Robert Feinberg: Buffett, Blankfein Discuss the Economy

Wednesday, 24 Oct 2012 10:05 AM

By Robert Feinberg

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This morning, CNBC conducted an extensive interview with Warren Buffett, CEO of Berkshire Hathaway and generally acknowledged as the leading CEO in the country. Buffett learned value investing from the master, Benjamin Graham, and has built a portfolio of operating companies whose value has grown steadily over several decades and provides the best demonstration of how long-term investing can reward investors. This does not mean that the strategy works for everyone, of course, as many investors have been disillusioned by losses they have incurred in indexed mutual funds if they happened to enter at an inopportune time.

Buffett’s model is to acquire companies that have demonstrated outstanding management and let the managers grow the companies. The largest commitment of Berkshire is to the insurance and reinsurance industry. Buffett is attracted to the property and casualty business because, as he puts it, the customers send you money that you earn interest on, and if you can break even on the underwriting, it’s very profitable. Buffett had to take some losses for a couple years in reinsurance due to the need to wind down positions in derivatives that he confessed he did not understand. He called these derivatives financial weapons of mass destruction and resolved to unwind them and take the losses.

He also made sizable investments in housing government-sponsored enterprises (GSEs), especially Freddie Mac and Fannie Mae, both of which ended up in government conservatorship at a cost of about $200 billion and growing.

For many years, Buffett has been a leading backer of Wells Fargo (WFC), and he stated that he has invested another $1 billion in the bank. He also made very positive comments about the trends in the housing business, which he expects to boost profits in several Berkshire companies. Proponents of Wells Fargo have touted its achievement of a 30 percent share of the mortgage market. The contrary view is that this could be an indication of the start of yet another boom/bust cycle in this historically volatile business.

Buffett’s comments on the future leadership of economic policy were very intriguing. Asked if he has any suggestions as to who should be the next Treasury Secretary following Tim Geithner, Buffett said he would make a suggestion after the election. Given his stature as a leading Democrat, his suggestion might well be taken if President Barack Obama wins re-election.

The interviewer, Becky Quick, asked a clever question about the future of Federal Reserve Chairman Ben Bernanke, given that former Treasury official and Fed Governor Kevin Warsh has suggested that Bernanke might be ready to leave, even if Obama is re-elected. Buffett predicted that if Obama asked Bernanke to serve another term, he would accept another appointment. Buffett praised Bernanke’s work during the 2008 episode, but repeated his misgivings regarding the ability of the Fed to manage its continuing extensions of quantitative easing and the resulting growth in the Fed’s balance sheet.

Much less significant was an interview with Goldman Sachs CEO Lloyd Blankfein, who was leading a conference of entrepreneurs in California. However, the role of financial CEOs in the economy is so significant that any public appearance by Buffett, Blankfein or JPMorgan Chase’s Jamie Dimon is newsworthy.

Blankfein declared that promoting entrepreneurship is at the heart of what Goldman Sachs does, and the event seems calculated to burnish the firm’s image in the face of recent adverse publicity.

The interviewer, Carl Quintanilla, asked Blankfein about the prospects for the banking industry and for compensation of its employees in light of a tougher economic and regulatory environment in the wake of the 2008 crisis. Blankfein responded that the industry is still very profitable and that its performance justifies the compensation, adding that the U.S. industry continues to grow market share at the expense of troubled European competitors.

Asked about the noisy departure of Greg Smith, a vice president at Goldman Sachs who wrote a book attacking the firm, Blankfein responded that the book, which he said he has not read, caused the company to do a “deep dive” of introspection to make sure its processes are working properly.

The interview is instructive because it raises doubts once again as to whether Blankfein has processed the fact that Goldman Sachs was rescued by the government in 2008, and it indicates that in spite of all of the claims by federal regulators of its intent to end the policy of Too Big To Fail, the actual strategy is to underwrite the further expansion and growth of the biggest banks in the name of enhancing the U.S. share of global economic growth. This policy is reminiscent of the “national champion” strategy under which companies use their political clout to obtain government backing for overseas expansion. Blankfein mentioned China as another region where Goldman Sachs hopes to grow.

Bank of America Sued

Bank of America has been sued again for $1 billion over its mortgage transactions, this time by the GSEs, which contend that BofA misrepresented the products. This is not unusual, and a mere $1 billion is hardly material to a bank that enjoys the backing of the federal government. So in a sense, it is one GSE, or two GSEs, suing another GSE, like Spy vs. Spy.

What is interesting is that a trader who owns BofA defended the bank on the basis that it took over Countrywide as a favor to the government, the same argument that was made in response to a suit against JPMorgan brought by New York Attorney General Eric Schneiderman over transactions of Bear Stearns. This is the official industry message. An alternative view is that the biggest banks continued to get bigger by acquiring failing banks with the help of the government, and these suits are merely collateral damage that the industry’s crisis-management team handles as a matter of course. Just another day at the office.

Later, Rep. Barney Frank, D-Mass., made his first appearance on CNBC coming to the defense of JPMorgan. Frank repeated the industry argument that it is unfair to ask banks to take over problem institutions and then sue them for transactions of which they probably had no knowledge. He even went so far as to say that JPMorgan was pressured by the government to take over Bear Stearns and that BofA was pressured to take over Merrill Lynch. Frank said he has no opinion on the Countrywide acquisition by BofA, except to say that the settlement with former CEO Angelo Mozilo should probably been stronger. CNBC also ran a tape of an earlier interview with Schneiderman in which he argued that an acquirer gets both the assets and the liabilities of the acquired entity.

On other issues, Frank opined that there is no threat that the Republicans would try to repeal the Dodd-Frank Act if Romney were elected, which he suggested is unlikely. The reason, according to Frank, is that the Act is popular. Rather, he predicted, Romney would appoint regulators who would refuse to enforce the Act, and Republicans would continue to resist funding the regulators. Given generous time, Frank went on to say that his biggest regret regarding Dodd-Frank was that he was unable to achieve the merger of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Frank attributed this failure to the impossibility in America of putting the securities and commodities industries under one regulator, given that the SEC is under the jurisdiction of the banking committees, while the CFTC falls under the agriculture committees.

Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.

Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.

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