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Dear Mr. Buffett: What an Investor Learns 1,269 Miles From Wall Street

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Dear Mr. Buffett: What an Investor Learns 1,269 Miles From Wall Street

  Table of Contents

  Title Page

  Copyright Page




  Chapter 1 - An Unanswered Invitation

  Chapter 2 - Lunch with Warren

  Chapter 3 - The Prairie Princes versus the Princes of Darkness

  Chapter 4 - The Insatiable Curiosity to Know Nothing Worth Knowing (Oscar Wilde ...

  Chapter 5 - MAD Mortgages—The “Great” Against the Powerless

  Chapter 6 - Shell Games (Beware of Geeks Bearing Grifts)

  Chapter 7 - Financial Astrology—AAA Falling Stars

  Chapter 8 - Bear Market (I’d Like a Review of the Bidding)

  Chapter 9 - Dead Man’s Curve

  Chapter 10 - Bazooka Hank and Dread Reckoning (AIG, Fannie, Freddie, Lehman, ...

  Chapter 11 - Bond Insurance Burns Main Street

  Chapter 12 - Money, Money, Money (Warren and Washington)

  Chapter 13 - The Fogs of War, Religion, and Politics

  Chapter 14 - Finding Value




  Copyright © 2009 by Janet M. Tavakoli. All rights reserved.

  Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

  Published simultaneously in Canada.

  No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the Web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at

  Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials.The advice and strategies contained herein may not be suitable for your situation.You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

  For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.

  Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our Web site at

  Library of Congress Cataloging-in-Publication Data:

  Tavakoli, Janet M.

  Dear Mr. Buffet: what an investor learns 1,269 miles from Wall Street / Janet M.Tavakoli.

  p. cm

  Includes bibliographical references and index.

  eISBN : 978-0-470-44273-9

  1. Investments—Decision making. 2. Investment analysis. 3. Financial risk

  management. 4. Value. 5. Buffett,Warren. 6. Berkshire Hathaway Inc. 7. Tavakoli,

  Janet M. I. Title.

  HG4521.T34 2009

  332.6-dc22 2008035055

  332.6—dc22 2008035055


  Nobody was ever made by him [Claudius Maximus] to feel inferior, yet none could have presumed to challenge his pre-eminence. He was also the possessor of an agreeable sense of humor.

  —Marcus Aurelius


  In 2003, I moved from London to Chicago, my original hometown, and founded a finance consulting firm,Tavakoli Structured Finance, Inc. Sophisticated financial institutions call me when they have trouble understanding complex financial products, and in recent years, the products have exploded in size and complexity. They also call me when they fight with each other over these products. As a result, my firm is a lightning rod for the myriad problems facing the credit markets. My client list is short and elite, and in one way or another, most of my business comes from my former employers.

  I created a niche business at the right time. Structured finance birthed a plethora of new products with acronyms such as ABS, MBS, CDO, and CMO, among other alphabet combinations. Reporters and television networks frequently ask me to make sense of market madness. I’ve made repeat television appearances—CNN, CNBC, BNN (Canada’s Business News Network), CBS Evening News, Bloomberg TV, and First Business Morning News—on where I’ve frequently predicted problems long before the market or even the Federal Reserve acknowledged them. I’ve been quoted in major financial publications including the Wall Street Journal, the Financial Times, BusinessWeek, Forbes, Fortune and Investors Dealers’ Digest (among others) in which I was often the first to publicly and specifically challenge major financial institutions, the Federal Reserve Bank, and the major rating agencies: Moody’s Corporation (Moody’s); Standard & Poor’s (S&P), part of the McGraw-Hill Companies, Inc.; and Fitch, owned by France-based Fimalac SA.

  Beginning in 1985, I worked for various Wall Street firms in New York and London. These included Salomon Brothers (now part of Citigroup), Bank One and Bear Stearns (both now part of JPMorgan Chase), Goldman Sachs, Merrill Lynch, and others. I chiefly worked on trading floors, and most of my colleagues were men. My career travels took me to New York, Japan, continental Europe, and England. I traded, structured and sold complex financial instruments. Although I often held management jobs, I was chiefly a hired gun; I took the jobs others considered too new or too difficult.

  I wrote finance books well known to users of esoteric financial products with tongue-twisting names such as credit derivatives and collateralized debt obligations. Ten years ago, these products were limited to a small group, but now these products pose hot-button issues for investors ranging from very sophisticated banks to near-retail clients including local governments, small pension funds, and condominium associations. I wrote articles for major financial publications explaining problems in structured finance and warned that it would not end well. I predicted the mortgage meltdown, the global credit bubble, and the collapse of investments backed by unwise mortgage loans. I warned about the risks of hedge funds using leverage including Long-Term Capital Management (LTCM).While the rest of the financial community tripped over themselves to extend LTCM credit (and later regretted it), I recommended cutting their credit. Along the way, I acquired fans and a few groupies. At a Washington D.C. conference, a woman approached me in the ladies room to ask me to sign a blank sheet of paper, just to have my autograph. At a New York conference, an attendee from the Netherlands asked me to sign an extra book he had packed for his absent colleague, a fan who could not make the trip to New York. As I was finalizing paperwork at my doctor’s office in Chicago, a man standing at the counter said: “Tavakoli? Are you the lady who wrote the credit derivatives book?”

  I stumbled upon a career in finance. My parents met near the end of World War II, during which my mother’s brother was killed after par
achuting into Normandy. My Wisconsin-born father was chief of surgical services tending wounded soldiers in the Central Europe and Rhineland campaigns. My mother, who hailed from Buffalo, nursed burn victims in England. They met through mutual friends and returned to Chicago to raise a large family. My father had worked his way through medical school at Jesuit-run Loyola University during the first half of the last century, when well-educated adults were expected to be well-read polymaths. He died when I was 12, and during the summers of my teenage years, I read his collection of books, including texts about medicine, mathematics, Greek philosophy, history, and poetry. My father had read the Wall Street Journal every day, but after he died, my mother had not kept up the subscription. I was interested in finance, but I did not yet know much about it.

  I graduated with a B.S. in chemical engineering from the Illinois Institute of Technology, and got married five days after graduation. I worked as a chemical engineer, and a couple of years later (in 1978), I moved to Iran with my Iranian (and now ex-) husband. Our timing couldn’t have been worse. Six months after we arrived, Iranians deposed the Shah, and the Ayatollah Khomeini returned to lead an anti-American, repressive theocratic government. I returned to the United States carrying one suitcase of clothing and $1,000. My husband remained in Iran with his wealthy family. He returned to the United States a few years later to start a business with his father’s help, but by then, he was my ex-husband. I had lost my possessions and savings, but my true wealth is portable and remained on my shoulders. I worked as an engineer by day and received an MBA from the University of Chicago’s Graduate School of Business night program, where I later taught derivatives part time.

  Just because one is an expert in complicated financial products like derivatives, it does not mean one is good at value investing. (But it doesn’t mean one is bad at it, either.) Although I had read a lot on the subject of value investing, I had not really absorbed it, and I had not diligently practiced it when making investments for my personal portfolio. Then I took a trip to a city 1,269 miles from Wall Street, and my perspective changed.

  Harry Truman once said: “The only thing new is the history you don’t know.” I thought I knew a lot, until I met Warren Buffett. In June 2005, I received a letter from Warren Buffett inviting me to visit him in Omaha. A few years earlier, I had sent him a copy of a book I wrote on credit derivatives with a letter stuffed between the pages. It was a pleasure to receive his invitation; but I delayed in responding to him, even after learning that lunch with Warren Buffett went for $202,000 in 2004 and $351,000 in 2005 in charity auctions on eBay (the winning bid in 2008 was $2.11 million, and the proceeds benefit the Glide Foundation, a charity dedicated to helping the poor and homeless get back on their feet1). I am glad I didn’t delay our meeting longer because when I finally met Warren Buffett, I came to realize that I still have a lot to learn. Truman is right that we can learn a lot from history (Buffett’s annual letters to Berkshire Hathaway’s shareholders), but Warren Buffett also taught me that I can learn new things about evaluating the present to improve the odds that the future will be better.

  This book is about my meeting with Warren Buffett on the eve of the greatest market meltdown in history and how meeting him subtly changed the way I look at the global financial markets. I already knew the principles, but meeting Warren encouraged me to think about all financial products in a Benjamin Graham-style framework.

  I also changed the way I invest. I have no illusions that I am in the same league with Warren Buffett, but I improved after I met him. Buffett’s successful track record spans a half century, so you’ll have to check back with me in fifty years to see how well I performed to use him as a benchmark. But you will have to do the measuring. I don’t measure myself against benchmarks any more than Buffett does. Instead, I focus on value.

  Benjamin Graham was Warren Buffett’s mentor. Over time, Buffett applied and interpreted Graham’s framework to his own unique investment style.This book is not about Graham’s ideas or Buffett’s ideas, it is about my reinterpretation of my own ideas about the financial markets as I looked through the lens of the value framework of Benjamin Graham and Warren Buffett.

  My ideas and conclusions are my own and may differ somewhat from Warren Buffett’s. No two people think exactly alike; that is what makes a market. But in areas where we may disagree, I should also point out that Warren Buffett has more experience and a much better track record, and I am still learning. Like him, I consider myself a life-long learner. But unlike Buffett, I have so much more to learn.

  Monetary wealth is just one measure of value, however. Steven F. Haward, in writing about Winston Churchill, noted the characteristics that set him apart from other men: “candor and plain speaking, decisiveness, the ability to balance attention to details with a view of the wider scene, and a historical imagination that informed his judgment.” 2 I could say the same for Warren Buffett. But I have to add that he has a genuine affection for the human race, and a generous desire for everyone to get as much from life as he does. He shared that with me, and now I am sharing it with you.

  In the interest of full disclosure, I own Berkshire Hathaway stock (BRKA).


  I would like to thank the many people who offered comments, encouragement, and suggestions, especially Arturo Cifuentes, Ph.D., managing director, R.W. Pressprich & Co.; David Kuenzi, head of Risk Management and Quantitative Research at Man Glenwood; Lee Argush, cofounder and executive managing director of Concord Wealth Management; Jim Rogers of Rogers Holdings; Hilary Till, cofounder, Premia Capital Management, LLC; Carl Schuman; Costas Kaplanis; Kenneth Brian Brummel, who made tactful comments on an early draft; Greg Newton, founding publisher, MAR/Hedge; Michael Siconolfi, senior editor at the Wall Street Journal; Eric Gleacher, founder and chairman of Gleacher Partners; Stephen Partridge-Hicks, cofounder of Gordian Knot; Suzette Haden Elgin, Ph.D. (for decades-old encouragement—you may have forgotten, but I have not); and Edward Stone, Nancie Poulos, Fred Watson, Julian Tyacke (for the question), Andrew Tobias, Osamu Yamada, J.Allen Meyer, Mary Anna Evans,Allen Salter, Rita Ilse Guhrauer, Teresa Brinati, and Libby Hellmann. I would also like to thank the many people who did not wish to be named but who acted as mutual sounding boards.

  My manuscript benefited from constructive comments from the editors of John Wiley & Sons, namely Pamela van Giessen, who took a special interest in this project and gave developmental suggestions; Emilie Herman, who removed many speed bumps; Kate Wood, who facilitated; Todd Tedesco, senior production editor; and James Reidel, who copyedited.

  Finally, I would like to thank Warren Buffett, chairman of Berkshire Hathaway, who told me to “keep writing.”

  No opinions or theories presented in this book necessarily represent those of the people I have thanked. I am responsible for any errors, statements, interpretations, or conclusions.

  Chapter 1

  An Unanswered Invitation

  Be sure to stop by if you are ever in Omaha and want to talk credit derivatives . . .

  —Warren Buffett in a letter

  to Janet Tavakoli, June 6, 2005

  It was August 1, 2005, and I was rereading a letter in my correspondence file dated June 6, 2005.The letter was from Warren Buffett, the CEO of the gargantuan Berkshire Hathaway conglomerate. I had not yet responded and had no explanation for the delay save for a little awe. For the several years prior, Fortune listed Warren Buffett as either the richest or second richest man on the planet. He and Bill Gates annually jousted for the top spot, with the outcome depending on the relative share prices of Berkshire Hathaway and Microsoft.

  Several years earlier, I had sent Warren Buffett a copy of my book, Credit Derivatives & Synthetic Structures. In his letter Buffett wrote that he had been looking at the book again and had just found a letter I had tucked between the pages, “Please accept my apologies,” he continued, “for not replying to you when I first received it.”1 He invited me to stop by if I were ever in Omaha. I looked up. After a
ll this time, I could not remember what I had written in that old letter. I did know that I had not expected a response. But certainly now a response was needed from me, a belated one.“Dear Mr. Buffett,” I began.

  I am an investor in Berkshire Hathaway “A” shares, but Mr. Buffett would have no way of knowing that since I hold shares in brokerage accounts. Perhaps Mr. Buffett had a bone to pick with me, but I had warned about the risk of credit derivatives and the hidden leverage they created. I was so persistent in exposing the flaws in the financial system that BusinessWeek called me the “Cassandra of credit derivatives.”2 But most journalists overlooked a much more important derivatives quote in Mr. Buffett’s 2002 shareholder letter. Berkshire Hathaway invests in multinational businesses with a variety of complex operations, and that means that investments have to be hedged or entered into in ways that create tax or accounting advantages. Mr. Buffett had also written:“I sometimes engage in large-scale derivatives transactions.”3 Yet I dithered and had not responded to his letter.

  In 1998, Berkshire Hathaway acquired General Reinsurance. Warren Buffett initially called it his “problem child,”4 and its General Reinsurance (Gen Re) Securities unit was its problem sibling. Even before the acquisition, both Warren Buffett and Berkshire Hathaway vice-chairman Charlie Munger realized that the value of Gen Re Securities derivatives transactions was overstated and vainly tried to sell it. Some of the contracts were for 20-year maturities, and the operation would take years to wind down. Furthermore, the models valuing the derivatives give poor approximations of the true mark-to-market value—the price at which the derivative can be bought and sold in the market—of some of Gen Re Securities’ esoteric derivatives contracts. There was no real market. Instead, the derivatives contracts were priced or marked based on model valuations known as mark to model. Buffett wrote that in extreme cases, it was a “mark to myth.”5

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