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From http://seekingalpha.com/article/97158-goldman-sachs-buffett-... :

"In the news yesterday, Goldman Sachs (GS) announced that Berkshire Hathaway (BRK.A), Buffett's investing vehicle, will purchase $5B worth of perpetual preferred shares with a 10% dividend being paid in return for exclusive use of this capital injection. Not only does Berkshire get a dividend nearly double that of Canadian bank issued perpetuals, but the holding company also receives warrants to purchase $5B of common stock at $115 during the next five years."

So let's put it together.

* Buffett and Munger buy tons of stock in the above mentioned "casino".

* The casino loses big.

* Casino gets huge tax bucks from you and me to cover its loses and pay huge bonuses to itself.

* The tax money flows back to Berkshire via the holdings listed above, and form thence to Buffett and Munger.

* Munger writes folksy article damning "casino gambling".

For those who weren't aware, Buffett was a director of Goldman for many years. You know, the years when all this latest crap was happening. The years when he and Munger must have talked at least once a week. Those years.

EDIT: Buffett is the largest individual investor in GS, and was apparently asked (on that basis) to join the board, but apparently never did. My bad. On the other hand, his involvement in TARP is even worse that I knew:

From http://www.mcclatchydc.com/2009/04/05/65496/buffett-champion... :

"Buffett's company, Berkshire Hathaway, hasn't received any of that federal aid, but Berkshire, based in Omaha, Neb., owns stock valued at more than $13 billion in the top recipients of TARP funds, including Goldman Sachs Group, US Bancorp, American Express and Bank of America, which analysts all thought were in deep trouble before TARP was approved in October."

I'm a huge believer in economic freedom, i.e., the free market. I only wish that most large businesses were. It's so much easier for them to rent-seek.

All absolutely true, but note the lack of derivatives and hedges. The Goldman transaction was a straight equity deal, with a big emphasis on dividends. In a nutshell, it was a chance to squeeze one of the 'casinos' hard, while still staying out of the whole CDO/default swap/derivative mess.

Both Munger and Buffett have a habit of stealing your wallet while telling you you're an idiot for letting them do it. The article and the Goldman deal are reflections of that attitude.

The Berkshire and Goldman deal was, but Goldman plays in derivatives. Where are the fundamentals there? Or when is Goldman going to announce their new business model?

You'd hope someone like Buffet, with his cache and savvy could suggest some reasonable ways to end "too big to fail." All things right now make me think we'll have another bust in a couple years, nothing is fundamentally different.

You cannot avoid playing in derivatives. Do you have a bank account? Do you own U.S. currency? Is all of your wealth in gold? In any of these cases the price is set by the market and strongly effected by derivative trades. You need to understand derivatives just to do a reasonable job avoiding them.
Warrants are derivatives.
If you classify options as derivatives, then you're right. However, if you use that definition then the Berkshire/Goldman warrants are the simplest derivative that I've ever seen.

The Goldman warrants are an option to purchase an additional $5 billion of stock at $115 per share, any time in the next 5 (now 4) years. Basically, they're a plain vanilla call option.

What's really interesting about those warrants is that they behave identically to an equity purchase, only without the downside. Berkshire literally can't lose money. Plus, if the warrants are ever exercised, then Berkshire simply gets more equity. It never gets tarted up with default swaps and tranches and triggers and all that crap. The deal is the complete opposite of the 'casino' mentality that Munger is decrying.

So, yeah, you might be technically correct. However, you've also got to look at the spirit of the thing.

Actually depending upon how the warrant is structured it's most likely a pseudo-derivative, not a pure play on pricing action.
"The Goldman transaction was a straight equity deal, with a big emphasis on dividends."

No. They were derivatives. Goldman was to pay those heavy dividends by executing credit default swaps they had purchased from AIG. Trouble is, the securities underlying the swaps were overcommitted, meaning the swap prices would be driven way down in an open market. And Goldman didn't own the securities. And the securities hadn't necessarily defaulted. And AIG had no money.

This was solved by the Munger/Buffet helping arrange for the taxpayer to pay off AIG's gambles at 100% without Goldman even delivering the securities underlying the swaps.

Make no mistake, the Goldman deal was a naked derivative play combined with brazen government corruption.

There's no question that Goldman had to pay off those dividends with some kind of shenanigans. IIRC, they were up to their eyeballs in default swaps and CDOs, both of which were beyond toxic at the time. That 10% payout was going to have to come from somewhere.

However, my understanding was that from Berkshire's perspective, it was a straight equity investment for preferred stock. They didn't really care where the dividend cash came from, so long as they got paid. So, if it was a derivative play, it was an indirect one. Berkshire never had those default swaps on its books.

That's how I remember it going down, at least. It's entirely possible that I got some of this wrong.

Buffet was never a director at Goldman. Berkshire did not loan the $5 billion and receive the options until well after the financial mess, after Goldman's stock dropped over 50%. The article talks about casinos dealing "financial derivatives" which are completely different from equity securities, and which were the primary investment vehicle that led to the collapse in 2008. Munger is dead on.
It's also worth noting that Buffett occasionally likes to take a turn at being the house. Between 2005 and 2008, he sold a notional $40 billion of puts on various equity indexes. This is basically a highly leveraged bet that the market would go up 5% a year for the next 15-20 years, entered into at the height of a bull market.

It also backfired on him at the height of the credit crunch. While he was smart enough to write the contracts in such a way that he didn't need to post collateral, he didn't account for the way that someone looking to hedge their counterparty risk with him would behave. When the market collapsed, the buyers of the puts proceeded to short both the equity and debt of Berkshire to protect their investment. http://crookery.blogspot.com/2008/11/valuing-large-options-i... and http://crookery.blogspot.com/2008/05/warren-buffetts-vega-ga... have some of the technical details, and http://www.portfolio.com/views/blogs/market-movers/2008/11/2... has a good general explanation of what went wrong.

Buffett may not have been in the casino all the time, but he had plenty of side bets that could have wiped him out.

BH could have paid 40 billion today let alone in 10+ years from now so it's not highly leveraged. Highly leveraged for BH would have been placing a 4,000+ billion bet. If you read up on this deal BH maximum risk is a small fraction of their projected net worth and they can’t be forced to pay up early. They would need to lose ~90% of their value today and never recover for this to be an issue. At the same time to be on the hook for the full 40 billion the indexes would need to be at zero (at which point the company would have already failed).

PS: Leverage means making money from money you don't have ex: loan on rental property. But to classify as highly leveraged you need to risk 10x or more money than you actually have.

Buffet was never a director at Goldman.

Thanks for the catch. See my edit above for more.

Berkshire did not loan the $5 billion and receive the options until well after the financial mess...

This is effectively wrong, since the TARP funds were issued after the investment. See the link at the edit above.

Sure they were, but he didn't make the loan until well after everything collapsed. In fact the U.S. Treasury was practically begging for him to make these investments and he said he would only do a deal with Goldman because he knew they were the only bank left that was financially sound. EDIT: And Wells Fargo. He bought into Wells Fargo huge.

In any case, I think that if there anyone who has demonstrated an immense understanding of the American economy for the last 50 years, it's Warren Buffet and his partner Charlie Munger. There is no one/duo that has been more successful at investing and predicting long term economic scenarios over this time period.

I don't like casinos much either, but I wouldn't mind owning one. The preferred shares in a profitable company shows the usual skilled negotiating that Buffet uses to get large pieces of large companies in deals with a high margin of safety. Here, he gets a solid dividend on his investment with the possibility of upside. The problem that Berkshire Hathaway have is size : they are running out of profitable places to invest $5 billion dollars. Their primary responsibility is to invest well for their shareholders, so that's what they are doing.

The parable is designed to highlight the folly of having 25% of your GDP devoted to what is essentially gambling. I don't think the story is weakened by the author having invested money in one of the 'casinos'.

I'll bet it's not part Goldman's normal business model to borrow money at 10% to fund operations. Perhaps Buffett was just taking advantage of their weakness to extract some cash from the beast and invest it into more sound vehicles in the future.
From what I have read, investing in Goldman was Buffet's idea. Are the any articles that list Munger talking about the equity stake in goldman as well?
You can disagree with the scheme of things while exploiting it. Buffet thinks his taxes are too low but he doesn't offer to pay extra unless he is forced to.
I think it's hard to criticize the man on those grounds since he has pledged to give the "bulk of his fortune" to the Gates Foundation. That's arguably more productive than donating money to the government.

http://www.washingtonpost.com/wp-dyn/content/article/2006/06...

I was disagreeing with the original commenter.

I was arguing it's possible to not agree with the way the world works, but still exploit it. Of course buffet shouldn't pay taxes until the laws are changed. Hs's publicly argued many times that taxes are too low on rich people, just as he argues derivatibes are net destructive to society - it desn't mean he should not deal in derivatives if he sees an opportunity.

Wouldn't voluntarily paying extra taxes be akin to donating money to the government? Say what you will about Buffet, but I don't think you can criticize him for not writing a few extra zeros on his tax check.

EDIT: Fixed duplicate words.

marshallp wasn't criticizing him. On the contrary, he was just pointing out that Buffet's actions are morally consistent.
Munger is clearly advocating for "the Volker Rule" and a middle of the road economic policy when it comes to regulation (It's hard not to agree).

The finger pointing at Bershire here from self-proclaimed free market advocates is bunk. In theory, we all benefited indirectly from TARP, they just had enough foresight to position themselves to take advantage of the opportunities presented by the turmoil.

It would also be nice to clearly differentiate Bucket Shops and Over-the-Counter Trades. The concepts are very similar, but only one is legal. Anyone have a good explanation?

P.S. The article is a good parable, but switching from the casino metaphor to talk of actual casinos threw me for a loop.

P.P.S. Most everything is a derivative. The problem is with counter-party risk and transparency. Derivatives are not inherently bad.

One of my discomforts with almost all economic arguments is the strong partitioning of ideas. If you are free market, the government can do no good and if you are "Progressive" corporations are evil. Munger is mostly above this level of naivete, but not completely. He points out that government spending is too high and that leverage can be too dangerous (i.e. gambling.) However, he seems to be prescriptively mute on the former and favors prohibition on the later.

The school of thought to which I am a recent entrant suggests a more uncommonly (expressed) alternative. Keep all the gov debt and spending as low as possible when times are good. Regulate to a minimum. When a crisis occurs, the government should sometimes step in to stabilize a violently turbulent system. (Sounds like Keynes, no?)

However, you don't bailout a company. That ruins the fabric on which capitalism is built. The losers loose their money. An option is a derivative; not all derivatives are options. Bailouts make all derivative speculation, speculation in cheap options. Don't ban derivatives. Ban bailouts.

You can be progressive and free-market if you believe corporations tend to be are anti-free-market. Which they often are.
"If you are free market, the government can do no good."

Absolutely false, and I bet you can't name one scholar from Hoover who agrees with you.

Ok, how about this phrasing,

"If you're a scholar from Hoover, you'll write dozens of articles a year castigating government involvement in the marketplace as a general idea, while never, ever, once writing anything that praises government action [unless maybe if it was government action by a republican]"

So what's going on with bank reform, anyway? I haven't really kept up. I distinctly recall Bernanke saying, "too big to fail has got to go" around the time of the bailouts. Yet I haven't heard much about progress on that front...
Good question. Since the Government bailed out the banks that were too big to fail they have midwifed the merger of a couple of those banks so the banks that were too big to fail are now even bigger.
And then they made enough money to pay the government back.
Proof by fiction is even worse than proof by anecdote.
I'm offended by this "disproof by one liner." The linked article is a parable, and trying to do exactly what parables usually do; give you enough distance to revisit something that you already have opinions about.

Maybe you like it, maybe you don't. "Proof by fiction" is simple mischaracterization.

I am not saying the story is wrong, so I don't "disprove by one liner". I don't like the device for manipulating opinion, that's all.

If you read such a beautiful fairytale, you can nod along feeling comfy all the way (maybe sitting in front of a cosy fireplace among friends).

Overall, I am pretty sure opinions are not formed by logic, but by factions - we believe things because it benefits us and makes us belong to our faction. So to create a comfy fireplace fairytale setting is simply a manipulative device. I feel it is a good idea to be wary of such approaches, just as an anecdote is interesting, but should not be sufficient basis for judgment.

I wouldn't dismiss this piece out of hand. As co-captain of Berkshire Hathaway, Charlie Munger's got a pretty good window into the global financial system. Both he and Buffett have a pretty folksy manner, but behind the goofiness is usually some razor-sharp analysis.

To make it more palatable, substitute 'United States' for 'Basicland', and 'investment banks' for 'casinos'. Then it becomes a pretty accurate picture of our current situation.

The problem with this piece is that it doesn't touch on the controversial issues. The purpose of casinos is to entertain. That is a good purpose and they fulfill it well. So the parable breaks down rather quickly because he doesn't even touch on the question of what the purpose of the financial system is and what role derivatives play as part of that.

That's important, because the theory wasn't just that "the market is always right" and therefore we must let derivatives trading run amok. The theory is that derivatives help the financial system to fulfill its role better by making it more flexible, more robust in the face of volatility and risk.

I don't want to go into whether this is true or not, but without discussing the purpose of financial markets, their role in providing finance and the inevitability of speculation, etc, any critique is pointless.

That's what I thought he was getting at, but near the beginning of the piece, he describes Basicland as "rich in all nature's bounty except coal, oil, and natural gas". But the U.S. has enormous coal deposits, and in the 19th and early 20th centuries was the world's largest oil producer. Its natural gas deposits aren't too shabby either.
I got the analogy, and the story may or may not be accurate. I have heard the name Charlie Munger before, but I don't know what he stands for. I just don't like the general approach of convincing readers with fiction. It appeals to the subconscious rather than logic. I prefer logic in such matters.
It's not "proof by fiction" but a parable. He and Warren have always traded based on fundamentals, and he's saying the fundamentals got lost along the way. It's a fair point.
As a completely uninformed person, can I ask whom "the good father" in the parable refers to?

I have to say that while parables can be very powerful, this one only so thinly veils reality, that it confuses more than it helps.

"Proof by fiction is even worse than proof by anecdote."

Where did he assert "proof" in that article?

Dupe: http://news.ycombinator.com/item?id=1144930
Is there much point in pointing out a dupe if there is no discussion on it?
This problem has to be solved by pg, or whoever maintains the code here. It's really too much to expect users to review all posts to see if what they want to submit has been submitted before. It's also too much to expect that there is only one url to the same content.
good article, how can a system based on greed, corruption, and imaginary wealth survive? The U.S. has concentrated less and less on production and innovation, and needs to refocus it's efforts it it's going to get out of this hole. Energy is a great example of where production and innovation is now needed, and could revive the U.S. Economy. I hope this comes to pass.
not trying to single you out, but your post is a good example of the type of rhetoric that i dislike on economic subjects. "feel good" statements about greed and corruption discourage the kind of dispassionate analysis we actually need.
I'll go further: all economic systems are based on greed and corruption because those are parts of human nature. The question is how to you harness the former and limit the latter. We seem to do a very good job with both when compared to the rest of the world.

In terms of the bottom lines of economic growth, standards of living and employment, again, we do much better than the rest of the world (I'm not going to count the special case of China emerging from decades of communism, returning a billion plus people to the world market is a one time thing ... and their recent grow should be weighted against how much they lost economically during the previous period).