Friday, May 21, 2010

2010 Pilgrimage, Part III: In Defense of Goldman Sachs, Circa 1976


The essential question for Warren Buffett—“Would you defend Goldman’s actions if you didn’t have a $5 billion investment in the company?”—has not been asked today.

And it will not be.

That’s the downside of the Berkshire meeting format. Despite the fact that half the questions are asked directly by shareholders and the other half are questions that have been submitted to (and sifted by) three reporters, all the questions asked of Warren Buffett and Charlie Munger are asked on behalf of the shareholders.

This is not a press conference.

Thus there can be no follow-ups to whatever glaring howlers, if any, come out of the two men’s responses—and one such howler, we think, there has been.

It was Buffett’s dismissive referrence to one investment bank (Lehman Brothers) as “another carny” while he was stoutly defending another investment bank (Goldman Sachs), whose carny-like behavior went well beyond that of Lehman Brothers in the very example Buffett himself gave to shareholders.

Goldman, for readers who just arrived from Mars, is being pursued by the SEC for creating a destined-for-failure mortgage package at the behest of a hedge-fund client, with the sole purpose of selling it to another client. Lehman, on the other hand, had merely asked Buffett to insure a package of plain-vanilla municipal bonds.

Whether Goldman did anything actually illegal, as opposed to unethical, is the question which the SEC’s complaint has raised in the minds of many on Wall Street and here in Omaha.

Charlie Munger, for his part, clearly sides with the ‘unethical but not illegal’ camp. His earlier summation of the case had generated approving murmers and nods in this crowd:

“I think a lot of companies should decline business that would be legal…the standard should not be what’s legal and convenient.”

Buffett, on the other hand, has cut Goldman some serious slack, admitting neither to illegal or unethical behavior on the part of the “jockeys” in charge of that “horse,” on which he slapped a $5 billion wager during the crisis:

“We think plenty has been wrong, but our experience with Goldman Sachs goes back 44 years… We’ve bought more businesses through them than any other investment bank… They helped build Berkshire Hathaway….And we trade with them as well.

“And they can very well be shorting for their own account…they do not owe us a divulgence of their position any more than we do…they are acting in a non-fiduciary capacity when they are trading with us.”

Nevertheless, regardless of what Goldman might “owe” to its clients, Goldman’s true colors have already been well-aired in public.

And those colors, as anyone on Wall Street might have told anyone on Main Street even before the storm broke when the SEC complaint came down in April, look like this: Goldman Sachs does what is good for Goldman Sachs, period.

The fact that this appears to be a surprise all of a sudden is a mystery to anybody working in Lower Manhattan, and it seems to be a surprise to Warren Buffett.

Indeed, even a casual observor of Berkshire Hathaway might wonder why Warren Buffett would have invested $5 billion of Berkshire’s hard-earned money into Goldman Sachs during the worst financial crisis since the Great Depression unless Goldman operated in its own self interests—and did so always?

And that same observor might also ask themselves how else an investment bank operating in the most cutthroat business on earth could have managed through the storm with only one money-losing quarter, while 3 of its 4 brethren vanished completely?

In any event, today, May 1, 2010, in front of 17,000 shareholders packed into the Qwest Center arena and another 25,000 watching on big screen TVs elsewhere in the building, Buffett has cleverly shifted the discussion away from the legal and ethical issues by providing a sentimental journey of his and Munger’s history with investment bank now under fire.

“Now if they’re working with us on an acquisition or a financing, that’s a different story. I’d like to take you back—some people here will remember this—the very first bond deal Charlie and I did, our maiden voyage in 1967…Slide 2 please…”

Buffett’s call for another slide—this is a very well prepared defense—brings up on the giant screens alongside the stage an image from the front page of a very old prospectus:

“Diversified Retailing Company,” he says, harking back to an early investment of his and Munger’s.

“We went out to raise $5.5 million….What happened in this one was we were having trouble raising $5.5 million, and I called Gus Levy of Goldman Sachs and Al Gordon of Kidder Peabody and said would you guys help me? And both Gus Levy and Al Gordon said to me ‘Warren we’ll take a big piece.’”

A third slide shows the Goldman and Kidder names highlighted in yellow on the back of the prospectus. As Buffett relates the story, neither firm wanted to be on the front page despite their hefty investments:

“They wanted to give us money under an assumed name.”

This brings laughter and Buffett uses that goodwill to say more nice things about Goldman Sachs, and Kidder too.

“I do have a long memory for people that take care of Berkshire over a long time. Al Gordon was a remarkable man. Gus Levy was a remarkable man.”

For the record, Al Gordon sold Kidder to GE in 1986—almost a quarter century ago.

Gus Levy stopped running Goldman Sachs upon his death in 1976—almost 35 years ago.

Things have changed since then. A lot.

Yet this isn’t the first time Warren Buffett has held a quaint, but outdated, view of a business he thought he knew well.

Readers of “Pilgrimage to Warren Buffett’s Omaha” (McGraw Hill, 2008) will recall that Buffett held a similarly rose-colored view of General Reinsurance, for which he spent $22 billion in precious shares of Berkshire Hathaway, in 1998.

Here’s how Buffett described the situation in his almost ten years later:

For decades, General Re was the Tiffany of reinsurers, admired by all for its underwriting skills and discipline. This reputation, unfortunately, outlived its factual underpinnings, a flaw that I completely missed when I made the decision in 1998 to merge with General Re. The General Re of 1998 was not operated as the General Re of 1968 or 1978.

Now, thanks to Joe Brandon, General Re’s CEO, and his partner, Tad Montross, the luster of the company has been restored…

Is the Goldman Sachs of 2010 being operated as the Goldman Sachs of 1976, or 1966, or 1940, when a precocious 10 year old named Warren Buffett visited the firm with his father and traded stock ideas with Sidney Weinberg?

Not likely.

And Andrew Ross Sorkin, the ace New York Times reporter now asking a question, isn’t going to let Buffett off as easily as Becky Quick and the last two Berkshire shareholders.

Those three apparently picked up on Buffett’s vibe that he had finished with Goldman and shifted the focus to other areas, including:

1. The current financial reform bill being debated in Washington, of which Munger observed:

“I don’t think anybody in America, including Congress, knows what’s going to happen, and I would guess that most of them have not read the bill”;

2. Buffett’s lobbying to protect Berkshire from derivative collateral changes, which Munger defended by calling the proposal:

“Both dubious and unconstitutional”;

3. The fallout from Greece’s march towards insolvency, of which Munger said flatly:

“I think in this country—and other countries too—responsible voices are now realizing we’re NEARER trouble from government lack of credit than at any point in my lifetime.”

Sorkin, author of the best and most readable account of the financial crisis, “Too Big to Fail,” somewhat apologetically but firmly returns to Goldman, with several terrific questions rolled into one:

“As a Berkshire shareholder, who would you like to see run Goldman Sachs if not Lloyd Blankfein? Were you made aware of the Well’s notice? Would you have disclosed it? Have you been contacted about the Galleon investigation?”

Buffett begins his answer by disposing of the last question, which relates to the fact that a Goldman Sachs board member has been accused of tipping former Galleon hedge fund honcho Raj Rajaratnam about Berkshire’s imminent investment in Goldman Sachs, with a dismissive joke:

“We’ve not been contacted in any way about Galleon. No contact from anybody, and I can’t pronounce the name of the guy that runs Galleon.”

Ironically, Raj—as everybody on Wall Street, even those who didn’t know him personally, referred to him in his Master-of-the-Universe heyday—has a fairly mellifluous surname when it comes to native-born Sri Lankans, at least to American ears.

But Buffett’s point is this: he doesn’t know the guy, period. He then moves on to the Wells notice issue.

A Wells notice is a sort of legal heads-up the SEC provides to those individuals or institutions against whom it is considering bringing a civil action. The SEC had delivered one such Wells notice to Goldman Sachs in July of 2009, but Goldman chose not to disclose it until the SEC filed its complaint in April of 2010.

That lapse raised eyebrows above and beyond the eyebrow-raising that occurred when Goldman’s behavior in arranging the ABACUS transaction hit the tape, because the receipt of a Wells notice by a financial institution whose business relies on a good relationship with its regulators is surely worth knowing about if you’re an investor in that institution.

Buffett, however, disputes the notion that the Wells notice was that type of “material” information and, therefore, would have demaned immediate public disclosure. He does this by going back in time to when General Reinsurance received such a Wells notice:

“The Wells notice, we didn’t get the Wells notice, but then the Gen Re executives got the Wells Notice …that was not us receiving, but we stuck it in the 10-Qs,” the quarterly financial filings required of exchange-listed companies.

“I’ve been on the board of at least one public company for many years that got a Wells notice and they didn’t disclose. I wouldn’t have regarded it as material either.”

Buffett did not say whether that public company was a financial company dependent on the goodwill of the Securities and Exchange Commission for its daily bread, which would make his example more analogous to the Goldman situation.

More likely, Buffett is referring to Coke, on whose board Buffett served while its make-the-numbers CEO, Robert Goizueta, was driving the business to meet Wall Street expectations so hard that the company would later settle with the SEC on charges of what essentially amounted to channel-stuffing in order to hit earnings targets.

Nevertheless, Charlie Munger supports his long-time business partner’s view:

“I wouldn’t have regarded it as material either,” Munger says, and then makes an excellent point that derives from his perspective as an attorney:

“And you don’t want to give blackmail material to people that make claims.”

Buffett concludes the Wells notice discussion by saying he doesn’t know “what percentage of Wells notices” actually turn into an enforcement action anyway.

As for Lloyd Blankfein, Goldman’s CEO, Buffett gives as complete an endorsement as he can:

“If Lloyd had a twin brother I’d go for him. I haven’t given it a thought. There’s no reason to think of it. Like Penn Central problem in 1972: there was no reason to have someone other than Gus Levy running it. I just don’t see this as reflecting on Lloyd.”

Munger, who has expressed greater discomfort than Buffett with the general “scuzziness” of investment banks, firmly agrees:

“Well there’re plenty of CEOS I’d like to see gone in America, but Lloyd Blankfein isn’t one of them.”

Buffett, who likes to finish up such discussions on a light note, ends the discussion of Goldman Sachs with a nod to Munger, who is not known to hold back when it comes to expressing condmenation:

“I was worried he was going to start NAMING them.”

The crowd chuckles and Buffett moves to the next question, h
is defense of the ABACUS transaction, Lloyd Blankfein and Goldman Sachs & Company complete and on the record.

It is still early Saturday morning, May 1. There are another 50 questions to come. They will be varied in both quality and topic, and the responses will be varied, too.

In some cases, Buffett and Munger will be entirely predictable…but in others they will be surprising. And that is what keeps people coming back to Omaha.

To be continued…



Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

4 comments:

Lyon Jewett said...

Buffet is complete sell out. Once he bought 10% of GE and GS, he started showing up with Becky Quick on CNBS every other day.

His dissembling is pathetic. The dude is now a diva that has shown his true colors. He doesn't give a rats rear end how he wins (there is nothing wrong with kicking butt, just admit your soulless and get on with it).

By defending the indefensible he has shattered his "holier than thou" image of the past.

Everyone knows GE and GS are hedge funds subsidized by our fellow taxpayers. Until about 18 months ago, I worshipped Buffet and thought he'd be the last guy to go for privatized gains and socialized losses. I was wrong.

John said...

Thanks Jeff - I am enjoying this series of reports.

For those readers who would like to read some of Mr. Mungers wisdom - here is a link to an excellent speech he gave to an economics class in 2003.

www.tilsonfunds.com/MungerUCSBspeech.pdf

Allan said...

"Shaping up to be a fairly hard-nosed look" indeed.

Jonathan said...

"The essential question for Warren Buffett—“Would you defend Goldman’s actions if you didn’t have a $5 billion investment in the company?”—has not been asked today."

Very important part of this report. I can't stand everyone's favorite billionaire because he is a fraud. He made millions of dollars from the bailout money.

Buffett should swear an ethics oath and if he breaks then gets sent to the guillotine!