Roger Lowenstein wrote a best seller on Buffett, and is an expert on pensions, and the financial crisis. He was asked to testify before The Financial Crisis Inquiry Commission-Roger Lowenstein, Author • MP3. We discussed Warren Buffett, Seth Klarman (Lowenstein is a close friend), pensions, and the financial crisis.
Below is Lowenstein’s bio and the interview.
Roger Lowenstein, a best-selling author, has published five books;Buffett: The Making of an American Capitalist, When Genius Failed, The End of Wall Street, While America Aged and Origins of the Crash, . Mr. Lowenstein is a contributing writer for The New York Times Magazine and a columnist for Bloomberg. He frequently contributes articles and reviews to those and other publications. He is also a director of Sequoia Fund. His father, Louis Lowenstein, was an attorney, Columbia Law School professor and author and a noted critic of the financial industry.
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Below is our interview.
Buffett named Greg Alexander as one of his top three investors . I know Greg Alexander keeps a low profile; do you know him from Sequoia Fund?
I know Greg. I think Warren is right. He’s a great investor, but as Sequoia director I am not going to comment on Greg personally.
Buffett also named Seth Klarman as one of his favorite investors. Klarman recommended reading all your books, and I think you interviewed him. Do you want to comment on Seth?
He’s a great investor. Seth walks the walk. It’s hard to think of someone does a better job of actually carrying out the discipline of looking for value wherever it is. Seth doesn’t wake up in the morning and say, “I need more exposure to foreign markets, domestic markets, stocks or bonds”; he looks for future streams of cash that are underpriced. He has the total courage of his convictions, and he goes with his judgments regardless of what others may think. He’s very bright. One way that he differs from Warren is that he built an entire organization which is first class. I don’t know how many people Klarman has at Baupost, more than 100 people I believe, but Buffett as an investor has always been a lone ranger.
Despite running a massive company, if it’s a quiet day, it’s just Warren when it comes to investing. On a busy day, it’s Warren, Lou Simpson before he retired, and now Todd Combs. But Seth has built an entire organization that is uniquely skilled, professional, disciplined, and ethical. it’s an entire, investing organization and I think that’s one way in which his model has differed from Warren’s.
While on the topic, do you by any chance know Buffett’s third favorite investor Li Lu?
No, I do not know him personally.
You wrote your bestseller in 1995 on Warren Buffett, Buffett: The Making of an American Capitalist; do you think that Buffett as a person, an investor, or an image has changed since you wrote the book?
His image is much more widespread. I wrote the book in 1993 and ’94, and then it came out in ’95. In ’91-‘93, when I was still doing research for the book, he was remarkably unknown. The incident that made me want to write the book was when he got involved with Salomon Brothers, which was widely covered in the news. Prior to that he was really an unknown as far as the average American was concerned; even after that, his story and approach still weren’t known. I think that has changed by virtue of the country’s increasing fascination with Wall Street, by virtue certainly of his increasing wealth, and also by virtue of the fact that he’s become much more willing to go on shows like CNBC. He’s become a celebrity for both value investing and for his ethical approach to business. When I wrote the book, there were touches of celebrity but only touches.
I don’t think he has changed really much at all. He is older (we’re all older). The biggest thing is that with his business, his company has moved much more from traded stocks to wholly owned companies. Buffett gave the figure that he owns 60 or so companies. That was already apparent when I wrote the book (the shift into insurance and away from stock picking). There was a column in the press recently that took a shot at him and stated that Berkshire Hathaway has recently been gaining book value at a slower rate than the S&P. That was an absolutely uninformed piece of writing, because 99% of what happens to book value at Berkshire has nothing to do with his stock picking. It’s dependent on the change in value in those embedded companies which he isn’t going to trade year in and year out. So long term, it’s a reflection on his skill in acquiring companies and overseeing their managers. However, if Berkshire’s book value goes up more than the S&P does, it doesn’t mean Buffett had a great year picking stocks any more than it means he had a bad year picking stocks if book value underperforms the S&P.
Anyway, those changes have been evolving for a long time. The biggest change that has happened since my book (and I actually put out a new edition with an afterward to reflect it) was that he decided to plan what to do with his shares and his estate, and to give it to the Gates Foundation. I thought that was a major decision and a lifecycle step. His plans for succession have continued to evolve; as I think that they will continue to evolve. Otherwise, I view it as the same company. It’s interesting to see his branching into utilities, energy, and rails. That’s new and it’s almost a return back to his roots at the same time. He’s almost going back to his bread and butter, where he is the “Ben Graham investor” of buying industries with lots of fixed assets.
Could you touch on Pensions? I recommend your book While America Aged to everyone. Throughout it, you were way ahead of the curve, and you were very balanced in your approach. In your book you start by being fairly anti-union and seem to lean to the right, but then at the end you criticize San Diego for under taxing its citizens. It was very nice to see the balanced approach; it’s very hard to find these days. Nowadays, it is almost like color war, blue versus red.
(Laughter) Thank you! That flows from the belief that there is no right amount when it comes to pensions. I believe that there’s no right amount that a teacher should be paid. That’s a political issue as voters have a right to well-paid teachers and wonderful schools, and they also have a right to lousy teachers and lousy schools if that’s what they want. However, the government does not have the right to approve benefits and not fund them.
The point of the book was, if you want pensions, then fine. Fund them. If you don’t want them, then cut them out. But, you can’t take the “head in the sand” route. So I’m indifferent as to whether you raise taxes to fund them or whether you cut back on them if you still think you can attract teachers, firemen and so on. But, what you can’t do is to try to have it both ways and award the benefits and then just pass the buck. That’s bad math, and regardless of being A republican or democrat, it just doesn’t work.
I’m glad it’s widely received. The issue has become much more front and center. You don’t want to be too late and sometimes you don’t want to be too early either when it comes to writing a book on a subject. You never know when these things will become hot topics. You may begin to think “When will the time come were people see this topic’s importance?” Then suddenly, something sparks it. For the pension issue, it seemed like the financial meltdown sparked the collapse in state budgets and suddenly the voters are feeling it. They’re feeling it either from the level of services declining or because taxes are going up. The rubber is finally hitting the road. Many are seeing people in the public sector retiring in their mid or late 50’s in some cases, while the rest of us in the private sector are working into our mid or late 60’s. Then additionally, some basic things seem way out of kilter, like we are laying off teachers. So, you can’t predict these things, but at least the issue has very much come into the public consciousness now.
Do you have any thoughts on the chaos in Wisconsin?
Yes. I think the state houses are right to try and trim costs and try to bring some common sense to benefits. It seems that they want to align the benefits of the public sector employees with benefits in the private sector. What I don’t support is the attempt to strip away bargaining rights. It is almost as if Wisconsin officials are saying they are so afraid that bargaining with workers will lead to a bad deal that they must take away the right to bargain. When I think of the countries that have taken away bargaining rights, I think of the Soviet Union and what we used to call Communist China. I think of countries without basic freedoms and I think the right to bargain is a basic freedom that should be maintained.
What is the best way for the states to handle pensions?
Pensions are in many senses an ideal savings vehicle. They collectivize the various risks of retirement. Think about the risks of retirement. If you’re saving for yourself you have to worry you might live until 110 and consequently you’ll have to over-save. The beauty of a pension plan is that it saves for a whole group of people and you can actually make a pretty good guess that the average won’t live until 110. So you just save until the average of 84 (or whatever the average mortality is).
You also have to worry that when you retire as an individual, the market could be very low — say as it was in 2009. However when you are saving for a whole group of people, you know that some people will be retiring every year and on average they will retire when the market is average. You can’t count on herculean or fabulous returns, but you can count on average market returns.
I also think we’ve overestimated the extent to which the average person, certainly the average union member or public employee, is confident to invest their own retirement assets. So, pensions are able to do a lot of good, but they have to be brought to line with economic reality. They have to be funded and there is no magic formula for this.
One reason why public sector pension funds are underfunded is because of the early retirement age in the public sector. The private sector usually retires in their mid-60’s. You could eliminate a whole lot of pension underfunding if you raised the public service retirement age to that level as well. There are some jobs that can’t be done in the mid 60’s (for example, putting out fires), but there are a tremendous amount of public sector jobs that this doesn’t apply to. Meanwhile, many (if not most) public service workers who retire in their 50’s are collecting their pension while working a second job! The idea of the pension was never to get a double income and given the fact that people are living longer, entitling people to 30 and 40 years of retirement has made that burden of funding huge. So I think that if we could scale that back, then we could make pensions viable again; particularly in professions such as safety professions. Pensions are not all bad. The old saying on Wall Street is that you get into more trouble with a good idea than with a bad idea, because the good idea you take to the extremes, and I think that some of that has occurred with public sector pensions.
I wanted to discuss the financial crisis a little bit. You published When Genius Failed in 1998, which discussed the collapse of Long Term Capital Management (LTCM). I read it recently and it sounded like a near prophecy of what happens when financial institutions take on massive leverage. Did you foresee the subprime meltdown and financial crisis?
No I did not.
Do you think we learned our lessons?
I don’t think the question is did we learn our lessons because these lessons get learned and relearned. No better proof exists than LTCM. There were so many similarities between LTCM and the mortgage fiasco. I think the question is: have we put into place things that will stop and prevent reoccurrences even assuming we haven’t learned our lessons or at some point we will forget. Because, when the lure of some other bubble comes along, whether it is the belief that stocks in Japan are never going to fall, or bond spreads are always going to contract, or mortgages will never go bad; something like that will always come along. This time around, I think we have learned our lesson. The new rules on bank leverage and capital go a significant way in terms of limiting the leverage that banks are allowed. The stated rules on compensation are very important, too. The rules state that you can’t pay a trader $10 million for some deal he made, without a claw back in case the deal goes bad. What we don’t know is how effectively those rules will be enforced and whether they will be an effective deterrent. What we really care about is whether the trader thinks it will be affective. We want the trader to be worried at the time and say, “I guess I can’t make this trade, because there is a good chance that it will go sour and then I’ll have to return the money.” That’s the kind of thinking that we need people at these firms to internalize. It’s too hard to tell yet how all the regulation on derivatives will work out through exchanges and so on.
I would have gone further with financial reform, and simplified it in some ways. I think we should have outlawed some forms of derivatives. I’m not convinced that the credit default swaps do more good than harm for the world. I think some derivatives are basically big casinos for gambling. If they occurred in Las Vegas you would say that they were just gambling contracts and CDSs have a real dangerous feedback, because people look at them and say, “Wow, the price of your insurance is going up, maybe I shouldn’t lend to you.” Some of that happened to Lehman brothers and there is no doubt that it contributed to Lehman’s duress
You stated recently “The upside of the current great recession is that it will drive a stake through the heart of academic notion known as efficient market hypothesis.” In your opinion how large of a role did the efficient market theory play in the financial crisis?
I think it’s adaptation on Wall Street that had a tremendous effect. Basically the options theory that came from academia was accepted by all of Wall Street. The premise of randomness on markets was behind the method that rating agencies used to evaluate structured securities and mortgage backed securities and those were the Monte Carlo methods. The idea that (in short form) mortgages would just default in random patterns, and it would be very unlikely to happen in unison, or for every city to have a high rate of default at once and so on. As opposed to a fundamental analysis method which would, instead of looking at past statistical rates in full, would examine what’s going on in mortgage markets, what are the standards that people are using to grant mortgages? Have the standards been loosened, are there new types of mortgages being granted? This sort of belief in the random pattern defaults, sort of married to the belief that basically whatever the market does is okay, and that It will only trip up with random occurrences of defaults and failures. That’s really what everyone who bought these securities was thinking.
In the very beginning that bankers used to scrutinize every loan—that was a fundamental approach. When Wall Street went to securitizing mortgages, the investor who was a pension fund in Ireland for example, couldn’t go door to door in Southern California and ask people if they were current on their mortgages. They needed another method, and the academic formulas were really the only tool they had. And it turned out that they were completely wrong. So in that sense, I think it very much contributed to the financial crisis.
Do you have time for one last question?
Can I get controversial?
You publically criticized Bruce Greenwald in the past. Warren Buffett has praised him, and recommended taking his class. Would you care to comment?
(Interviewer’s note: in the book, Lowenstein wrote: “Greenwald, an MIT-trained economist, had married into money, made a million or two in bond futures, lost a similar sum in oils, and quit at the insistence of his in-laws. ‘As an investor, I am a complete idiot,’ he noted affably, adding that it was speculating that turned him on. He invited Buffett to give a guest lecture, but did not think him imitable. ‘I am sympathetic to the Graham-Dodd point of view,’ Greenwald said, ‘but I’m not really a Graham-and-Dodder’”.)
That quote was from 1992. I think that he is a very different person today. He’s doing a great job with the value investing program in Columbia. The Heilbrunn program has become quite well known and he’s done great things with it. It seems to me he’s gotten religion. I said in the book that he was an odd choice, and at the time he was. I think he has grown into it and he’s done wonderfully. I do hear good things about his class. My son took Bruce’s class and enjoyed it. People are allowed to change and grow.