What do Lehman Brothers, Morgan Stanley, Bear Sterns, AIG, Wachovia and Freddie Mac all have in common? If you said they are all (or were) in the financial services industry, you would be right. If you said they all struggled or went out of business during the recent U.S. financial crisis, you would also be correct. But what you may not have known is that during the last few years, they all offered investor Warren Buffett opportunities to make significant equity or debt investments that he declined.
What’s the insight here? As a very successful investor who has been in the market for over sixty years, Berkshire Hathaway CEO Warren Buffett is clearly in a league of his own when it comes to picking winners and avoiding losers. Is he always right? Of course not. Is he right more often than not? Yes.
According to a December 12, 2009 Wall Street Journal article, when approached by all these companies, Buffett personally reviewed their financial information. Why is this important? It is a classic example of intelligent risk-taking. He did his research and drew on insights gained from past experiences.
You might say that declining every opportunity is easy and you would be right. But that is not what Buffett did. During the same time period, he took advantage of opportunities he was presented to invest in or purchase Burlington Northern Santa Fe Corporation, Goldman Sachs and General Electric.
So how does this illustrate intelligent risk-taking? In two ways. First, Buffett did significant research so he knew what he was considering. Second, he drew on past experience and hard earned insights. An example was his review of mortgage giant Freddie Mac. He quickly concluded that their problems where too severe. “I said no fast on that one,” was his comment on that opportunity.
You might be thinking that anyone with money to invest during the last few years could have done well with so many companies undervalued due to the global downturn. However, that is not the case. TPG made a disastrous $1.35 billion investment in Washington Mutual Inc. and investors in Abu Dhabi invested billions of dollars Citigroup before their share price plummeted.
Was every decision Buffett made during the financial crisis correct. No. But be being thoughtful and methodical, he appears to have risked intelligently.
Some blame risk-taking for the recent economic downturn. To them I would say there is risk-taking and intelligent risk-taking. The former gives the later an undeserved bad name.
I think Greenspan is getting senile, today he said that you can stop asset bubbles by increasing capital requirements. That just increases the cost of credit. The next time you have a real estate bubble, you’ll have the same problem, assuming that banks are still in the business of loaning against real estate. If you want to stop this problem, then eliminate the federal subsidies for real estate development and investment, then require people in that industry to put their own money at risk instead of someone elses. If Greenspan really wants to change the banking system, though, then simply ban 95% and 90% LTV loans. Require a bigger equity cushion. BTW, the “too big to fail” argument is a fallacious one. During the Great Depression, Canada had no bank failures. The reason was that their banks were very large. The banks closed branches, etc., but none of them failed. By contrast, the US was dominated by thousands of very small banks, and we had more than 10,000 of them fail. So there is nothing inherently unsafe about a banking system dominated by large banks. The real problem with large banks is that during good times, they don’t provide enough competition for each other.
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