Thursday, October 2, 2008

buffett's non sequiturs

I am just now watching warren buffett on charlie rose. despite his jolly manner, he's adamant the US economy is entering a recession.

still, he thinks people in the USA will be richer in 10 years and that everything will be ok. I can accept that kind of optimism -- it's something you'd expect in a successful businessman... but many of his points made no sense.

first, he says he believes in mark-to-market principles.

secondly, he hopes the government pays rock-bottom prices for all these mortgage-backed securities. that way the taxpayer will make a profit.

it seems to me these 2 convictions could be a recipe for disaster: right now many banks have not written down the value of their mortgage portfolios... mainly because they are long-term illiquid (aka "level 3 assets").

what happens if the government creates a highly liquid market characterized by rock-bottom prices? won't this force banks to reclassify their loans at much cheaper prices? won't this trigger more writedowns and capital inadequacy?

why does he want the government to drive down the price of bank assets? can't the market accomplish that on its own?

I made this point in the posting immediately below this one. I am not an accountant, so I might be wrong. but from what I know of the accounting rules, it seems like a potential worry.

my second big worry about warren buffett's comments: the entire economy is deleveraging, and
only the US treasury can lever up to buy these assets. to me, that sounds like a big glaring invitation for us to lose our AAA credit rating. it will surely take time, but already germany credit default swaps are trading tighter than the US. it's a very nascent and unclear market, so I dont want to make too much of it.

but this is how issuers lose their AAA ratings -- they take them for granted and abuse them.

it will take time, but this is the beginning of the end for US treasuries -- the last remaining bubble.

here's the real worry about a bubble: once it breaks, the thing that used to be gold becomes excrement. tech stocks had a bubble, then people couldn't run away fast enough -- and investors swung in the opposite direction, seeking "common sense" plays like retailers and dividend paying stocks.

I also think the US dollar had a bubble in 2001.. it rallied massively and unnecessarily against european currencies, even with unjustifiably low interest rates... then the ONLY trade for the next 7 years was to short the dollar.

treasuries are also in a bubble now. why?
1- you have a long-term rally going back to the early 1980s
2- their fundamental valuations are now poor, yielding much less than inflation
3- their corporate/soveriegn fundamentals are now deteriorating. the government faces growing deficits and has a worsening culture. other countries have spent the last 10 years rebuilding themselves into stronger states with more transparency, freer markets and greater access to capital. they have fought their way out of crisis. our politicians, on the other hand, are like spoiled children. they are incapable of carrying out any kind of meaningful action.
... interestingly, I am seeing ron brownstein on tavis smiley right now, talking about how extreme partisianship is derailing the government.

on this front, we are VERY early in the process of the US political system unwinding. I have long believed that our disregard for our own constitution has put us on a collision course with disaster. it will take a long time for this to pan out, but this economic meltdown is the start.

4- (on treasuries) plenty of more supply is coming ... we know this. the government is running deficits and will need to sell lots more bonds. plus the whole world is full up on treasuries and losing interest in buying more.

finally, one other thing buffett said: "inflation is a likely consequence" -- of the government bailout actions. he was also not very bullish on the dollar.

I think we're entering a very ugly period. I think the US credit market will freeze up.. if not now, then in another month or so.

I think the rest of the world economy will rebound much faster than the USA.
we will suffer inflation and stagnation and continued devaluation.

we are mexico circa 1985.

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