Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [6]
After almost 20 years working for Wall Street firms in New York and London, I made my living running a Chicago-based consulting business. My clients consider my expertise the product they consume. I had written books on credit derivatives and complex structured finance products, and financial institutions, hedge funds, and sophisticated investors came to me to identify and solve potential problems.
Although I was an experienced finance professional, I did not focus on value investing.The University of Chicago was steeped in the myth of efficient markets and leaned to theories put forth by eminent economists.Warren Buffett had earned his MBA at Columbia Business School. He became a friend and disciple of Benjamin Graham, and later worked for Graham’s hedge fund. I had read Security Analysis by Graham and David Dodd in 1985, but I had not actively practiced its principles for my own investment portfolio. Around the same time, I read John Burr Williams’ The Theory of Investment Value, and the fourth edition of The Intelligent Investor. My edition includes an introduction by Warren Buffett with a tribute to the late Benjamin Graham as well as Warren Buffett’s 1984 commencement address at Columbia University titled “The Superinvestors of Graham-and-Doddsville.” I remembered both the tribute and the address and reread them in preparation for meeting Mr. Buffett. My focus was chiefly on derivatives and complex securities. While I applied many of the principles of value investing to my analysis of complicated financial products, I did not yet focus on it for my own investments or as a way of looking at the global markets as a whole.
Derivatives are financial bets that something will or will not happen. Any financial investment involves a bet, but derivatives are leveraged bets. For very little money down—sometimes no money down—you can make gobs of money (or lose gobs of money). The part about losing gobs of money is something most investors try hard not to think about. Sometimes investment banks selling the products help investors achieve this goal by putting the part about gobs of losses in very fine print buried in hundreds of pages of documents.
Leveraged bets are so popular that there is more money at risk in derivatives than in stocks or bonds. The problem with leverage-driven binge banking is that everyone tends to disgorge assets at the same time, depressing market prices. Financial leverage sometimes moves global markets, and if allowed to get out of hand, leverage can theoretically trigger a global market Chernobyl.
Warren Buffett disproved the theory of efficient markets that states that prices reflect all known information. His shareholder letters, readily available through Berkshire Hathaway’s Web site, told investors everything they needed to know about mortgage loan fraud, mispriced credit derivatives, and overpriced securitizations, yet this information hid in plain “site.”
I knew the financial markets were at great risk—like children playing with matches in a parched forest—but those thoughts were far from my mind on that hot summer morning in 2005 as I boarded the plane for Omaha. I was about to meet a financial legend, the greatest investor who ever lived.
Chapter 2
Lunch with Warren
Thanks for sending along the . . . link, which I had not seen.The next guy will probably name his company Buffett, Bernanke and Tavakoli.
—Warren Buffett
to Janet Tavakoli, August 27, 2007
The day was sunny and clear, and the flight from Chicago only takes a little over an hour. I wondered how a man with Warren Buffett’s enormous wealth would behave. The late Howard Hughes suffered from paranoid schizophrenia attributed to brain damage suffered during self-piloted plane crashes.According to popular legend, he once roared: “I am not a paranoid deranged millionaire. Godammit . . . I’m a billionaire.” A sense of humor