's return slumped, and it will be interesting to see if Gross ends up a net winner or a net loser as the market struggles for balance.

Jamie Dimon, JPMorgan Chase's CEO, bought Bear Stearns, and Ken Lewis, Bank of America's CEO, bought Merrill Lynch. Did either of them get a good deal? Did both of them get good deals? Who got the better deal? Ken Lewis certainly pa.s.sed up Jamie Dimon in size, but only time will tell how this plays out. For my part, it seems that Ken Lewis is the more underestimated of the two.

In May 2003, I heard both CEOs give luncheon speeches at the Federal Reserve's Conference on Bank Structure and Supervision. Jamie spoke the day before Ken Lewis. Jamie dressed in a light suit and spoke rapidly, sounding as if he had just drunk a pot of coffee. He seemed to suggest he had solved all of the problems at Bank One in the vein of a public relations speech (this predated its merger with JPMorgan Chase). He seemed uncomfortable with silence. In between questions the microphone was pa.s.sed around for a few seconds. Jamie added to his already complete answers, and it seemed an attempt to fill dead air. The next day Ken Lewis spoke. He wore a conservative dark blue suit with a flag pin in his lapel. His grooming was impeccable. His speech flowed. Unlike Jamie, he spoke about corporate governance, the topic at hand. He gave clear and balanced reasons why (contrary to popular wisdom) it made sense in Bank of America's case for him to occupy the position of both chairman and CEO. Ken Lewis left me with the impression that he is a very ambitious man who comes prepared. He did not underestimate his audience.

Perhaps these CEOs have a better crystal ball than Warren Buffett and I.The list of accounting distortions seems endless, 51 515253 but the key is to understand business fundamentals first, and then consider what the accounting statements imply. but the key is to understand business fundamentals first, and then consider what the accounting statements imply.

By October 2008, J.P. Morgan acquired Bear Stearns and Washington Mutual; BofA acquired Merrill; and Wells Fargo acquired Wachovia. Morgan Stanley and Goldman Sachs became bank holding companies. The Treasury invested tens of billions of dollars in each. AIG got a bailout. Lehman was bankrupt. The situation is fluid. Meanwhile, Berkshire Hathaway has limited debt (leverage) and a lot of cash.

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Starting around 1980, Berkshire Hathaway's nonreported (undistributed) earnings nonreported (undistributed) earnings from the ownership of equities exceeded from the ownership of equities exceeded reporting earnings reporting earnings generated by the business it owns.That means there is a lot of hidden value that does not show up on accounting statements. Earnings and return on equity are important measures, but the generated by the business it owns.That means there is a lot of hidden value that does not show up on accounting statements. Earnings and return on equity are important measures, but the intrinsic value intrinsic value of the company is the key. of the company is the key.

Today, investors can purchase low-fee index funds, so a reasonable benchmark is the S&P 500. Each year, Berkshire Hathaway compares its performance with the S&P 500.Warren Buffett and Charlie Munger strive to increase intrinsic value, the true value including value that is obscured by accounting statements. They say that if they cannot beat the S&P that way, then they are not doing anything an investor cannot do on his or her own.

So far long-term Berkshire Hathaway investors, including me, have been delighted. No one can predict future performance, but long-term investors continue to hold their stock. Not only does Berkshire Hathaway invest in stocks and pieces of companies, many of the companies owned by Berkshire Hathaway also invest. If Berkshire Hathaway owns less than 20 percent (accounting rules are subject to change, so this percentage is just an example) of a company, it does not have to include (consolidate) the company's earnings on Berkshire Hathaway's balance sheet, even when this represents a huge wealth increase.

In 1990,Berkshire Hathaway owned 17 percent of Capital Cities/ABC, Inc. (Capital Cities). Berkshire Hathaway's share of Capital Cities earnings was $83 million, but Capital Cities retained more than $82 million (of Berkshire Hathaway's earnings) for future growth. Berkshire Hathaway only got about $530,000 net after-tax dividends. According to generally accepted accounting principle generally accepted accounting principle (GAAP), Berkshire Hathaway only had to record the dividends as earnings, so it recorded $530,000 (not $83 million). If Capital Cities/ABC, Inc. sounds unfamiliar to you that may be because Disney bought it in 1995 (GAAP), Berkshire Hathaway only had to record the dividends as earnings, so it recorded $530,000 (not $83 million). If Capital Cities/ABC, Inc. sounds unfamiliar to you that may be because Disney bought it in 199554 Berkshire Hathaway sold its holdings in Disney a few years after the takeover. Berkshire Hathaway sold its holdings in Disney a few years after the takeover. Warren's favorite holding period may be forever, but that does not mean he will hold something he no longer favors forever. Warren's favorite holding period may be forever, but that does not mean he will hold something he no longer favors forever.

Berkshire Hathaway prefers to purchase companies that generate earnings that do not have to be reported. If Berkshire Hathaway buys an entire business, Berkshire Hathaway must report the earnings. Sometimes, however, Berkshire Hathaway can acquire a minority interest in a company more cheaply (on a pro rata basis) than it would have paid for the entire company. Furthermore, Berkshire Hathaway does not have to report the earnings for the minority interest. The price is a relative bargain, and the unreported earnings should eventually become capital gains. In turn, the capital gains will increase Berkshire Hathaway's intrinsic value.

When Berkshire Hathaway acquires a company or part of a company, it looks for good managers. If the stock price falls below the value of the business the managers should buy back the stock. If the price is above the business value, however, managers will either (1) retain earnings if they can increase market value by a dollar for every dollar of earnings they retain; or (2) if they cannot do that, they should pay dividends. Good managers know these finance basics and follow them.

Accounting also misleads when it comes to the stock price that is recorded on the books (the carrying price). Berkshire Hathaway's subsidiaries may carry value at one price, while Berkshire Hathaway itself carries the same stock on its book at another price. Again, that is legal and proper accounting.

Highly leveraged investment banks stuff tens of billions of dollars worth of a.s.sets into black boxes (Level 3 accounting) and use other method to avoid showing market prices for a.s.sets (hold-to-maturity portfolios).The investment banks may have hidden problems. Investment banks may be worth less than their accounting reports suggest. Investment banks may be worth less than their accounting reports suggest. In contrast, Berkshire Hathaway has In contrast, Berkshire Hathaway has hidden value. hidden value. Berkshire Hathaway does not report retained earnings or capital gains on long-term investments unless the investments are sold. Berkshire Hathaway does not report retained earnings or capital gains on long-term investments unless the investments are sold.

Berkshire Hathaway reports fluctuations in market prices of its derivatives, however. Berkshire Hathaway took a loss on derivatives in 2007 and in first quarter 2008. Berkshire Hathaway's invested $4.88 billion in premiums (up from $4.5 billion at the end of 2007) for puts it wrote on equity indexes, and the first payment-in the unlikely event one ever comes due-is 2019. Berkshire Hathaway took a mark-to-market loss it can afford, a write-down of $1.7 billion in the first quarter of 2008. Magen Marcus, a medical doctor who has been a Berkshire Hathaway shareholder for five years, called them "unrealized losses."55 He is an informed shareholder. He is an informed shareholder. In his 2007 shareholder letter, Warren told us that he and Charlie Munger are not concerned about the price fluctuations: "even though they could easily amount to $1 billion or more in a quarter-and we hope you won't be either." In his 2007 shareholder letter, Warren told us that he and Charlie Munger are not concerned about the price fluctuations: "even though they could easily amount to $1 billion or more in a quarter-and we hope you won't be either."56 They are willing to cope with reported earnings volatility "in the short run for greater gains in net worth in the long run." They are willing to cope with reported earnings volatility "in the short run for greater gains in net worth in the long run."57 Berkshire Hathaway does not chase revenues for the sake of revenues; the price must be right. When rating agencies suggested that Berkshire Hathaway should increase insurance revenues to maintain its AAA rating, Warren told me he rejected their premise. Berkshire Hathaway is happy to do nothing when the risk is not priced correctly, but many insurance companies did not feel the same way. This critical difference led to an opportunity for Warren Buffett he never sought. An insurance regulator knocked on Berkshire Hathaway's door when it needed help.

Chapter 11.

Bond Insurance Burns Main Street You have been writing some terrific stuff. I send it along to Ajit and he's now a big fan.

-Warren Buffett to Janet Tavakoli, January 3, 2008

When he was in his twenties,Warren Buffett put three-quarters of his money (around $10,000) into property and casualty insurer GEICO, and reaped a healthy profit. Since then, he has been keenly interested in insurance opportunities. The credit crisis dropped an opportunity in Berkshire Hathaway's lap.

As Bear Stearns and the Carlyle fund struggled for their survival on March 12, 2008, news about bond insurance was not a highlight, but it should have been. In what would become an ugly pattern, one of the bond insurers that had been AAA at the start of 2008 was downgraded several grades (by Fitch), and it filed a lawsuit in an attempt to nullify a nearly $2 billion guaranty.1 Bond insurers traditionally provided credit enhancement for munic.i.p.al bonds needed to fund roads, schools, water treatment plants, and many other necessary public works. Now bond insurers are an integral part of the credit bubble problem. Most of the bond insurers (or monolines monolines2) have exposure to subprime home equity loans or troubled loans bundled in risky securitizations. Most bond insurers have done dicey deals dirt cheap. Most of them need more money. It is as if they offered hurricane insurance on homes and insured everyone in Florida without enough money to cover potential obligations. Instead of insuring homes, the insurers were insuring bonds without enough money to cover the potential obligations or to keep their AAA ratings. Their folly affects the average American taxpayer and many retail accounts.

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Bond insurers provide guarantees for munic.i.p.al bonds, which often have very long maturities. The interest rate is set at periodic auctions, and these auction-rate securities (ARS) were sold as if they have been like a cash instrument or a money market instrument.The same day in March 2007 when the bond insurer filed its lawsuit, I was in New York. I met with the CEO of a large foreign manufacturing company. He told me he was suing the investment bank that sold his cash manager more than $10 million in auction-rate munic.i.p.al bonds guaranteed by a bond insurer. "[The investment bank] told him it is the same as cash." By February 2008, around 70 percent of the $330 billion auction-rate securities market for munic.i.p.alities, student loans, and colleges failed when investment banks and banks stopped bidding for the "insured" bonds that investors wanted to sell (or did not want to buy).

Usually auction-rate bonds are bought and sold at a prespecified short period such as every 7 or 28 days.The interest rate is determined by buyers. If the auction fails, the interest rate goes up, usually to a rate specified in the doc.u.ments. In some cases, the rate for unsold bonds rises as high as 20 percent (rates vary by bond), and the investor is left holding the old bonds. Auctions have rarely failed, so the market was in a panic. Some ARS were a bargain, but that meant munic.i.p.alities were paying higher interest costs solely due to the confusion. For munic.i.p.alities, that means taxpayers may pay higher taxes. Munic.i.p.alities struggle to find a way to refinance into reasonable fixed rate debt in the dicey market, and as of June 2008, only 25 percent have refinanced. Local tax rates may increase to cover their problems.

Banks and investment banks are hurting from lack of ready cash (liquidity) and would not buy back bonds since everyone's confidence is so shaken that it is hard for the banks to trade them. Many investors were told by their bankers that the bank would always buy the bonds if an auction failed. Many investors were told these bonds were as safe as T-bills. Investors felt scammed. Some investors did not even see a prospectus until the auctions failed. Cash management accounts across the globe ranging from large corporate clients such as Google to small condominium a.s.sociations could not sell their ARS.That may not be a crisis for Google, but customers like some condominium a.s.sociations could not pay their bills and have to ask condo owners for more money.

Even pension funds invested in these "AAA money market" securities. These a.s.sets are "guaranteed," but many bond insurers are in trouble, so their "guarantee" is not worth anything. In some cases the underlying a.s.sets seem sound (so the "guarantee" does not matter), but in other cases there is a genuine risk of princ.i.p.al loss and the guarantee people depended on is worthless because "sophisticated" bond insurers guaranteed bad products manufactured by investment banks and the guarantee people depended on is worthless because "sophisticated" bond insurers guaranteed bad products manufactured by investment banks. Some but not all of the top underwriters (sellers) of munic.i.p.al auction-rate securities included players in the subprime market: Citigroup, UBS, Morgan Stanley, Goldman Sachs, Bear Stearns, Merrill Lynch, Wachovia, Bank of America, JPMorgan Chase, Royal Bank of Canada, and Lehman Brothers, but few of the underwriters have clean hands when it comes to this new problem. Cla.s.s action suits abounded. Banks and investment banks had undisclosed conflicts of interest with their retail customers, and seemed to pa.s.s on their liquidity problems to their customers.345 Many banks paid fines to settle claims with U.S. regulators and agreed to buy back ARS at full price (par) from retail clients and small businesses. Many banks paid fines to settle claims with U.S. regulators and agreed to buy back ARS at full price (par) from retail clients and small businesses.67 The buy-back was unprecedented, but it did not include all customers. Larger customers are deemed to be sophisticated enough to know what they are doing, whether or not that is actually true.Those customers are usually left to work out their disputes themselves. The buy-back was unprecedented, but it did not include all customers. Larger customers are deemed to be sophisticated enough to know what they are doing, whether or not that is actually true.Those customers are usually left to work out their disputes themselves.8 Many of the small accounts are handled by the "retail" side of banks and investment banks. Small investors thought their banks had a fiduciary responsibility to them.Yet, it now seems as if finance has become a game of "every man for himself." In The Spanish Prisoner, The Spanish Prisoner, Steve Martin plays a confidence man who advises:"Always do business as if the other person is trying to screw you because most likely they are, and if they are not, you can be pleasantly surprised." In the current financial environment, it has come to that, because regulators failed to do their jobs. Steve Martin plays a confidence man who advises:"Always do business as if the other person is trying to screw you because most likely they are, and if they are not, you can be pleasantly surprised." In the current financial environment, it has come to that, because regulators failed to do their jobs.

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A certain and stable AAA rating is extremely valuable to any bond insurer. Investors pay for the guarantee believing it means uninterrupted cash flows and that belief means market liquidity. Even if interest rates in general rise and prices drop somewhat, the fact that one can count on cash flows makes reliable AAA bonds easier to price and trade. But if ratings are in doubt, the market freezes.

In December 2007, seven bond insurers were rated AAA. Standard & Poor's said underwriting quality for several of the bond insurers was high, but that was not true. The underwriting standards were actually naive and bond insurers overly relied on faulty models. It was as if the rating agencies were daring the market to contradict them.910 So we did. So we did.

William ("Bill") Ackman, head of Pershing Square Capital Management, warned the market for years that bond insurers underestimated the risk of structured finance business. Whitney Tilson, a value investor, made presentations at conferences with Bill Ackman supporting his view. David Einhorn, founder of Greenlight Capital, also made public his concerns about the overrated bond insurers. Ackman sold short the holding companies of the two largest publicly traded bond insurers, MBIA and Ambac. In 2007 he announced that he would donate his personal gains to the Pershing Square Foundation, a charity.11 Pershing Square's hedge funds stand to reap billions, which benefits Ackman in the long run. Pershing Square's hedge funds stand to reap billions, which benefits Ackman in the long run.

Ackman took the extraordinary step of using Internet-based Open Source to post the subprime related holdings of Ambac and MBIA. He, in turn, obtained the positions from an investment bank he declined to name. Usually, outing positions is not the done thing, but in this case I heartily approve. Ackman took flack because he put out high loss numbers for the bond insurers. He tried to make his opinion transparent, but the spread sheet is a black hole of time-sucking minutiae.

Armed with Ackman's publicly available information, I simplified the a.n.a.lysis. According to Ackman's spreadsheet, many of the CDO positions held by Ambac and MBIA are horrifying. Most bond insurers had CDO-squared positions, with inner CDOs including constellation deals and other CDO-squareds.12 On January 3, 2008, I wrote my clients that most of the bond insurers deserved much lower ratings, and On January 3, 2008, I wrote my clients that most of the bond insurers deserved much lower ratings, and all all of the major bond insurers, including Ambac and MBIA-the largest insurers of munic.i.p.al bonds-deserved to lose their AAA ratings. of the major bond insurers, including Ambac and MBIA-the largest insurers of munic.i.p.al bonds-deserved to lose their AAA ratings.13 This was bad news for the munic.i.p.al bond market. Ambac and MBIA insure around $2 trillion in securities, and FGIC insures another $315 billion. Ambac and MBIA insure most of the public finance market including $1 trillion of U.S. "guaranteed" munic.i.p.al bonds. What's more, investment banks that bought protection from bond insurers already had billions in mark-to-market losses. Investment banks would have to take losses of many billions more. This was bad news for the munic.i.p.al bond market. Ambac and MBIA insure around $2 trillion in securities, and FGIC insures another $315 billion. Ambac and MBIA insure most of the public finance market including $1 trillion of U.S. "guaranteed" munic.i.p.al bonds. What's more, investment banks that bought protection from bond insurers already had billions in mark-to-market losses. Investment banks would have to take losses of many billions more.

In early January 2008, I told CNBC that the bond insurers are in deep trouble: "They did the financial equivalent of insuring drunk drivers with bad driving records at the same prices as they would insure teetotalers with good driving records."14 Management will have to go and there will have to be a restructuring. MBIA and Ambac need capital and there is a "crisis of confidence in that management." Management will have to go and there will have to be a restructuring. MBIA and Ambac need capital and there is a "crisis of confidence in that management."15 CNBC's Becky Quick asked why people were surprised by something that I had been predicting for a long time. Jack Caouette, then vice chairman of MBIA, had written a blurb for my 2003 book on securitization saying CNBC's Becky Quick asked why people were surprised by something that I had been predicting for a long time. Jack Caouette, then vice chairman of MBIA, had written a blurb for my 2003 book on securitization saying caveat emptor caveat emptor-yet, the bond insurers had been careless.

CNBC contributor David Kotok, chief investment officer of c.u.mberland Advisors, an investor in munic.i.p.al bonds (among other things), did not agree with me. He said there are "seven triple-A munic.i.p.al bond insurers,"16 and thought this was an opportunity. He said the munic.i.p.al bond insurance would be fine. He seemed unaware of the ratings peril. and thought this was an opportunity. He said the munic.i.p.al bond insurance would be fine. He seemed unaware of the ratings peril.

On January 10, 2008, MBIA paid 14 percent in interest to raise $1 billion in capital; the 10-year U.S. treasury yield was less than 4 percent.17 The market no longer seemed to believe that MBIA was AAA rated.Warren laughed as he asked me:"Did you ever think you would see a triple-A raise money at 14 percent [with treasury rates so low]?" The market no longer seemed to believe that MBIA was AAA rated.Warren laughed as he asked me:"Did you ever think you would see a triple-A raise money at 14 percent [with treasury rates so low]?"

In January of 2008, Eric Danillo, the New York insurance regulator, called a meeting of investment banks to discuss the way forward for the monoline insurers. Based on market feedback, Danillo knew the bond insurers needed capital, and cash-strapped investment banks did not want to cooperate. Danillo, however, had more to say.

A key feature of credit derivatives is that fraud is not a defense against payment. That means that if a default occurs, both sides settle up, and if there is a problem, allegations of fraud can be litigated later. Bond insurers had done a particular type of credit derivative contract called pay-as-you-go. Danillo pointed out it looks like an insurance insurance contract, and he is an insurance regulator. According to one banker, Danillo brought up the fact that there is an extraordinary amount of fraud a.s.sociated with mortgage loans backing the deals guaranteed by the bond insurers. Danillo suggested these were unusual circ.u.mstances. contract, and he is an insurance regulator. According to one banker, Danillo brought up the fact that there is an extraordinary amount of fraud a.s.sociated with mortgage loans backing the deals guaranteed by the bond insurers. Danillo suggested these were unusual circ.u.mstances.

The smarter investment banks were alarmed. If push came to shove, bond insurers might use fraud as an excuse to avoid payments, or the bond insurers might try to nullify contracts.That would mean billions of dollars of losses for the investment banks.

On January 25, 2008, I told CNBC's Joe Kernen that the underwriters (not the rating agencies) are responsible for doing due diligence, and Danillo raised the issue of insurance and fraud. The investment banks might have to take the loans back on balance sheet, and they took Danillo very seriously.

Charlie Gasparino a.s.serted the rating agencies are the "culprit."18 I responded that blaming rating agencies without mentioning the role of the underwriters is incorrect, since investment banks buy and sell the securities and are obliged to do due diligence. I responded that blaming rating agencies without mentioning the role of the underwriters is incorrect, since investment banks buy and sell the securities and are obliged to do due diligence.

Dinallo, Gasparino said, "is probably hiding under his desk," and that "what he did is completely irresponsible," referring to the bailout plan. He added that Dinallo "has a little explaining to do."19 But Matt Fabian of Munic.i.p.al Market Advisors observed that investment banks and rating agency interests are aligned, and "the bailout plan is a pretty obvious one." But Matt Fabian of Munic.i.p.al Market Advisors observed that investment banks and rating agency interests are aligned, and "the bailout plan is a pretty obvious one."20 Fabian said the investment banks must have a problem coming up with the money. Fabian said the investment banks must have a problem coming up with the money.

The investment banks struggled to hold off a wave of write-downs and were dismayed by the prospect of coming up with money to help the bond insurers.The banks were worried that the bond insurers would figure out a way to get out of the contracts and all of that risk would come right back on the investment banks' balance sheets.

By the end of June 2008, MBIA and Ambac lost their AAA ratings and three other bond insurers had been downgraded from AAA to junk (below investment grade).21 Some bond insurers sued, others investigated options to nullify contracts. But they left it too late. The bond insurers have been damaged and investment bank took more losses as they took risk back on their balance sheets. The fights will go on for years. Some bond insurers sued, others investigated options to nullify contracts. But they left it too late. The bond insurers have been damaged and investment bank took more losses as they took risk back on their balance sheets. The fights will go on for years. Eric Dinallo is not the one with a little explaining to do. Eric Dinallo is not the one with a little explaining to do.

Strong munic.i.p.alities do not need guarantees from bond insurers. Besides, the guarantees are worse than worthless. In many cases, munic.i.p.al bonds can get a strong investment grade rating on their own merits. During the summer of 2008, munic.i.p.alities worthy of a single-A rating on their own merits-and many merited higher ratings-found their bonds would trade more easily without the guarantee. As of September 2008, the munic.i.p.al bond market remained in a state of flux as Moody's announced that in about a month hence it would change the way it a.s.signs ratings to tax-exempt borrowers. This would result in higher ratings for many munic.i.p.alities, but of course, this is not an actual upgrade in quality; it is merely a relabeling.22 By the time this book is published there may be more clarity and consistency in munic.i.p.al bond ratings, but until there is, the confusion may make it more difficult for munic.i.p.alities to predict their borrowing costs. By the time this book is published there may be more clarity and consistency in munic.i.p.al bond ratings, but until there is, the confusion may make it more difficult for munic.i.p.alities to predict their borrowing costs.

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When we first met, I told Warren that I am an avid Benjamin Franklin fan and have read his short autobiography several times.Warren looked at me as if I were pulling his leg. He handed me a copy of Poor Charlie's Almanack- Poor Charlie's Almanack-Vice-Chairman of Berkshire Hathaway and longtime friend Charlie Munger's self-styled finance homage to Franklin. Munger is also a great admirer of Benjamin Franklin, the statesman, philosopher, author, founder of the first North American library, publisher and inventor. Those are reasons enough for admiration, but Franklin was also the father of the North American insurance business, a lynchpin of Berkshire Hathaway's success.

Inspired to take action after a 1730 fire destroyed the shops on Fishbourn's wharf in Philadelphia, Benjamin Franklin wrote a guide on "different accidents and carelessnesses by which houses are set on fire . . . and means of avoiding them."23 Shortly thereafter, Benjamin Franklin started Union Fire Company, the first volunteer fire department in North America. Even more important to the future success of the as-yet-unborn Warren Buffett and Charlie Munger, Franklin also started the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire, the first successful (Charles Town's earlier effort was unsuccessful) fire insurance organization in North America. The first board meeting was held in 1752, the year the colonies switched from the Julian calendar to the Gregorian calendar, two years before the British colonies sent representatives to the Albany Congress, and 24 years before those colonies declared independence from Britain. Franklin noted that when it came to fires: "An ounce of prevention is worth a pound of cure," Shortly thereafter, Benjamin Franklin started Union Fire Company, the first volunteer fire department in North America. Even more important to the future success of the as-yet-unborn Warren Buffett and Charlie Munger, Franklin also started the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire, the first successful (Charles Town's earlier effort was unsuccessful) fire insurance organization in North America. The first board meeting was held in 1752, the year the colonies switched from the Julian calendar to the Gregorian calendar, two years before the British colonies sent representatives to the Albany Congress, and 24 years before those colonies declared independence from Britain. Franklin noted that when it came to fires: "An ounce of prevention is worth a pound of cure,"24 but for what one cannot prevent, insurance helps provide the pound of cure. but for what one cannot prevent, insurance helps provide the pound of cure.

Run properly, underwriting risk is a money-making machine that makes a commercial bank look like a child's piggy bank in comparison. A successful insurance operation generates float, float, premiums received before losses are paid-sometimes years or decades before losses, if any, are paid. An insurance company does not technically own its float, called premiums received before losses are paid-sometimes years or decades before losses, if any, are paid. An insurance company does not technically own its float, called reserves reserves, but it has the use of the reserves for investment purposes. A rising tide lifts all boats, and an increasing stream of well-invested float lifts all returns. A rising tide lifts all boats, and an increasing stream of well-invested float lifts all returns.

Americans love to buy insurance. My cyber-friend, Andrew Tobias, wrote a cla.s.sic book on the insurance industry, The Invisible Bankers, The Invisible Bankers, more than a quarter of a century ago. Some regulations have changed, but the fundamental principles of making money in the insurance business have remained the same.Tobias cites a more than a quarter of a century ago. Some regulations have changed, but the fundamental principles of making money in the insurance business have remained the same.Tobias cites a Playboy Playboy survey in which 91 percent of the men thought a car is a necessity-and it is difficult to use that necessity without car insurance. 88 percent of the men thought health insurance was a necessity. Even though only 60 percent of the men surveyed were married, 79 percent of the men responding thought that life insurance was a necessity, not a luxury. Only 16 percent of the men thought that dining out every week was a necessity. survey in which 91 percent of the men thought a car is a necessity-and it is difficult to use that necessity without car insurance. 88 percent of the men thought health insurance was a necessity. Even though only 60 percent of the men surveyed were married, 79 percent of the men responding thought that life insurance was a necessity, not a luxury. Only 16 percent of the men thought that dining out every week was a necessity.25 So the question isn't whether or not Americans will buy insurance, but rather, how much will they buy and from whom? how much will they buy and from whom?

The competence of the insurer is crucial, because Mr. Market's manic depressive cousin prices insurance risk. The magic trick in the insurance business is to avoid volume just for the sake of volume.

Auditors do not seem competent to evaluate reported reserves, since anyone can create huge reserves by underwriting bad business. How did that work out for MBIA and Ambac? How did that work out for MBIA and Ambac? The rating agencies seem even worse than the auditors. When rating agencies told Berkshire Hathaway they liked to see an increasing revenue stream in AAA insurance companies, Warren told me he said he would never let revenues be his target. Anyone can increase revenues by underwriting risk at the wrong price. In a shareholder letter, he wrote: The rating agencies seem even worse than the auditors. When rating agencies told Berkshire Hathaway they liked to see an increasing revenue stream in AAA insurance companies, Warren told me he said he would never let revenues be his target. Anyone can increase revenues by underwriting risk at the wrong price. In a shareholder letter, he wrote:

Where "earnings" can be created by the stroke of a pen, the dishonest will gather.26

Warren's insurance businesses only underwrite insurance risks when market prices are favorable. Insurance success depends on pricing premiums so that premiums exceed losses and expenses. When prices aren't favorable, Berkshire Hathaway ignores Mr. Market's cousin. But when it can underwrite risk at premium prices, Berkshire Hathaway's insurance businesses partic.i.p.ate ma.s.sively.

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Simonides, a Greek poet and philosopher, was among a handful of survivors after an earthquake destroyed the great hall of a palace where he attended a party. The crushed victims' bodies were so badly disfigured that grieving relatives could not identify the corpses for burial. Simonides recalled each of the two hundred guests by name and remembered each guest's exact location in the hall, allowing the mourners to separate and identify the bodies of their friends and relatives. He hadn't antic.i.p.ated the earthquake. His mental picture was formed before before the disaster. the disaster.

Simonides is not around anymore, but fortunately for Berkshire Hathaway, it has Ajit Jain to tend to Geico and General Reinsurance, Berkshire Hathaway's large insurance company holdings. He joined Berkshire Hathaway in 1986, and built its reinsurance business from scratch.The reinsurance reinsurance business may be even better than primary insurance. Jain tries to price premiums so that no matter who verifies the claims, the insurance business remains profitable. business may be even better than primary insurance. Jain tries to price premiums so that no matter who verifies the claims, the insurance business remains profitable.

For the right price, Berkshire Hathaway's reinsurance companies underwrite the excess risk other insurance companies are eager to shed, reducing their maximum possible loss. Insurance companies sometimes need to expand capacity, exit an insurance business, or protect themselves against rare catastrophic losses, and they are often willing to pay up to meet these needs. For nothing more than a promise, Berkshire Hathaway receives large premium payments in advance. Losses and loss payments are usually delayed far into the future. In the hands of skilled investors like Buffett and Munger, those payments compound to levels that can far exceed any potential future payments.

The super catastrophe super catastrophe or or super-cat super-cat business may be even better than the reinsurance business, but no one really knows. Berkshire Hathaway is also in this business, and reaps very high upfront premiums. But in a horrific year, the super-cat business will take a huge hit.When it comes, the compounding of the cash has to be great enough to cover the losses. business may be even better than the reinsurance business, but no one really knows. Berkshire Hathaway is also in this business, and reaps very high upfront premiums. But in a horrific year, the super-cat business will take a huge hit.When it comes, the compounding of the cash has to be great enough to cover the losses.

In December 2007, Ajit Jain set up Berkshire Hathaway a.s.surance to take advantage of opportunities in munic.i.p.al bond insurance. In an unprecedented move, New York insurance regulators proposed the idea to Berkshire Hathaway and quickly cut through red tape. In late January 2008, Jonathan Stempel at Reuters Reuters asked me if Warren Buffett planned to reinsure the monoline's structured finance positions. I stopped myself from laughing, and suggested he check his facts directly with Berkshire Hathaway. asked me if Warren Buffett planned to reinsure the monoline's structured finance positions. I stopped myself from laughing, and suggested he check his facts directly with Berkshire Hathaway.

Warren has repeatedly said he wants to do "premium business at premium prices,"27 and he insures risks he can understand. Stempel could not reach Ajit Jain or Berkshire for comment, but I had already told this much: "I would be surprised if he were to touch the financial guarantors' [bond insurers'] structured products, given that the underwriting standards seemed so poor." and he insures risks he can understand. Stempel could not reach Ajit Jain or Berkshire for comment, but I had already told this much: "I would be surprised if he were to touch the financial guarantors' [bond insurers'] structured products, given that the underwriting standards seemed so poor."28 After the munic.i.p.al bond market auction failed in the second week of February 2008,2930 Warren Buffett's Berkshire Hathaway a.s.surance reinsured $50 million of bonds and was paid a 2 percent premium, double the original 1 percent premium for primary insurance from the bond insurers. Put another way, Berkshire Hathaway a.s.surance received Warren Buffett's Berkshire Hathaway a.s.surance reinsured $50 million of bonds and was paid a 2 percent premium, double the original 1 percent premium for primary insurance from the bond insurers. Put another way, Berkshire Hathaway a.s.surance received two times the original premium to back up the existing insurance, two times the original premium to back up the existing insurance, in case the insurer cannot pay. in case the insurer cannot pay.31 By the end of February Berkshire Hathaway a.s.surance did 206 transactions and was paid an average of 3.5 percent on business that the primary insurer originally underwrote at 1.5 percent. By the end of February Berkshire Hathaway a.s.surance did 206 transactions and was paid an average of 3.5 percent on business that the primary insurer originally underwrote at 1.5 percent.32 Warren is happy to do zero business when risk premiums make no sense. Berkshire Hathaway's triple-A rating is trusted as a genuine rating. Its stated intention of doing premium business at premium prices may leave the largest of the legacy bond insurers scrambling for sc.r.a.ps.

Chapter 12.

Money, Money, Money (Warren and Washington) That's the problem . . . you can't regulate it anymore.You can't get the genie back in the bottle.

-Warren Buffett (in Reuters), May 24, 2008

In the spring of 2008, both Warren and I said the United States was already in a recession. In May 2008,Warren told CNBC that "it will be deeper and last longer than many think."1 Yet many economists sound like the Merchants of Death (MOD squad) in Yet many economists sound like the Merchants of Death (MOD squad) in Thank You for Smoking Thank You for Smoking : "Although we are constantly exploring the slowdown, there is currently no economic evidence to suggest the economy is in a recession." The cla.s.sic definition of a recession calls for two consecutive quarters of negative growth, and as of the summer of 2008, the numbers did not yet show it. Election years bring out the best in the economy. In the long run, we need to improve productivity and spend less-I will get to that later. In the short run,Warren is right.The United States is in a recession combined with inflation and low growth, a condition called : "Although we are constantly exploring the slowdown, there is currently no economic evidence to suggest the economy is in a recession." The cla.s.sic definition of a recession calls for two consecutive quarters of negative growth, and as of the summer of 2008, the numbers did not yet show it. Election years bring out the best in the economy. In the long run, we need to improve productivity and spend less-I will get to that later. In the short run,Warren is right.The United States is in a recession combined with inflation and low growth, a condition called stagflation. stagflation.

How did this happen? For most of this century, Washington has pumped money into the economy by keeping interest rates low. Easy money tempts crooks. Speculators and fraudsters had a party. Regulators became enablers. Cheap money fueled bad lending, including predatory lending, and cheap money expanded the housing bubble.There are genuine victims of predatory lending.The war on poverty became a war on the poor. Those victims face crushing debt, a weaker dollar, and rising prices. Now even the average American is the victim of bad policies combined with widespread financial crime. Most Americans feel the negative wealth effect of rising prices, falling home values, and tighter credit. Consumers cut back on spending while struggling with higher food and gas prices. Bailouts of poorly regulated investment banks and corrupt mortgage lenders mean Washington is printing more money, which weakens the dollar. Inflation adds to the misery. Americans feel poorer.The United States is in a recession combined with stagflation.

Washington is supposed to provide a strong national defense; but we were attacked from within our own borders-sometimes by those charged to protect us. Washington failed in one of its most important duties.Washington failed to protect our money.

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What is money? Money is a store of value. Money is a store of value. It does not matter whether we talk about gold coins, silver, diamonds, bearer bonds, pieces of paper with pictures of dead presidents, salt, cacao, tulip bulbs, or a signed check. We accept these things as money, because we have a common agreement (or hallucination) of their value. It does not matter whether we talk about gold coins, silver, diamonds, bearer bonds, pieces of paper with pictures of dead presidents, salt, cacao, tulip bulbs, or a signed check. We accept these things as money, because we have a common agreement (or hallucination) of their value.

Our idea of value changes as circ.u.mstances change. If crops fail and I am starving, I'd prefer to stockpile wheat rather than gold. If you have no wheat, I would prefer to have gold than take your credit, since it will be easier for me to convert gold into food than to convert your credit into food. We invented money to enhance our probability of survival. We invented money to enhance our probability of survival. The best money is an abundant store of value measured in a standard and reliable manner. When anyone-especially someone we elected to a position of authority-messes around with the value of money, we should all take it very seriously. The best money is an abundant store of value measured in a standard and reliable manner. When anyone-especially someone we elected to a position of authority-messes around with the value of money, we should all take it very seriously. Homeland security requires a secure homeland currency. Homeland security requires a secure homeland currency.

There are three basic kinds of money. The first is commodity money, something usable that humans value. Children quickly grasp the concept of commodity money the first time they swap toys. Commodity money is gold, silver, rice, wheat, oil, salt, or any number of usable goods. Beads went out of fashion as currency in the United States soon after Europeans used them to purchase Manhattan from Native Americans. Gold is still in fashion because the global community agrees it has value. The gold standard was dissolved in 1971, but before that, Europe relied on it both officially and unofficially for about 900 years. Central banks still stockpile physical gold. Gold is still considered a benchmark, even though it is no longer the standard.

Warren invests in businesses that make things that people use and that are unlikely to go out of fashion (for a long time). For example, people enjoy eating Dairy Queen's ice cream treats, and human taste buds are unlikely to evolve to new preferences in our lifetime.

Credit is the second kind of money. Most of us have checking accounts. People who accept our checks a.s.sume our credit is good enough that the check will clear. Our a.s.sets in the form of checking deposits back our check, and the currency in our checking account will keep its value long enough to have the same purchasing power when the check clears. If there is hyperinflation, merchants will not accept checks. Credit has been around since humans shared food with the expectation that they would benefit from a future meal-an a.s.set-provided by their fellow tribesmen. Shipping merchants have used trade receivables for centuries using credit against a shipment of saleable goods.This only worked, because everyone expected your "ship to come in." International banking was born, because we wanted to trade goods between distant lands.

Warren and Charlie Munger avoid leverage, because it makes it much easier for people to trust that Berkshire Hathaway will always meet its obligations and keep its genuine AAA rating. Furthermore, since its businesses are throwing off so much cash, Berkshire Hathaway's ship is always coming in. Berkshire Hathaway's businesses throw off cash of around $100 million per week. It has no problem meeting obligations. Its problem is finding more good businesses in which to invest all of this money.

The third kind of money is fiat fiat money (this is not money to buy a designer car, as many young Wall Street bankers seem to think), such as the pieces of paper your government prints and issues as its currency notes. Fiat money is not backed by a commodity. Fiat money is not backed by a.s.sets (unlike a check which is backed by checking deposits). The money (this is not money to buy a designer car, as many young Wall Street bankers seem to think), such as the pieces of paper your government prints and issues as its currency notes. Fiat money is not backed by a commodity. Fiat money is not backed by a.s.sets (unlike a check which is backed by checking deposits). The faith and credit faith and credit of a government back fiat money.The world relied on commodities such as gold until we formed the nation-states. Until then, we did not trust each other's coins and printed papers. Until the beginning of the twenty-first century, of a government back fiat money.The world relied on commodities such as gold until we formed the nation-states. Until then, we did not trust each other's coins and printed papers. Until the beginning of the twenty-first century, hard currencies, hard currencies, defined as reliable currencies, included the U.S. dollar, Swiss franc, pound sterling, Deutsche mark (now replaced by the euro), and j.a.panese yen. The Deutsche mark (before the euro) and dollar held premier positions as reliable global currencies. By 2008, the dollar's reliability as a store of value lost credibility as the world looks askance at the United States' inconsistent policies and disastrous dollar diluting actions. China's currency, the renmimbi, is gaining credibility. Some consider it an emerging hard currency, but that remains to be seen. defined as reliable currencies, included the U.S. dollar, Swiss franc, pound sterling, Deutsche mark (now replaced by the euro), and j.a.panese yen. The Deutsche mark (before the euro) and dollar held premier positions as reliable global currencies. By 2008, the dollar's reliability as a store of value lost credibility as the world looks askance at the United States' inconsistent policies and disastrous dollar diluting actions. China's currency, the renmimbi, is gaining credibility. Some consider it an emerging hard currency, but that remains to be seen. When it comes to money, government matters. When it comes to money, government matters. If you live in a Third-World country and your government is run by corrupt thugs who loot the treasury and destroy the local economy, your country's fiat money will be nearly worthless to the international community. It is a lot harder to shake down a currency like the United States dollar. The United States is still a rich country, so a little corruption will not destroy the currency. But a lot of corruption combined with making promises for which we cannot pay (a $9 trillion national debt) and lower productivity are destroying faith in the U.S. dollar. Lately, the United States policymakers have demonstrated a twisted genius for causing the dollar to lose value. If you live in a Third-World country and your government is run by corrupt thugs who loot the treasury and destroy the local economy, your country's fiat money will be nearly worthless to the international community. It is a lot harder to shake down a currency like the United States dollar. The United States is still a rich country, so a little corruption will not destroy the currency. But a lot of corruption combined with making promises for which we cannot pay (a $9 trillion national debt) and lower productivity are destroying faith in the U.S. dollar. Lately, the United States policymakers have demonstrated a twisted genius for causing the dollar to lose value.

In finance, credibility is extremely important. Warren Buffett and Charlie Munger educate Berkshire Hathaway's 40,000 odd shareholders so that they understand that Berkshire Hathaway's AAA rating is solid.The entire financial community trusts it.Washington should have worked hard to make sure the dollar kept its credibility in the global financial markets.

The dollar is weakening partly because of growing U.S. current account deficit. The United States used to produce more than it consumes, and the rest of the world owed us. We reached a turning point in 2006 and headed in the wrong direction. We started consuming more than we produce. We now shovel $2 billion per day out the door and into the pockets of the rest of the world. It is as if we have a large lot of land and are selling off the fringes of our gardens so we can buy more consumable goods for the house.We are transferring a part of the ownership of our country abroad. For the first time in about 100 years, we are relying on credit with the rest of the world and have become a net seller of our a.s.sets to subsidize our spending habits. The current generation is spending and building up a large debt. How will your children and grandchildren feel if after you die they have to spend part of their time working to pay off tens of thousands of dollars of credit card debt you left behind? While the debt we are taking on is not credit card debt, our children and grandchildren will have to pay it off if we do not come up with a better solution soon.The solution is to start producing more than we consume, and it will not be easy. America is aging, and the number of workers is declining.

Washington has created a $9 trillion gross national debt. The size of the debt is around 80 percent of the $11.5 trillion U.S. residential mortgage marke

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Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street Part 7 summary

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