[Editor’s Note:  The views expressed here are solely those of Ross Kaplan, and do not represent Edina Realty, Berkshire Hathaway, or any other entity referenced.  Berkshire Hathaway is the ultimate parent company of Edina Realty.]

buffettAficionados of Warren Buffett’s annual missive to shareholders (I’m one) will recall that last year’s included a doozy:  Buffett’s advice to people who can’t replicate his skills and investing acumen.

In other words . . . everyone.

Buffett’s magical — and shockingly simple — formula?

Put 90% into a low-cost index fund that captures broad market returns (presumptively, the S&P 500), and the rest into a short-term government bond fund.

If that’s good enough for Buffett’s sister, it’s good enough for you and me.

Crash Whodunnit:  Wall Street (Mostly)

So what’s buried in this year’s letter?

Buffett’s take on The 2008 Crash:

“There is no question that reckless practices in home lending played a major role in bringing on the financial panic of 2008, which in turn led to the Great Recession. In the years preceding the meltdown, a destructive and often corrupt pattern of mortgage creation flourished whereby (1) an originator in, say, California would make loans and (2) promptly sell them to an investment or commercial bank in, say, New York, which would package many mortgages to serve as collateral for a dizzyingly complicated array of mortgage-backed securities to be (3) sold to unwitting institutions around the world.

As if these sins weren’t sufficient to create an unholy mess, imaginative investment bankers sometimes concocted a second layer of sliced-up financing whose value depended on the junkier portions of primary offerings. (When Wall Street gets “innovative,” watch out!) While that was going on, I described this “doubling-up” practice as requiring an investor to read tens of thousands of pages of mind-numbing prose to evaluate a single security being offered.

Both the originator and the packager of these financings had no skin in the game and were driven by volume and mark-ups. Many housing borrowers joined the party as well, blatantly lying on their loan applications while mortgage originators looked the other way. Naturally, the gamiest credits generated the most profits. Smooth Wall Street salesmen garnered millions annually by manufacturing products that their customers were unable to understand. (It’s also questionable as to whether the major rating agencies were capable of evaluating the more complex structures. But rate them they did.)”

–Warren Buffett; 2016 Berkshire Hathaway Letter to Shareholders.

Revisionist History

I just have two quibbles with Mr. Buffett’s analysis:

One.  I prefer the term, “The 2008 Crash,” to “The Financial Panic of 2008” and its aftermath, the so-called “Great Recession.”

titanicWhile there certainly was panic associated with the collapse of the housing market and all the securities tied to it, that’s like saying that the passengers on the Titanic panicked, too.

No doubt — but that wasn’t what caused the ship to sink.

Instead, panic was an inevitable effect of the boat striking an iceberg and sinking, just as panic was an effect of the air coming out of the Wall Street-inflated financial bubble in 2008.

Cause vs. Effect

Which leads to caveat #2:  Buffett lets the credit rating agencies off easy.

Instead of characterizing their massive ratings failure as a competency issue, I’d call it a matter of compromised judgment if not outright corruption.

That’s predictably what happens when the three major credit raters (Standard & Poor’s, Moody’s, and the Fitch Group) are paid by the same Wall Street firms issuing the securities — a practice that continues, unchanged, today.

Complicating matters somewhat for Mr. Buffett:  Berkshire’s sizable investments in Moody’s, as well as consummate Wall Street player Goldman Sachs.

See also, “Financial House of Cards — But Insured!“; “Drug Dealers vs. Investment Bankers:  ‘Top 10’ Differences”; “Goldman Sachs:  ‘It’s Not My Dog'”; and “Movie Review:  ‘The Big Short’ Entertains, But First it Has to Educate.”

About the author

Ross Kaplan has 19+ years experience selling real estate all over the Twin Cities. He is also a 12-time consecutive "Super Real Estate Agent," as determined by Mpls. - St. Paul Magazine and Twin Cities Business Magazine. Prior to becoming a Realtor, Ross was an attorney (corporate law), CPA, and entrepreneur. He holds an economics degree from Stanford.

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