Little obscure markets are picked over too; it isn’t just the big ones. I heard of a money manager who made a presentation to a major university the other day. Guess where he’d generated a successful investment record? Sub-Saharan Africa! There is a specialist in investing in sub-Saharan Africa. And, by the way, he’s done very well. It’s kind of like Ben Graham – he just picks some field that nobody else is interested in. The headlines are so awful in sub-Saharan Africa. He just went into these relatively illiquid securities and dominated every little pocket and made $500 million. It’s quite rational. If a thing is despised enough and ignored enough, you can run a Geiger counter over it and find a few things that make it go click. But he had no illusion that he could make another $500 million in sub-Saharan Africa. He’d accomplished what he was trying to do for a while in the field he’d chosen. I think that’s what you find around the world. Even if you did go into sub-Saharan Africa, which not many people are likely to do, you’d find the field pretty well occupied. And this is a guy who thinks a lot the way you do and he knows everybody and that’s pretty much the way you’ll find the world.
Point 14. The World Has Changed But In Some Respect It Hasn’t (Buffett’s Investment in South Korea Notwithstanding)
Warren, liking examples that markets are not all that efficient, is now telling business school classes and others that a few years ago he looked at the Moody’s manual for South Korea [and found a lot to invest in]. There’s a nuclear North Korea to the north, huge scandals at home, chaebols that didn’t seem to care about the shareholders, a huge consumer credit boomlet that led to a huge collapse. And in the middle of that, Warren found a flour mill trading for two times earnings and he thought he was young again. [Laughter]. So he bought a lot of these securities right out of the manual and made a lot of money. So [he concluded], the world hasn’t changed.
Well, the world has changed. If you’re Warren Buffett, maybe you can find the one place where that still works, but I don’t think many ordinary people can find a great many pockets as crazy as South Korea [was].
Point 15. Credit Card Spending Can Make You a Slave
Now you have the problems of the macro scene. Let’s take credit expansion. Consumer credit has expanded to levels that nobody’s ever seen before. All of these credit cards and all of these algorithms… people [meaning lenders] really want that particular customer that’s just crazy enough to overspend but not so crazy that he goes bankrupt. [Laughter] They have computer algorithms to identify these people – they seek them out with clever marketing techniques. I always say it’s like having serfs when you finally get them. They while away at their job and you’re the lord of the manor and at the end of the month they send you [the money they make].
They’ve gotten so rich that [the lenders] keep surfing for more serfs with ever more liberal credit, and so forth. That is the world of consumer credit.
Point 16. Excessive Mortgage Credit and Over-Leverage In Real Estate (Sic: Will Lead To A Bust)
Now you get into mortgage credit. Again, to the people in this room, this is a new world. Warren sold that house in Laguna that he’d owned for many years. He asked the buyer how much he’d borrowed for the $3.5 million or whatever the house cost, and he said 100%. He got an 80% loan and then got an equity line and with a little manipulation, he could borrow 100%. Now you have all these mortgages that say that if it’s inconvenient to pay the interest, it’s no big deal, just add it to the principal and you can get to it later. [Laughter] You not only don’t have to pay the principal, you don’t have to pay the interest! Of course, with this arrangement, you can buy a lovely spread.
And the accountants let people write mortgages like that and let you accrue substantially all of the income even though the credit risk has obviously gone up.
And they do that because they can’t see any difference in the credit losses yet. That is not the way I would do accounting – but a lot that I see is not the way I would do accounting.
It was quite logical for people to gamble that with interest rates going down, housing prices would go up. And if you really took advantage of the low interest rates and really laid it on and took on a lot of leverage, I think that was very clever and you could even argue it was totally sound. People did it big time and made enormous amounts of money – unbelievable amounts of money. The rest of us were really dumb. It was a very logical thing to do if you stop to think about it: as interest rates were sure to go down, the value of property was sure to go up. The rest of us were stupid. It looked risky, but really wasn’t. It was a pretty smart thing for these people to do.
Whether it’s smart to continue it now from our present level is a very interesting question. I would think no. There are many instances of collapse after liberal mortgage lending. England had a tremendous collapse maybe 10 or 15 years ago. A combination of very extreme extra leverage in mortgage lending, combined with the leverage in consumer lending…
Commercial Real Estate Lending
Let’s talk about commercial lending to real estate developers. A good friend of mine just invested in a very intelligent real estate development project, with a gooddeveloper. The total development is going to cost $140 million. And guess how much non-recourse equity the developer put up? $8 million! I don’t care how promising the real estate market is – if you leverage something that much, there could be a lot of pain for the real estate lenders.
We are in a weird period. I think it’s extra dangerous because it’s worked so marvelously well for everybody who did these loony things in the past. Everything’s worked.
Point 17. Many People Got Creamed in Silicon Valley Bubble Including (And Especially) Marginal Players In The Early Stage Venture Capital Investments
People really got creamed who were the marginal players in the early stage venture capital business. Some of them have not recovered and have even disappeared in the collapse in Silicon Valley. But that was an unbelievable bubble. I negotiated with a young woman at the height of that, thinking she should come work for us. She was 23 years old and in her second job and had Silicon Valley stock options. She said, “My stock options are now vesting at the rate of $40,000 a week,” so we’d have to start compensation to offset that before she’d consider changing employment. [Laughter] By the way, her brother was a Ph.D economist at some reputable university and he was looking at his sister earning $40,000 per week and thinking this was not part of economics when he was learning it. [Laughter] But at any rate, that’s the weird situation we’re now in.
Wesco and Berkshire Still Holding and Occasionally Buying Stocks
Obviously, since Wesco and Berkshire are still holding stocks and occasionally adding to something, we’d rather own selected common stocks at these prices rather than own, say, municipal bonds long term – we’re at least that optimistic. And we think we’ll find occasional things to do where we’ll earn returns at least moderately approaching some of the things we did in the past. That’s my role as a director, to orient you to the way the world looks to me.
- The right way to do it, of course, is to scan a broad area until you find something you understand and that you’re sure will work and then load up hugely, after properly considering other opportunities.
The proper thing to do looking back is to realize how stupid we all were. We all blow a fair amount of obvious opportunity. By the way, Berkshire did do some fixed income arbitrage and distressed debt. It’s not like nothing at all has gone on in recent years. But looking back, I would say that we were all a little bit brain blocked – we could have done better in recent years. The right way to do it, of course, is to scan a broad area until you find something you understand and that you’re sure will work and then load up hugely, after properly considering other opportunities. Most of us, including the one speaking, didn’t scan enough. I didn’t try as hard as I did when I was young. We should have scanned a little more intelligently and been a little more ambitious in the things we did. I don’t think it’s a game that everybody will win at. The mistakes we all made were pretty much standard in human nature. Most people are way worse at making decisions than the people in this room.
Notes from 2006 Wesco Financial Annual Meeting – By Whitney Tilson