Wednesday, March 16, 2011

March 16, 2011 - Berkshire Hathaway Class Project

1. What is moral hazard?


Sleeping around, can actually be useful for large derivatives dealers because it assures them government aid if trouble hits. In other words, only companies having problems that can infect the entire neighborhood – I won’t mention names – are certain to become a concern of the state (an outcome, I’m sad to say, that is proper). From this irritating reality comes The First Law of Corporate Survival for ambitious CEOs who pile on leverage and run large and unfathomable derivatives books: Modest incompetence simply won’t do; it’s mindboggling screw-ups that are required for the government bailout.

2. What are the results for small business when the government goes "in terms of poker, all in"? Remember our class on government (especially state) contracts. In Idaho, is the honey pot the contract for real estate leases to state agencies (state never moves, you leverage the contract at the bank for financing and cash in on your building with taxpayer money - and escalate the rent every year) - Is this right?

3. "In God we trust, all others pay cash" - do you agree with this statement?

4. "Buyer of Choice" for businesses. Is it a good approach to build up your business and look for a buyer? Pros and cons? Then holding purchased companies through thick and thin, "preferring thicker and thicker". Remember our discussion on blue sky. Call of the question: exit strategy.

5. What is an LBO? New term: private equity. Pros and cons. What is their game, really? Note:

Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing. A number of these acquirees, purchased only two to three
years ago, are now in mortal danger because of the debt piled on them by their private-equity buyers. Much of the bank debt is selling below 70¢ on the dollar, and the public debt has taken a far greater beating. The private equity firms, it should be noted, are not rushing in to inject the equity their wards now desperately need. Instead, they’re keeping their remaining funds very private.

6. Define derivatives. Note:

Derivatives are dangerous. They have dramatically increased the leverage and risks in our financial system. They have made it almost impossible for investors to understand and analyze our largest commercial banks and investment banks. They allowed Fannie Mae and Freddie Mac to engage in massive misstatements of
earnings for years. So indecipherable were Freddie and Fannie that their federal regulator, OFHEO, whose more than 100 employees had no job except the oversight of these two institutions, totally missed their cooking of the books.

Improved “transparency” – a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives.
Auditors can’t audit these contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin).

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