March 2, 2009 Monday

'Beware of geeks bearing formulas'

Buffett blasts business world while chastising himself for dumb moves

NEW YORK: - Renowned investor Warren Buffett was uncharacteristically critical of himself and the business world at large in his annual letter to shareholders of his holding company over the weekend, as he sifted through the wreckage of his worst year in four decades.

Mr Buffett's company, Berkshire Hathaway, posted a 62 per cent drop in net income for 2008 and saw a decline in book value per share for only the second time since he took control in 1965.

Berkshire shares, which peaked in late 2007 at over US$148,000 (S$228,000) each, closed last Friday at US$78,600.

With characteristic candour, Mr Buffett, 78, took the blame for some of the falls, saying he 'did some dumb things', lamenting in particular an ill-timed bet on oil and the purchase of shares in two Irish banks, which have fared poorly.

But he also needled regulators and an assortment of unidentified chief executives as he predicted that fallout from the credit crisis would leave the stock market a shambles through 2009.

The letter, as ever, gave shareholders an overview of Berkshire's annual performance, but it also doubled as a folksy state-of-the-economy address from one of the most revered investors in the US.

In language by turns blunt and witty, he decried what he called 'a series of life-threatening problems within many of the world's great financial institutions'.

An inveterate optimist about the American economy, he forecast an eventual recovery, asserting that the US has faced even more severe travails in the past.

Despite its record losses, Berkshire still has about US$25 billion cash on hand and has been buying preferred shares of General Electric and Goldman Sachs.

Mr Buffett is shopping for bargains while the share prices of most companies are sliding - his own portfolio included.

In his letter, he blasted the decisions and habits that led to the credit crisis.

Reviewing the performance of Clayton Homes, a Berkshire unit that sells manufactured homes, he noted that its lending arm had managed to keep foreclosure rates to less than 4 per cent, even among sub-prime mortgage borrowers, or those with weak credit ratings.

He contrasted that relative success with the failures of just about everyone else in that business.

'The stupefying losses in mortgage-related securities came in large part because of flawed, history-based models used by salesmen, rating agencies and investors,' he wrote.

'These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible,' he went on.

'They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn't afford.'

Also blissfully ignored, he wrote, were the perils of relying on mathematical models devised without worst-case situations in mind. Too often, he wrote, Americans have been enamoured of 'a nerdy-sounding priesthood, using esoteric terms such as beta, gamma, sigma and the like'.

'Our advice: Beware of geeks bearing formulas.'

Mr Buffett was just as scathing on the subject of derivatives, which he had likened to weapons of mass destruction long before they started eviscerating the balance sheets of banks around the world.

He explained that the danger of derivatives was not merely the difficulty in assessing their value; rather, it was the 'web of mutual dependence' they create among financial institutions.

Derivatives contracts keep various parties entangled for years, which, as he vividly explained, can create real hazards once those assets start deteriorating.

'Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease.

'It's not just whom you sleep with, but also whom they are sleeping with.'



'I made at least one major mistake of commission and several lesser ones that also hurt... Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.'

Investor Warren Buffett on a bad 2008


'Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal diseases: It's not just whom you sleep with, but also whom they are sleeping with.'

On the mutual dependence among financial institutions


'The tennis crowd would call my mistakes 'unforced errors'.'

On seeing US$244 million of investment in two Irish banks dropping 89 per cent in value