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Posted on 30 Oct 2008 by Forager

Prepare yourself for a 20-year bear market

Prepare yourself for a 20-year bear market

How can a 20-year bear market be possible if the market wasn’t overpriced to begin with? Surely it’s only a matter of time until reason is restored and the market returns to its previous level? Sorry, but I think that’s unlikely. As I pointed out in a 2005 article titled Profits won’t defy gravity forever, the P/E argument is naïve.

Yes, the P/E was in line with its long-term average. But corporate profits – the ‘E’ part of the equation – are the highest they’ve ever been when expressed as a percentage of the overall economic pie. All of the forces of capitalism work to bring this ratio back to its average. Shrewd investor Jeremy Grantham’s US research led him to the conclusion that this is ‘one of the most mean-reverting series in finance’. But even if you reject Grantham’s argument, you will, as Warren Buffett put it, ‘get into certain mathematical problems’ if you expect part of the economy to continue growing faster than the whole.

Prepare yourself for a 20-year bear market

For mine, I’m on board with Grantham. I expect the profitability of corporate Australia to fall, in some cases dramatically. In fact, the process is already under way.

Profits under fire

The first profits we’re seeing disappear are those that were never there to begin with. The fictional profits reported by the likes of Macquarie Airports, Macquarie Infrastructure Group and a litany of property trusts – thanks to asset revaluations – are a thing of the past (thankfully).

Next in line are the financial sector’s profits. This sector’s share of the economy was about 1% in 1960. In 1990, it was still about 1%. But by December 1999 it had doubled to 2%, and in June 2007 financial corporations were generating 3% of the nation’s gross domestic product (GDP).

Cheap credit and soaring asset prices translated into rapid loan book growth and record low default rates (it’s hard to default when they keep giving you more money). Some of the change is related to deregulation and could be permanent. But finance remains a highly cyclical industry and the cycle has most definitely turned.

Perhaps the largest contributor to the wonderful times for corporate Australia, however, was the resources boom. Most resources are not sold domestically. They’re exported, which means that in theory resources sector growth could outstrip domestic growth for a long and sustained period. But, for the moment, commodity prices are in a tailspin. Zinc is off 77% from its 2006 high and copper has fallen 60% since July. Nickel, a tonne of which would have cost you US$54,300 in May 2007, is now changing hands for US$9,800 a tonne.

Those prices are in US dollars and a plunging Australian dollar will shield local miners to some extent, but nowhere near enough to maintain current levels of profitability.

Blue chips expensive

These two sectors, mining and finance, represent roughly 70% of the total Australian market. So when you consider the overall market’s P/E of 10, you need to consider the fact that the low P/Es of these businesses are dragging the average down. And justifiably so, based on the evidence at hand. In fact, as I wrote last week, many blue chips look decidedly expensive next to some of their international peers.

And I’m not particularly confident about the rest of the economy either. In relation to both their assets and their income, households are carrying more debt than at any time in our history. We have a generation (my generation) of consumers and companies that know nothing but good times and easy credit.

Australia is fortunate enough to have a large government surplus and room to move on interest rates. That gives the authorities ammunition to defray some of the pain caused by falling house prices and tight credit, but it doesn’t change the fact that spending more than you earn is an unsustainable practice. An adjustment to a sustainable level of consumption needs to take place and it won’t be pleasant for those businesses, particularly retailers, that have grown fat on the profligacy of the consumer.

In short, while substantially lower share prices compensate for much of the doom and gloom, we remain concerned about the state of corporate Australia. In many cases share prices still don’t seem to compensate today’s investor adequately for the risks they’re taking on.

That, in a nutshell, is why I think you should prepare for a long and protracted bear market. Don’t be fooled into thinking things can’t get any worse.

Making money in a bear market

My strategy for dealing with this scenario is not complicated. First, avoid potential disasters – no matter how enticing the potential returns on offer. Mr Market, a fictional character first invented by value investing’s godfather Ben Graham to describe the stock market’s bipolar personality, is in a foul mood. He’s short-tempered, quick to anger and impatient, and this is no time to be asking him for favours (just ask GPT shareholders who have seen their stakes in this iconic group severely diluted by a forced capital-raising at $0.60 per unit). Stick to businesses that don’t need any favours from anyone and avoid those that need to refinance debt or raise equity.

Second, find stocks that will deliver their value to you in cash. If you hold such stocks, the length of the bear market won’t make the slightest bit of difference. Take, for example, electronic-parts-catalogue manufacturer Infomedia. This business sells essential software subscriptions to the automotive industry and generated $13m in profit last year. It consistently pays 80% of its profit out as fully franked dividends, equating to a yield of more than 8%. The company has $14m of cash (as at 30 June), no debt, high profit margins, and 80% of its revenues are earned in US dollars and Euros. If the currency stays at its current low levels, it will have a substantial impact on Infomedia’s profit, increasing 2010 earnings (and, likely, dividends) by more than 50%.

If you want your money back in a hurry, there are a number of income securities trading at exceptionally attractive prices at the moment. These debt-like investments are listed on the stock exchange just like ordinary shares. Our favourites are the Southern Cross SKIES (SAKHA), Seven’s TELYS (SEVPC) and the Timbercorp Corporate Bonds (TIMHB), but there are more than 10 we think are attractive. They all offer returns of more than 15% a year, and in many cases you’re due to get your cash back within the next few years, giving you the chance to take advantage of future opportunities.

This simple, safe strategy will be extremely effective in a protracted bear market and provide you with returns well in excess of a cash account. Of course, if the market does roar back into record territory, you’ll miss some of the big gains. But it is, in my opinion, better to be safe than sorry.

For more value investing analysis and advice, register for a free trial to The Intelligent Investor.

The author, Steve Johnson, owns shares in Infomedia as do other staff at The Intelligent Investor.

Warning: The advice given by The Intelligent Investor and provided on this website is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it, seeking advice from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all people.

Posted on 14 Oct 2008 by Forager

The End of the Financial Crisis

We may still be headed for recession. There may still be plenty of bank loans ‘go bad’. But the risk of systemic failure has been eliminated by the largest government bailout in the history of financial markets.

Europe’s governments, including the UK, yesterday committed the astonishing sum of €1.9 trillion to shore up their banking system. Between 10% and 20% is earmarked for direct investment in new capital, mostly in the form of preference shares (the UK’s deal with Royal Bank of Scotland could leave it with 60% of the bank’s capital).

The remainder of the funds, more importantly, provide credit guarantees for inter-bank lending. Governments around the world have already protected depositors. Now they’re protecting banks from each other as well.

If that doesn’t kick-start the inter-bank lending market, nothing will. Banks have been refusing to lend to each other because they’ve been worried about counterparty risk. Now, with government guarantees, there really is nothing to worry about – apart from the solvency of the governments themselves.

For the world’s financial markets, this is undoubtedly good news. For those banks that need to sign up for a rescue package, selling cheap equity and agreeing to have the government as your master won’t mean wonderful returns for existing shareholders. But it’s better than going broke.

And for those, like Macquarie Group, that are well capitalised and have managed to steer clear of the disastrous investments causing their peers so many troubles, the return of functioning credit markets is a godsend. As it is for the thousands of well-managed, conservatively financed businesses dependent on credit markets for their day-to-day operations. Finance directors around the world should sleep a little better tonight.

The rest of us, however, have a little more to worry about. Nothing good is free, so my mother tells me, and the cost of this stupendous bailout will be borne by taxpayers. The main countries involved were already running large budget deficits and the cost of these measures will push them out to truly concerning percentages of GDP – the Financial Times expects UK public sector debt to rise to levels not seen since 1977 when the then Labour Government was forced to borrow from the IMF. Consumers will have to live with higher inflation and we’ll all have to live with the stifling impact of unprecedented government influence in financial markets.

Those, however, are tomorrow’s problems. Today, financial markets will rejoice.

Posted on 07 Oct 2008 by Forager

Reserve Bank Cuts Interest Rates

Today’s 100 basis point (1 percentage point) cut in the official interest rate is the economic equivalent of a severe jolt from a defibrillator. And the result has been a dramatic convulsion throughout Australian financial markets.

Reserve Bank Cuts Interest Rates

Today’s 100 basis point (1 percentage point) cut in the official interest rate is the economic equivalent of a severe jolt from a defibrillator. And the result has been a dramatic convulsion throughout Australian financial markets.

The stockmarket roared its approval, with the All Ords rallying more than 200 points from its daily low of 4,395. Markers in the short-term money markets also surged, including 90-day bank bills (where the yield fell 60 basis points) and three-year government bonds (where the yield fell more than 25 basis points). For those unfamiliar with money markets, a fall in yield equates to a rise in price.

Meanwhile, in another corner of the financial markets, the reaction was more subdued. The price of 10-year government bonds actually fell, before rising a little. These long-dated bonds are more sensitive to inflation expectations, and they greeted the RBA’s move warily.

And you can see why. Australia’s money supply (M3) has been growing at a jaw-dropping rate for more than 12 months now. The latest data, for August, showed a 19% year-on-year increase. This kind of wanton money-printing is likely to lead to higher inflation down the track and lowering the price of money so dramatically is not likely to help. In trying to alleviate the immediate and pressing problem of the global credit crisis, there’s every chance the RBA is setting the Australian economy up for even bigger challenges in future.

Posted on 03 Oct 2008 by Forager

Wesfarmers’ board gets it all wrong

Wesfarmers' board gets it all wrong
Wesfarmers MD Richard Goyder

Economics used to be known as the dismal science. But that description could hardly be applied to the authors of scintillating books such as Freakonomics (Steven D Levitt) and The Logic of Life (Tim Harford). This new breed of economist focuses its attention on practical questions viewed through the prism that, as Levitt puts it, ‘incentives are the cornerstone of modern life’. And they both make a compelling case, explaining fascinating conundrums by examining the underlying incentives.

Charlie Munger, Warren Buffett’s business partner, puts it this way: ‘I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it.’

At The Intelligent Investor, we’re convinced: incentives matter. A lot. That’s why I’m always interested in the compensation schemes managing directors are able to negotiate for themselves. And I took a particular interest in the incentive scheme recently announced by Wesfarmers for its MD, Richard Goyder.

All too often, executives get large ‘golden handshakes’ for arriving, and even larger ‘golden parachutes’ for leaving, well it appears that Goyder is being offered a generous ‘golden armchair’ just to stick around. The new remuneration arrangements apparently reflect ‘the increased responsibilities the Coles Group acquisition has brought to the role’ (hmmm … did somebody force him to make that deal?) and follows ‘an independent review of his remuneration’ (which I’d have thought was one of the key things shareholders pay the board to do). But it’s the details shareholders need to worry about.

The sheer quantum of the numbers is striking: a base salary of $3.15m; the same amount again if he meets his short-term (less than a year) performance targets; 100,000 shares if ‘long-term’ return on equity (ROE) targets are met; and another 100,000 shares for each percentage point that the ROE exceeds the undisclosed target. The performance shares won’t be allocated for at least three years, and only then if ROE is ‘sustained’ above the relevant level (‘sustained’ meaning for a period of two years, at least for the additional percentage point bonuses; it’s not clearly spelt out for the first 100,000 shares).

At the current share price of $29, each percentage point he adds to the ROE would mean an extra $2.9m to Goyder’s hip pocket. By way of comparison, former managing director and careful steward or shareholders’ capital Michael Chaney’s salary was $2m a year. Chaney’s short-term performance bonus was a maximum of $500,000 and, when the business’s outstanding performance meant the payments due to him under the long-term incentive plan had ‘risen to levels beyond those originally envisaged for excellent performance’, he voluntarily capped his bonus at $2m a year.

Chaney’s behaviour is to be commended. But, in the scheme of things, a few tens of millions of dollars paid to the managing director won’t make a huge difference to Wesfarmers’ $19bn market capitalisation. My concern lies with the more insidious incentives this scheme puts in place for Goyder.

Boosting return on equity, in the short to medium term, is not difficult. Especially if you have a bunch of high quality assets like those on Wesfarmers’ books. Ask any investment banker and they’ll tell you the secret: borrow. Borrow all you can. If the returns provided by the assets are above the cost of debt, your return on equity will skyrocket. The highly leveraged acquisition of Coles shows Goyder knows this trick all too well.

Of course there’s a degree of risk involved. But, from Goyder’s point of view, it’s a good bet that it will take a few years before any risks rear their ugly head. Even if he struck out with an early disaster, his base salary is hardly chicken feed (and he’d have a lovely golden parachute to escape with).

Why boards don’t lock the remuneration up for longer is beyond me. If they do need to offer such potentially lucrative rewards (I’m sure Goyder would do it for half as much), at least tie him in. Make him hang on to his shares for 10 years – the company confirmed today that he can sell them the day he gets them – and he might think differently about the risks he’s taking on.

I have no reason to believe Richard Goyder is a bad person or that he’d intentionally destroy shareholder value. But most of the world’s current financial problems can be traced back to intelligent, confident, driven people, incentivised to maximise their own wealth without regard to risk. This Wesfarmers plan sounds far too similar.

Posted on 25 Sep 2008 by Forager

Buffett Interview on CNBC

Here’s an extremely interesting CNBC interview with Warren Buffett about his Goldman Sachs investment, Treasury’s bailout of Wall Street and the gravity of the situation facing the US economy. You can watch the video using the following links or I’ve copied the transcript below. Enjoy.

Part 1 (9:56)

Part 2 (10:44)

Part 3 (9:45)


BECKY QUICK: We know you get all kinds of deals, all kinds of people who come knocking asking you to jump in. You’ve said no to everything to this point. Why is this the right deal at the right time?

WARREN BUFFETT: Well, I can’t tell you it’s exactly the right time. I don’t try to time things, but I do try to price things. And I’ve got a formula that says bet on brains, and bet of them when it’s the right type of deal. And in this case, there’s no better firm on Wall Street. We’ve done business with them for years, with Goldman, and the price was right, the terms were right, the people were right. I decided to write a check.

BECKY: Does the backdrop of the Federal government potentially getting involved with a massive bailout plan for Wall Street, does that have anything to do with this deal?

BUFFETT: Well, I would say this. If I didn’t think the government was going to act, I would not be doing anything this week. I might be trying to undo things this week. I am, to some extent, betting on the fact that the government will do the rational thing here and act promptly. It would be a mistake to be buying anything now if the government was going to walk away from the Paulson proposal.

BECKY: Why would that be a mistake? Because the institutions would collapse, or because you could get a better price?
BUFFETT: Well, there’s just no telling what would happen. Last week we were at the brink of something that would have made anything that’s happened in financial history look pale. We were very, very close to a system that was totally dysfunctional and would have not only gummed up the financial markets, but gummed up the economy in a way that would take us years and years to repair. We’ve got enough problems to deal with anyway. I’m not saying the Paulson plan eliminates those problems. But it was absolutely, and is absolutely necessary, in my view, to really avoid going over the precipice.

CARL QUINTANILLA: Warren, we can almost hear you measuring your words as you speak, because what we’re talking about has such gravity. There are people out there who either don’t, or are unwilling, to acknowledge what exactly, how serious the situation was last week. And I’m hearing you say is that, was it the most frightening experience you’ve had in your lifetime, in terms of evaluating where this economy stands?

BUFFETT: Yeah, well, both the economy and the financial markets, but there’re so intertwined that what happens, they’re joined at the hip. And it doesn’t pay to get into horror stories in terms of naming institutions or anything. But I will tell you that the market could not have, in my view, could not have taken another week like what was developing last week. And setting forth the Paulson plan, it was the last thing, I think, that Hank Paulson wanted to do. there’s no Plan B for this.

BECKY: Warren, you mentioned that Wall Street could not have taken another week like that. But what does that mean to the American taxpayer who’s sitting at home saying, ‘Why is this my problem?’

BUFFETT: Yeah, well, it’s everybody’s problem. Unfortunately, the economy is a little like a bathtub. You can’t have cold water in the front and hot water in the back. And what was happening on Wall Street was going to immerse that bathtub very, very quickly in terms of business. Look, right now business is having trouble throughout the economy. But a collapse of the kind of institutions that were threatened last week, and their inability to fund, would have caused industry and retail and everything else to grind to something close to a halt. It was, and still is, a very, very dangerous situation. No plan is going to be perfect, but thanks heavens that Paulson had the imagination to step up with something that is of the scope that can really do something about it. And what he did with the money market funds, that was not an idea that I had, but as soon as I heard about it, that was an important stroke. Because the money, pulling out of the money market funds and going to Treasuries, and driving Treasury yields down to zero. That — a few more days of that and people would have been reading about lots and lots of troubles.

JOE KERNEN: People listen, Warren, when you speak. And I don’t know if you watched the hearings yesterday …

BUFFETT: I got to watch some of them.

JOE: But when the more dire it looked, in terms of communicating, with some of these Senators, the three-month or one-month bill, again, started acting similar to what was happening on Thursday. Now we averted that disaster on Thursday, but it’s already been three or four days. It’s almost as if these guys already forgot about the position that we were in. Do you think that accounted — we’re still susceptible to that happening again if it looked like they’re not going to go through with this?

BUFFETT: No, it would get worse. Last week will look like Nirvana (laughs) if they don’t do something. I think they will. I understand where they’re very mad about what’s happened in the past, but this isn’t the time to vent your spleen about that. This is the time to do something that gets this country back on the right track. What you have, Joe, you have all the major institutions in the world trying to deleverage. And we want them to deleverage, but they’re trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that’s willing to leverage up. And there’s no one that can leverage up except the United States government. And what they’re talking about is leveraging up to the tune of 700 billion, to in effect, offset the deleveraging that’s going on through all the financial institutions. And I might add, if they do it right, and I think they will do it reasonably right, they won’t do it perfectly right, I think they’ll make a lot of money. Because if they don’t — they shouldn’t buy these debt instruments at what the institutions paid. They shouldn’t buy them at what they’re carrying, what the carrying value is, necessarily. They should buy them at the kind of prices that are available in the market. People who are buying these instruments in the market are expecting to make 15 to 20 percent on those instruments. If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.

BECKY: Are you buying instruments like these in the market?

BUFFETT: Well, I don’t want to leverage up. No one wants to leverage up in this thing. So, if I could buy a hundred billion of these kinds of instruments at today’s prices, and borrow non-recourse 90 billion, which I can’t, but if I could do that, I would do that with the expectation of significant profit.

JOE: But the government can do that. You can’t. And that’s why the private sector can’t, even you, can’t save the system.

BUFFETT: I can’t come close to it. But they have the ability to borrow. They can borrow much cheaper than I can borrow. They can borrow unlimited. They don’t have covenants. They don’t have — I mean, they are in the ideal position. So, for example, if I were hiring advisers, as I talked about doing to buy these things, I would tell those advisers, ‘Look it! People are buying these instruments to make 15 percent. So if you’re going to charge me any fees, I’m going to defer those fees until I get rid of these instruments later on. If I don’t make at least ten percent on my assets, you know, your fee goes down the drain. Because it should be a lead-pipe cinch to make 10 percent at the kind of prices that exist now. I wouldn’t try to write that into the legislation. I don’t think you should — I think they should punish, in many cases, the people — I would think they might insist on the directors of the institutions that participate in this program waiving all director’s fees for a couple of years. They should, maybe, eliminate bonues. They may wish to do some of those things. I don’t think you should try to write it into the instrument, though. I think that gets so damn complicated and ties people’s hands. But if I were administering the program, I think I’d be fairly tough about some of those things, and I’d make sure that the advisers earned me a return that was well above my cost of borrowing before they got paid a dime.

BECKY: Would you administer the program?

JOE: Yeah, can you be on the oversight board? (Buffett laughs.) Can you be on the oversight board?

BUFFETT: I’d love to administer (laughs). I’d love to administer it for nothing, but I would really love to administer and get some kind of an override in terms of the profits, which is naturally the way Wall Street thinks. No, it’s not my game to do that, but I will tell you that the buyers of the instruments these days are going to do better than the sellers. And the big buyer, if they — they shouldn’t pay any attention to the cost of these instruments to the selling institutions. They shouldn’t pay any attention to the carrying value. In fact, one thing you might do, is if someone wants to sell a hundred billion of these instruments to the Treasury, let them sell two or three billion in the market and then have the Treasury match that, for what they pay. You don’t want the Treasury to be a patsy. But I’ll tell you, with Hank Paulson on top of it, you couldn’t have any better guy to do that. The important thing is that if this program extends into the next administration is to have somebody in the next administration that has similar market savvy

CARL QUINTANILLA: Separate from the bailout, Warren, people obviously this morning want to look at the Goldman deal, I guess on top of Mitsubishi-Morgan, which happened yesterday and wasn’t nearly as popular, at least from a market point of view. But they want to point to you as the ‘canary in the coal mine.’ Is that fair? Do you have a problem with that?

WARREN BUFFETT: Well, as long as the canary lives, I’m fine. (Laughs.)
CARL: I’m guessing you’re going to live. At least, you’re guessing you’re going to live?
BUFFETT: Yeah, I think so. (Laughs.) This is, you know, from our standpoint, we’ve had a lot of cash. And we now are seeing things that, you know, give us a chance to use that cash sensibly. And this was a five billion dollar opportunity to, I think, deploy cash sensibly. I understand, incidentally, that there will be another five billion. In other words, they mentioned 2-1/2 billion, but I think they’re going to allocate it down to five billion additional. So Goldman will have ten billion, I believe, of new money coming in.

BECKY: In that capital offering. In the release, they said 2-1/2 billion (of common stock would be offered in addition to Buffett’s investment.) You’re saying you understand it’s five billion?

BUFFETT: Yeah, I think they have quite an outpouring of orders, so I think — They’ll be allocating it down, but I think from all over the world. So I think there will be five billion of additional common stock sold. That will be determined and announced, I believe, before the opening.

JOE: How much do you know about AIG and their books right now, Warren?
BUFFETT: Well, I think I know a fair amount, but I don’t think anybody knew what they needed to know, including the management. the troubles there were in the subsidiary, AIG Financial Products, and they had hundreds of thousands, I’m sure, hundreds and thousands of derivative contracts. And I think that top management did not have their mind around what was involved with those contracts. And you can do a lot of damage on Wall Street with a pen and a piece of paper.

JOE: How many of those units are going to end up under the Berkshire umbrella?
BUFFETT: Well, we would have an interest in a couple of ’em. And actually over that weekend I expressed an interest in one or two, but the pressures were such, and the hole was deep enough, that they simply couldn’t get it worked out. And some of those units, most of those units, I believe, will be for sale over the next year or two. And we would be interested in a couple of them. I think they’ll probably do a pretty intelligent job of selling them, which means we won’t be as good a buyer.

BECKY: You know, Warren, we’ve been trying to figure out — I have to admit that I was shocked when I heard the news yesterday about this deal with Goldman, because you haven’t put any money into an investment bank since 1987, Salomon. And that was a deal you had to get personally involved with later in 1991 when you went to run the company for almost a year. It was a very difficult experience. I’m shocked that you would get back in with another investment bank. Why do it?

BUFFETT: (Laughs.) Well, the pain has worn off. That won’t be happening with Goldman, but I — That was a very unfortunate experience, and it was actually caused by just a couple of people out of a workforce of 8000 that got the company into big trouble. And I had the help of a lot of people at Salomon in getting out of it. But I don’t think this experience will be similar. Goldman has been extremely well run. My experience with Goldman goes back, when I was nine or ten years old my parents took me back to the New York World’s Fair, and by an odd chance I got to sit down with Sidney Weinberg, who was the dean of Wall Street then, and he talked to me as if I was a grown-up for 45 minutes. I’ve never forgotten the experience. Gus Levy (who later ran Goldman in the 1970s) was a good friend of mine when I worked in Wall Street. In 1955, we only had four wires to Wall Street firms and one of them was to Goldman Sachs and Gus was on the other end of the phone. So I’ve had a long experience with Goldman and they’ve done a lot of things for me recently.

JOE: I just assume you know what was going on at all of these firms because I know everybody probably came to you and you made your decisions one-by-one on what to do. When you look at the way some of these assets were marked, could you tell that, for example, Lehman still wasn’t facing reality and perhaps Merrill Lynch was more in the real world?

BUFFETT: Well, I think that turned out to be the case. I was apprached on Lehman back in, I think, maybe it was April or March. But the first round of financing when they raised the four billion, and, yeah, it looked to me like it was pretty unrealistic where they were marking things. I feel good about the Goldman marks, incidentally, that’s one of the discussions I’ve had. And — You can be pretty fanciful in marking positions in Wall Street, particularly when things aren’t trading. The one thing you want to make sure, when the Treasury is buying things, is the marks they have don’t make any difference. Like I said, it wouldn’t be a bad idea, if you’re buying ten billion of a security and you’re the Treasury, to have them sell five-hundred million, or something like that into the market, so you find out what the real market price is and then buy the other 9-1/2 billion at that price. I really think, I really think the Treasury will make — I think they’ll pay back the 700 billion and make a considerable amount of money, if they approach it in that manner. But I don’t believe in trying to write that into some legislation. I think it gets so unworkable. I think you have a smart person in charge, and have them treat it like it’s their own money, and the taxpayers’ money, in terms of behavior, and I think it will work out very well. I think it’s not comparable to the RTC.

CARL: A lot of people who are watching us Warren, and even people who have just started watching us over the past week or two, look at the stock market every day and are confused. They want to use it as a metric for how we’re doing, or at least the progress we’re making on big issues. I’m guessing you don’t think it’s reflective of anything that’s based in reality right now?

BUFFETT: Well, the stock market in the short — my old boss Ben Graham said that in the short-run the stock market is a voting machine, in the long-run it’s a weighing machine. As a voting machine, it responds to people’s emotions. There’s no literacy test for voting. You vote according to how much money you have, not according to how smart you (are.) So the stock market does some very silly things in the short-run. Over the long-run, it behaves quite rationally. And, you know, five years from now, ten years from now, we’ll look back on this period and we’ll see that you could have made some extraordinary buys. That doesn’t mean it won’t get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well. But they shouldn’t own it on leverage. That’s what people have learned in this period, that you’ve got to be able to play out your hand and it’s a big mistake to let somebody else be in a position where they can sell you out.

BECKY: Warren, when you first invested back in ’87 in Salomon, I believe your partner, Charile Munger, was not as enthusiastic about the idea as you were. Is that true?

BUFFETT: That’s true. Of course, he’s never as enthusiastic about my ideas as I am. But I would say he was even less enthusiastic. (Laughs.)

BECKY: How does he feel about the Goldman deal?

BUFFETT: Well, I’m glad you asked because I, (laughs), didn’t tell him about it until after it was done. (Laughs.)

CARL: How rude!

BUFFETT: (Laughs.) Yeah, it is kind of rude. But Charlie’s wife had a bad fall and he’s (inaudible) and I called him last night about an hour after I committed it, or something, and I called kinda like a little boy … (laughs) … bringing into the house something he was a little worried about. But, Charlie’s all for it. (Laughs.)

BECKY: He’s all for it.

BUFFETT: Yeah. Now I’m really worried.

BECKY: Uh-oh. For the last nine months, Berkshire has spent a lot of that cash it’s been hoarding over the last several years.

BUFFETT: That’s right.

BECKY: I was trying to figure it out. I think it’s about 24 billion dollars you’ve spent in the last nine months?

BUFFETT: Yeah, we’ve spent a lot of money. The money, the money we’ve spent, you know, we’ve found things we like to do. It’s nice to have a lot of money, but you don’t want to keep it around forever. I prefer buying things. Otherwise it’s a little like saving up sex for your old age. (Laughs.) At some point, you’ve got to use it. (Laughter.)

JOE: Uh-oh.

BECKY: Twenty-four billion dollars. Is that a right guess and how much cash do you have left?

BUFFETT: You know, it would be 6-1/2 for the Mars deal, there’s five for this, there’s five for Constellation, there’s a couple of other things. So, yeah, your addition is fine, Becky.

BECKY: How much cash do you have left?

BUFFETT: Well, I’ve got enough. (Laughs.) I don’t really look at it every day. I look for opportunities every day, and then if I find opportunities, I see if I’ve got enough cash around to take care of them.

JOE: Well, by my calculation, if you lever that up thirty times, Warren, you can really get serious here. (Laughter.) Maybe you don’t want to do that, I don’t know. (Laughter.) What about, how are we going to deal with this looming 50 — we just had (New York State Insurance Commissioner) Eric Dinallo on, I don’t know if you were watching, Mr. Buffett. He talked about, he can, maybe New York and his unit can look at the twelve billion, or trillion, jeez, we’ve got to add a T. I’m finally getting used to Bs, now we have to add a T. But what we are going to do with that 50 trillion and how, having that still around, all these credit default swaps, how serious is that, and how are we going to unwind it and deal with it?

BUFFETT: Yeah, well, it goes beyond credit default swaps into all forms of derivatives. But the derivative genie got out of the bottle, and it’s a huge genie, and it will never get back into the bottle. It is a terribly tough problem because they are not homogeneous items. It’s one thing to have a clearing house for the futures in Chicago, or something, and every morning have everybody post to market and that’s a very efficient system. It’s very hard to do that with derivatives where you can derivatives based on the New Zealand money supply or the number of babies born in Japan, and all kinds of things as the variables. And they’re often very complicated. I applaud Dinallo. He is an outstanding insurance comimssioner. But getting regulation around the entire derivatives market is really tough. I’ve thought a lot about it. But it’s important. Derivatives have been an important part of the problem in financial markets. And they continue to be part of it. And in AIG’s case — AIG would be doing fine now, I think, if they’d never heard of the word derivative.

BECKY QUICK: Mr. Buffett, the front page of the Wall Street Journal and other media organizations around the globe have been picking this up, your move yesterday into Goldman Sachs, as a vote of confidence in the banking institutions across the globe. Is that fair?

BUFFETT: Well, I’m not buying a cross-section of banking institutions. But I certainly have confidence in Goldman. And you can say it’s a vote of confidence in the Congress to do the right thing with something that’s being debated before them right now.

CARL QUINTANILLA: You know, Warren, some might say, ‘OK, we know Buffett is a pure capitalist. he’s in this to make money and nothing else.’ But also you’re a philanthropist, you have interests in seeing the country do well over time. Some might say he’s doing this, he’s timed this to help get the package through. Is there anything — is that even close to reality?

BUFFETT: No. I timed this because Goldman Sachs yesterday came up with something that made sense to me. I’m not brave enough, to try and influence the Congress. The other way around, they influence me. And I am betting on the Congress doing the right thing for the American public by passing this bill and not trying to doctor it up with a hundred things that, you know, emotionally they feel should be on the bill but as a practical matter will gum things up.

CARL: When do you think, Warren — I don’t know if you even have an answer to this question — When is the absolute deadline by which you think this needs to happen? Is it this weekend? Can you be that specific? Or if this thing were to bleed into next week, or if they had to reconvene a special session, would that be disastrous?

BUFFETT: Well, I think anything that makes it look like it’s in doubt is what causes the problem. So if they said on Friday we’re absolutely having a vote on Monday, or something of the sort, I don’t think that would be a problem. But if they went home on Friday and there was doubt about whether they were going to do something on Monday, I think you’d see some things you don’t want to see in the markets and they would have some effects on the economy.

JOE: You were watching yesterday, and I don’t know, maybe I don’t know the ways of Washington. Maybe they say one thing and maybe they’re really planning — you know, they have to look good for their constituents. But I wasn’t convinced they really understood the seriousness of the situation, Warren, and that was after they said, look, Greenspan says we need this, Volcker says we need this, Bernanke, Paulson. Now we have you. I don’t know. Do you think they get it?

BUFFETT: Well, I think they will get it. I think enough of them will get it. You know, it’s not like Pearl Harbor where you could look at what happened with your own eyes and decide you had to do something that day. But this is sort of an economic Pearl Harbor we’re going through. And I think most of them will get it. And I do believe they will do what’s right for the country. They may vent their spleen a little bit by getting mad about the people that brought us into that, and I don’t blame them for that. I might do that privately, too. But in the end, you know, Republican, Democrat, I think they’ve got the interest of the country at heart and I think they will do the right thing. But I hope they do it soon. (Laughs.)

BECKY: Warren, how long were you talking to Goldman Sachs and how significantly did they have to change the terms of the deal to get you interested?

BUFFETT: Well, what they — they had talked with me — almost every financial institution has talked with me, that you read about, over the past few weeks. But, but, they were serious yesterday about doing something. They said, in effect said, ‘What would you do? What would Berkshire do? And I laid out something. And they said, ‘That makes sense to us.’ And we had a deal. It doesn’t take long.

JOE: You were kidding Becky when you said that you did this just ’cause you knew we were going to ask you when you were going to do something in financials again and you wanted to have an answer.

BUFFETT: Joe, Joe, I was not — you know, I was trembling with the thought of you asking me again, ‘When are you finally going to do something?’ (Laughs.) So this was definitely an attempt to get you off my back.

JOE: It was a cheap way, a mere five billion, so you’d have something to show us this time.

BUFFETT: That’s right. I mean, your withering questioning is just too tough for me. (Laughs.)

BECKY: You know, you mentioned earlier, in the grand scheme of things, it’s going to matter who the next Treasury Secretary is going to be. Are there names of people you think would be sound in either administration.

BUFFETT: Becky, if I were running things, Republican or Democrat, I would ask Hank to stay on. I mean, you don’t get talent like that very often in any administrative job. And the guy pays an enormous price to do it. He’s probably sleeping three or four hours a night. He knows the market. He’s got the interests of the country at heart. So I think if I were either Barack Obama or John McCain and found myself in the White House in January, I would go down there and say, ‘Hank, do me a favor, stick around another year.’

CARL: And Warren, if you believe, as a lot of people do, that we are in for several years of this unwinding process, the government’s going to play a huge role. If you were called to do something on the public side, would you do it?

BUFFETT: Well, I would certainly be glad to help in any way that I could. You know, I would be looked at as having conflicts-of-interest, I’m sure. But anytime I can be helpful on something — For example, in terms of what you might do with institutions that participated in this program, I think the Treasury can, they can lay down some terms for these people. I don’t think they should be in the legislation, but I think — And if anybody wants my opinion on it, I’d be glad to help them out.

BECKY: Warren, if …

BUFFETT: They can make money on this deal. I can tell you this. I would love to have 700-billion at Treasury rates to be able to buy fixed-income securities now that they’re in distress. There’s a lot of money to be made.

JOE: It’s just that, you know, they want these details, Warren. They said — Paulson says there’s the hold-to-maturity price and there’s the firesale price. We’re going to go somewhere in between, get a much better price but still leave enough for the people that are buying it to make some money. That can be done in principle? There’s a way to do that, do you think?

BUFFETT: I think what I would be looking for — I heard that hold-to-maturity price. I’m not as excited about that. I basically like a market, or something very close to a market-related price. And there are ways to determine that and I don’t think that Uncle Sam should be in the business of paying somebody a whole lot more than it’s worth in the market today. And if the guy that bought it doesn’t like it, he doesn’t have to sell it, and it was his problem, he bought it in the first place. I think a market price will enable people to be leveraged. The problem they have now is that some of the institutions, they’re loaded with this stuff, they’re having trouble funding, and they’re worried about being able to sell a ton of it. But take the Merrill Lynch deal. Merrill Lynch had to take back 75 percent of the sales price. Well, they didn’t want to take back that 75 percent. I would let ’em sell it for the same price, but I’d pay them the whole thing in cash. So they’d be a lot better off if they could have sold the whole thing at that same price but gotten paid a hundred percent in cash instead of having to take back 75 percent. And I see the government fulfilling that kind of a function.

JOE: All the outrage we’re seeing in these comments from viewers, and obviously the senators are hearing from constituents. If we take your word for it, that the government could even break-even, or only lose 50 billion, that 700 billion dollar number is out there in the public, and people think that we’re spending that.

BUFFETT: Yeah, they think that, yeah.

JOE: It seems crucially important to get the point across that, in your view, we could, the government could actually end up making money and saving the taxpayer from much worse, a much worse outcome if we didn’t do this.

BUFFETT: The government is getting 700 billion worth of assets, assuming they spend the 700 billion, they’re getting 700 billion of assets at what I regard as attractive prices. And they’ve got the staying power to hold those things. If I could get 700 billion, if I could borrow 700 billion on the government’s terms and buy these assets I’d be doing it myself. But unfortunately I’m tapped out. (Laughs.)

BECKY: And yet, Warren, Mayor Mike Bloomberg, I heard him making comments this morning, and he’s someone I know you’ve spoken very highly of ..

BUFFETT: I admire him.

BECKY: You admire him. he says this morning we should not be giving a blank check to have something passed in the dead of night. How dire is this situation?

BUFFETT: Well, I’m sure we didn’t want to go to war on December 7, 1941, maybe, in the dead of night, or whenever we did it, in the middle of the afternoon actually. But there are time when events force timetables on you, and force action, and you have to be — You know, it’s just like in my business. I might like to think over buying something for a month, I’m not that type anyway. But in the end, if somebody offers me something that makes sense, I better decide whether to act or not. And if it makes sense to me, I usually don’t attach unnecessary conditions, you know. It would be nice to have the luxury of thinking about this for three months. But I will tell you, if you think about this for three months, you’re going to have a situation where — If you think about it for three weeks, you’re going to be facing a situation that’s far different, and far more difficult, than if you do something now.