Monday, May 26, 2008

Despite being so rich, Warren Buffett is still ignorant of real economics

Buffett is clearly wealthier than I am, and I'll readily concede a "smarter" investor -- whatever "smarter" means. But he might want to use some of his billions and take some real economics courses. Walter Williams, Don Boudreaux, Russ Roberts at George Mason University, or Burt Folsom at Hillsdale College, could set him straight on free trade. And soon Buffett can take the class "History of [Economic] Thought" at Trinity University, which will be taught by Richard Ebeling. I'm proud to call Dr. Ebeling a friend, and I was saddened when he recently left his position as president of the Foundation for Economic Education to accept his position at Trinity.

Alternatively, Buffett can take sporadic lessons from me at no charge. I've previously written about his mistaken belief that a nation shouldn't import more than it exports. Now he could use a lesson on central banking and what it does. From his recent interview with El País (my translation from the original article's Spanish):
Buffett: It is certain that during the Bush era there has been a gradual reduction of taxes that the greatest fortunes pay, whereas the middle classes pay more and more. And I take advantage of each occasion I have to denounce it. On the subject of the crisis, it's evident that after what happened that we must have more regulation. Even the International Monetary Fund supports that. Perhaps not very short term, but all crisis brings about regulatory changes. I do not believe that they are deep, but without doubt what it has happened to banks and American investment banks will lead to stricter financial regulation.

El País: What has failed so that the mortgages garbage unleashed this storm? Do we attribute the errors to the banks or to bank supervision?

Buffett: The banks exposed themselves too much, they assumed too many risks. So the problem is evidently the banks. They are the guilty ones. It does not need to be put on anyone else.

EP: Crisis or recession?

Buffett: I believe that real problems could have arisen in the case of Bear Stearns' drop. The recession is a technical term defined by the National Bureau of Economic Research: two trimesters of falling GDP. We have not arrived at that, so technically we cannot speak about recession.

EP: If you ask someone who's remained unemployed in Spain like the United States...

Buffett: For the one who loses a job there's surely a recession. But to my surprise, the unemployment rate has not changed too much up to now. It shocks me that with everything that happened in financial markets, real estate markets and other sectors, that unemployment has not risen more. I would not be surprised that unemployment will increase in the next months.

EP: That means the worst is yet to come?

Buffett: The steps that authorities and supervisors have taken hold the possibility that problems of bigger size may arise. I do not believe that the situation will deteriorate in the financial markets. General conditions in the business world will deteriorate, but only for a time.

EP. Are there going to be more victims after Bear Stearns?

Buffett: In March we crossed over the worst moment and in my opinion the Federal Reserve's decision in the case of Bear Stearns was a great step forward. It was a decisive moment for the financial system. A line in the sand to contain the crisis. This incident helped eliminate the problem, or at least it was moderated for other investment banks.


Buffett: We have an enormous bubble in the real estate sector. Not in all of the country, but in states like California, Arizona or Florida yes we have a true bubble. And we have it because many of those houses were financed at 95% to 100% by banks that in many cases didn't even know what they were buying. Combined with the financial crisis, the repercussions of all that are going to be very painful.


EP: You do not seem very satisfied with what's happened in the Bush era. Between the Democrats: Barack Obama or Hillary Clinton?

Buffett: I would bend over backwards completely with both.

Note: the verb used there is "Me volcaría," and the root "volcar" means a variety of things. But from what Buffett says after, it doesn't sound like he meant the "upset" or "overturned" meanings.

EP: Obama or McCain?

Buffett: Either of the two Democrats before the Republican candidate, although McCain is a good sort, with notable political ideas. I will support 100% the Democratic candidate.

EP: Why?

Buffett: I am closer to their ideas on the tax system, on health care, on abortion rights, the right of the woman to choose if she wants to have a child or not. John McCain is a wonderful man, but he would not agree with me on those. I believe that if McCain wins, it is not going to do anything about the matter.
We'll begin from the top. Is Buffett really so blinded by ideological bias, like Hillary Clinton, that he won't admit why a rich investor deriving income principally from investments will certainly pay a lower tax rate? It's because the income is derived mostly from investments, since capital gains are taxed at a lower rate than income. Buffett and other liberals want to tax investments the same as income, which is absurd: actually, any capital gains tax is absurd, because someone had to earn income to invest in the first place, hence it's double taxation. Moreover, raising the capital gains tax to equal income taxes will wreck the financial markets by crimping the incentive to invest. No skin off Buffett's nose, though, since he's already made his billions, but it will screw over the millions of Americans who are trying to save for themselves. This is what liberals want, however: if people can't save enough for themselves, if they can't earn enough for themselves (being taxed to death or even being taxed/regulated out of a job), then they must depend on government.

The truth is that those evil "investment managers" may pay an overall lower tax rate than "a teacher," but the former will still pay far more in absolute dollars. And as "honorable" as we're taught to think the teaching profession is, society judges these investment professionals to be worth more, because they're paid more. And why not? They're the ones creating wealth and prosperity, first for others through their jobs, and second for themselves by investing their own money back into the economy. They deserve their pay. "The labourer is worthy of his hire," the Lord reminded us. If a neighbor happens to get rich from his job, and he coerces no one, what is it to the rest of us?

And Buffett's such a hypocrite. If he thinks he's not paying enough in taxes, then he can voluntarily pay more. As President Bush said in the last State of the Union address, "Others have said they would personally be happy to pay higher taxes. I welcome their enthusiasm. I'm pleased to report that the IRS accepts both checks and money orders." Since Buffett can pay higher taxes if he wants, we can surmise it's clearly not about his taxes being fair. It's that he wants to force others into his flawed notion of "fair."

Well, I have a proposal for him: why doesn't he pay my tax bills, if he thinks I'm not paying enough? He wouldn't miss that money, and according to Congress' idiotic, Keynesian-based idea that "consumption spending" is all-important, my spending would be more than his investment income, right? (Actually no, because economic growth is the same whether the same dollars are spent or invested.) If Buffett wants to give all his money away, then why not devote his foundation to tax relief? And God knows "middle-class" Americans will need it, once our taxes are hiked in 2011 -- because Bush's "tax cuts for the rich" will expire, except that the tax cuts will go up for a lot more than just "the rich."

Regarding the housing "crisis," Buffett wants to blame the banks and the banks alone. While lenders do share some measure of blame, as I'll get to below, it's not entirely their fault. Borrowers must shoulder some blame too, because they're the ones who were irresponsible enough to take loans that they couldn't repay. If you take out a loan, you're borrowing someone else's property. The person lent you property and expected it back, plus compensation for not having use of the property. So if a borrower uses government to force the lender to "rewrite" the contract terms to a lower interest rate, or even "forgive" the debt, that's stealing from the lender.

If a borrower takes out a loan that he knows he won't repay, that's fraud. It's irrelevant if the borrower truthfully represented his (in)ability to repay (meaning the bank failed to realize or perhaps "overlooked" it). If a borrower knew he lacks/will lack the means to satisfy the agreed-upon loan payments, then the borrower made a criminal decision to take someone's property and not give it back as promised. We should be prosecuting the hell out of these predatory borrowers, who are committing fraud and grand larceny by walking away from their mortgages (often literally). But most Americans have bleeding hearts, so they sympathize with the supposed "victim" and want to punish lenders instead. It's the same mentality by which juries award multi-million dollar judgments to plaintiffs in ridiculous personal injury lawsuits.

Lenders share some blame for being too eager to make loans, but all loans have a built-in penalty for that: lenders can lose potentially the entire amount of the loan, should the borrower default. Thus there's no need for statute or juries to penalize lenders merely for making bad loans; there should be punishment if lenders commit fraud, but that's never the case in the sob stories plastered all over the news. I've yet to see one case of a ARM where there wasn't a part of the contract stipulating how the interest rate would increase. There always will be a clause defining that, because lenders will want something enforceable in court (well not enforceable anymore, as I'll explain in a little), something clear enough to satisfy the "meeting of the minds" requirement of a valid contract.

I've always wondered, were these borrowers truly so stupid to think they'd get 1.9% forever? "Always read the fine print," the old saying goes, and just because it's small print doesn't mean it's unreadable. When something will last the next 30 years of your life, is it so unreasonable to read the agreement and perhaps consult a lawyer?

But lenders were coerced by Congress, who shoulders even more blame. Congress for two decades, but particularly in the last several years, has used legislative blackmail to "encourage" (i.e. force) lenders into giving loans to low-income people, notwithstanding that these borrowers are precisely the sort who likely couldn't repay. Let's be objective: should lenders give equal numbers of loans to low-income people as they do to higher-income people? Of course not; that risk makes no sense whatsoever. So when banks denied applications of low-income applicants, it wasn't based on race, but on qualifications. Banks are in business to make money, and the only color they care about is your money, not your skin. However, in the lower-income brackets there are more minorities than whites, so that's been perverted into "racism" and "discrimination." As I've mentioned before, Stan Leibowitz gave an excellent history of ACORN and other groups whining before Congress about "discrimination" in lending. Oh, but there should be discrimination, namely between those who can repay the loans and those who can't. "Discrimination" isn't inherently bad: the word means to determine differences. But ever since "the politics of victimhood" started taking root, everyone who wasn't qualified on true merit would cry "Discrimination!" and thus perverted the word's meaning.

The greatest blame is on the Federal Reserve, which made all of this possible with insanely low interest rates for the first half of this decade. As a line in one of my favorite movies goes, "Jesus, you can't make a buck in this market, the country's going to hell faster than when that sonofabitch Roosevelt was in charge. Too much cheap money sloshing around the world. Worst mistake we ever made was letting Nixon get off the gold standard." Nothing ever changes. As Bruce Bartlett told me, "The Fed always overdoes it."

We're not just finally feeling the effects, we have been for the last few years. We haven't seen this kind of inflation, and true inflation since we're talking purely about the money supply, since the early 1980s. And each time the Fed says it will "inject liquidity" and auction off more bonds, I cringe. It may have its financial uses, but the Fed is continually devaluing the dollar when it should let the financial markets correct themselves. The Fed made money so easily available and directly caused a credit crisis, of which the housing bubble is the most visible part. Lenders had every incentive to borrow as much as the Fed would create, since not partaking meant watching competitors help themselves and make profits. And the vast amounts available the borrow enabled borrowers to bid higher and higher offers on houses, driving up prices artificially. The Fed showed banks the carrot, giving banks the means to finance "no money down" mortgages, and Congress held the stick, namely the threat of investigations and regulations.

One of the most absurd explanations for the crisis is that it's the deregulation of the separation of commercial and investment banks; this two-paragraph concept was expanded into an entire book that my uncle briefly told me about. The repeal of the Glass-Steagle Act did encourage bank mergers, and eventually that banks would underwrite securities based on collateral-based loans like mortgages, but this wouldn't have been possible if the Federal Reserve hadn't made available such immense quantities of loanable funds.

Now people actually believe the Fed can alleviate the crisis by throwing more money at it, when it was the cheap money that caused the problems in the first place? A company can alleviate financial problems and stave off bankruptcy by diluting shares to raise capital. But if it constantly does so often that it becomes policy, investors will trust the company less and less. Why should the Fed be any different when it continually dilutes the money supply?

Buffett would have clarified the general nature of the problem, that it's not just housing, if he knew anything about real economics. He's a great investor, as I said, but did that, or his nickname "The Oracle of Omaha," or now being the world's richest man go to his head, that he goes by his own economic definitions? In this interview, he says the U.S. isn't in a recession, per NBER's definition. Yet he recently told Der Spiegel that "I believe that we are already in a recession. Perhaps not in the sense as defined by economists....But people are already feeling the effects of a recession." So which is it?

I'm actually not surprised that unemployment is so low. By our own historical standards, we're average, and our unemployment statistics in France or Germany would be considered an economic boom. The dollar is in bad shape, and that is a big problem, but overall the U.S. economy is far more resilient than Buffett or the other doomsayers think. Housing isn't the majority of the economy, despite its rippling effects, as are the major banks. Bear Stearns earned $9.2 billion and $5.9 billion in gross revenue in fiscal years 2006 and 2007, respectively. Its operations, including its $1.2 billion dollar headquarters in midtown Manhattan, could have completely vanished off the planet, its 14000 employees could have all stopped working, and it still would make hardly a dent in the $14 trillion American economy.

I tried explaining that a little while back to a pseudo-capitalist who said Bear Stearns was "too big to fail." Nonsense. A free market, with no bailout, would have sorted it out just fine: other companies would have bought out the pieces, and the employees would have naturally gravitated to other jobs, and this Schumpeterian "creative destruction" would have made things all the more efficient. But so many, Buffett included, are fans of the Bear Stearns bailout. Did he really have that big a long position in BSC? Or is he just another pseudo-capitalist who wants the "free market" and "competition" only when it suits him?

Then we have his Democratic bias, showing he's just a limousine liberal at heart. No surprise there. The money he's giving away will do many good things, but that's not enough. He has to force people into his own politics, using the weapon of government.

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Blogger jk said...

Buffet also pushes for higher estate taxes, and then buys companies at a discount when a family is forced to sell.

Like you, I respect the man's achievements, but at the end of the day it's all about "I've got mine, time to close the doors behind me."

Ah, well, he's still better than Soros...

Monday, June 02, 2008 10:25:00 AM  

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