Tuesday, August 9, 2011

Buffett: S&P Downgrade of the U.S. "Doesn't Make Sense"

From this Fox Business Network article:

Buffett to FBN: S&P Downgrade "Doesn't Make Sense"

...Buffett reaffirmed his belief in the quality of the United States' credit telling FBN, "In Omaha, the U.S. is still triple A. In fact, if there were a quadruple-A rating, I'd give the U.S. that."

Buffett also added the following...

"The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you're talking about inflation, that's a different question."

Now, contrast what Buffett had to say with this:

Jim Rogers on CNBC: "Don't See How U.S. Can Ever Pay Off Its Debts"

The U.S. doesn't deserve a AA-plus credit rating, much less triple-A, commodity bull and noted investor Jim Rogers told CNBC on Monday.

Rogers also said...

"It seems to me it's physically, humanly impossible for the U.S. to ever pay off its debt ," Rogers said. "They can roll it over and continue to play the charade, but the U.S. is bankrupt."

So Buffett says U.S. is quadruple-A and Rogers says U.S. is bankrupt.

Two informed participants with polar opposite views.

I'm guessing both views resonate with individuals who mostly think the other is crazy. No matter who you agree with it's worth knowing how and why others come to completely different conclusions with what seem like the same set of facts.

From this Bloomberg article:

Buffett Says Cutting U.S. Rating Was a Mistake, Sees No Recession

"Financial markets create their own dynamics, but I don't think we're facing a double dip recession," said Buffett, chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc. (BRK/A) "Clearly what stock markets do have is an effect on confidence, and this selloff can create a lack of confidence."

Who knows how this plays out. The nature of financial markets, especially the modern iteration, create tough to predict feedback loops that take on a life of their own.

In many ways, a monster of our own making that I'm not convinced serves its primary purpose all that well.

We could easily make it simpler, smaller in scale, less hyperactive, less expensive, and more stable if we wanted it that way. Yet, considering the interests involved, that's not going to happen anytime soon.

Some relevant quotes:

"...the 3% of GDP that was made up of financial services in 1965 was clearly sufficient to the task, the proof being that the decade was a strong candidate for the greatest economic decade of the 20th century. We should be suspicious, therefore, of the benefits derived from the extra 4.5% of the pie that went to pay for financial services by 2007, as the financial services share of GDP expanded to a remarkable 7.5%. This extra 4.5% would seem to be without material value except to the recipients. Yet it is a form of tax on the remaining real economy and should reduce by 4.5% a year its ability to save and invest, both of which did slow down." - Jeremy Grantham in Finance Goes Rogue

"In the '20s, a tiny class of people were financial promoters and a tiny class of people were buying securities. Today, it's deep in the whole culture, and it is way more extreme. If sin and folly get punished appropriately, we're in for a bad time." - Charlie Munger in the Stanford Lawyer

"When they wanted to make the securities market function better as a gambling casino with vast profits for the people who were croupiers—there was a big constituency in favor of dumb change....these changes repealed longtime control of margin credit by the Federal Reserve System." - Charlie Munger in the Stanford Lawyer

"...just one after another the very people who should have been preventing these asininities were instead allowing foolish departures from the corrective devices we'd put in the last time we had a big trouble—devices that worked quite well." - Charlie Munger in the Stanford Lawyer 

What we have then is a system that is much larger than what it has been historically. An example of where that additional size comes from is the making of fast-paced bets using various options, derivatives, and high-speed trading strategies.**

Now, I've no doubt those activities serve the participants involved quite well. Whether modern financial markets come even close to effectively serving their broader purpose or not an afterthought it seems.

"I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive "earnings" (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham." - Warren Buffett in the 2002 Berkshire Hathaway Shareholder Letter

The current large, overly complex, and often less stable iteration of the financial markets is the one we have to live with for now.

It will continue to impact the remaining real economy from time to time in not easy to foresee ways.

Adam

* Munger's point is that we're not controlling financial leverage if we have option exchanges. He also said: "Unlimited leverage comes automatically with an option exchange. Then, next, derivative trading made the option exchange look like a benign event."
**Here's what Charlie Munger said about high frequency trading at the last Wesco Financial Annual Meeting according to these notes: "Fancy computers are engaging in legalized front-running. The profits are clearly coming from the rest of us -- our college endowments and our pensions. Why is this legal? What the hell is the government thinking? It's like letting rats into a restaurant."
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