Buffett’s State of the World: There’s Folly in Wonderland
By FLOYD NORRIS
Published: March 1, 2008
The billionaire investor Warren E. Buffett disclosed Friday that he had earned profits for shareholders of Berkshire Hathaway by speculating in the Brazilian currency, the real, and by buying a large stake in a French pharmaceutical company, Sanofi-Aventis.
He also complained that many other companies were overstating earnings, and he expressed puzzlement that their auditors let them get away with it.
Mr. Buffett’s annual letter to shareholders, which was released Friday, has become something of a business institution, with the certainty that he will offer caustic comments and the hope that he will shed light on his investments.
This year, his scorn was aimed at the “financial folly” of lenders who financed the housing boom, since vanished, and at companies that use rosy assumptions of investment success to raise reported profits.
The comments, which were released after the market closed, came as Berkshire reported that fourth-quarter profit fell 18 percent, in part because of falling insurance rates. Net income decreased to $2.95 billion, or $1,904 a share, from $3.58 billion, or $2,323, a year earlier.
Mr. Buffett offered no commentary on Berkshire’s foray into the municipal bond insurance business, and no explanation of why he spent $1.5 billion to buy a 1.3 percent stake in Sanofi-Aventis.
But he was willing to say, in effect, “I told you so,” in recalling his warning a year ago about “weakened lending practices” in the mortgage market.
“Just about all Americans came to believe that house prices would forever rise,” he wrote. “That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that H.P.A. — house price appreciation — would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight.”
ELMAT: The banks only profitted from people's perceptions.
His criticism of other companies was based on the fact that many assume their pension funds will earn 8 percent a year from investments, a return he deems unlikely given the low level of interest rates, but one that lets them report higher profits now.
He compared money managers who promise double-digit returns to the queen in “Alice in Wonderland,” who proclaimed, “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Mr. Buffett added, “Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.”
Mr. Buffett pointed out that some companies with pension plans in both Europe and the United States assume better returns on the American plans than the European ones.
“This discrepancy is puzzling,” he said. “Why should these companies not put their U.S. managers in charge of the non-U.S. pension assets and let them work their magic on these assets as well? I’ve never seen this puzzle explained. But the auditors and actuaries who are charged with vetting the return assumptions seem to have no problem with it.”
“What is no puzzle, however, is why C.E.O.s opt for a high investment assumption: It lets them report higher earnings. And if they are wrong, as I believe they are, the chickens won’t come home to roost until long after they retire.”
Mr. Buffett also had harsh words for state and local governments. “Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement — sometimes to those in their low 40s — and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep.”
ELMAT: Thisd applies to GM. Applied to Siemens too: Need to close down businesses in order to get rid of the employees -thus destroying capital stock- because of asnachronic labor laws.
He did not discuss why he wanted to insure municipal bonds issued by governments making such promises.
Mr. Buffett also warned of lower profits ahead for the insurance industry, which has benefited from two years without major disasters.
“That party is over,” he said. “It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise.”
Berkshire’s investment in Sanofi-Aventis showed a profit of $109 million at the end of the year, but that profit has since vanished as the share price fell 23 percent in the first two months of 2008 amid concerns over possible generic competition for its best-selling drug.
Berkshire’s other major new stock investment in 2007, which was previously disclosed, was Burlington Northern Santa Fe, the railroad. On a $4.7 billion investment, Berkshire is now ahead by about $600 million.
Mr. Buffett said the company’s only direct foreign currency exposure last year was in the Brazilian real, an investment he conceded might seem odd. “After all, during the past century, five versions of the Brazilian currency have, in effect, turned into confetti,” he said. But the real position earned $100 million in 2007, according to the report.
ELMAT: Elroy needs to learn that. |
