Buffett's Dire Warning on Pensions?
Berkshire Hathaway chief executive Warren Buffett warned on Saturday that the growing crisis in public pensions will intensify, with "a lot" of bad news to come.I've already discussed Warren Buffett's pension wisdom in great detail. His dire warning on the pathetic state of state pension funds is right on the money. And even though pension deficits have improved dramatically over the past year, the worst is yet to come when deflation takes hold of the global economy, exposing investors who have been swimming naked over the last few years.
In his annual letter to Berkshire shareholders, Buffett said: "Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn't afford. Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them."
Buffett pointed out a 1975 memo he wrote to Katharine Graham, then chairman of The Washington Post Company, about the pitfalls of pension promises and the importance of investment policy.
In that memo, which is 38-1/2 years old, Buffett said the first rule regarding pension costs is "to know what you are getting into before signing up."
He wrote: "There probably is more managerial ignorance on pension costs than any other cost item of remotely similar magnitude. And, as will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs."
Many state and local governments are struggling to meet their obligations to retirees, stemming from the economic crisis which put enormous pressure on state and municipal budgets as well as poor decision-making.
On Saturday, Buffett said: "During the next decade, you will read a lot of news - bad news - about public pension plans. I hope my memo is helpful to you in understanding the necessity for prompt remedial action where problems exist."
In the 1975 memo, Buffett said it is "next to impossible to decrease pension benefits in a large profitable company - or even a large marginal one."
He said that language allowing companies to terminate or alter their pension plans had been eroded by law.
Over the past year, Detroit's bankruptcy filing and then Puerto Rico's shaky finances - because of loss of industry, coupled with lavish pensions - have rattled investors and economists.
Last year, municipal bond funds hemorrhaged $62.6 billion in net outflows, according to Lipper, a Thomson Reuters unit. That's more than four times the previous outflow record of $15 billion in 1994.
But as the bonds have tumbled, yield-hungry investors have once again started diving in. Those funds have seen net inflows for six of the past seven weeks, their best such performance in a year.
"I think that the key issue for the municipal market is to distinguish the state and the local governments that have made changes and are paying in from the ones that haven't and have major problems," said Natalie Cohen, the head of muni research at Wells Fargo Securities.
"That's not to deny that it's not a problem," she said.
Moody's Investors Service, where municipal bond downgrades made up four of every five rating changes in U.S. public finance last year, said in January that despite increased stability overall, pockets of pressure remain throughout the country.
You can read a recap of Berkshire's annual letter here. And keep in mind, even the Oracle of Omaha is prone to making huge investment mistakes, like his $2 billion investment in bonds of Energy Future Holdings Corp. Buffett lost $873 million investing in those bonds:
Warren Buffett on Saturday said he made a “big mistake” investing in a utility that was the subject of one of the biggest leveraged buyouts ever, but now may be on the road to bankruptcy.The Oracle of Omaha is one of the richest men in the world and a very swell guy too. I met a nice couple from Omaha a few years ago flying back from Greece and they told me they regularly see him in Omaha at his favorite restaurant.
In his annual letter to shareholders of his Berkshire Hathaway Inc, Buffett said he regretted buying US$2 billion of bonds of Energy Future Holdings Corp, created in 2007 from the US$45 billion buyout of Dallas-based TXU Corp.
Buffett, the so-called Oracle of Omaha and the world’s fourth-richest person, had bought the bonds without consulting his second-in-command, vice chairman Charlie Munger.
“Most of you have never heard of Energy Future Holdings. Consider yourselves lucky; I certainly wish I hadn’t,” Buffett, 83, said. “Next time I’ll call Charlie.”
He said he threw in the towel last year, selling the bonds for a mere US$259 million, leaving Berkshire with a US$873 million pre-tax loss after taking interest payments into account.
Buffett italicized “big” in “big mistake” in his letter.
The TXU buyout was led by KKR & Co, TPG Capital Management LP and Goldman Sachs Group Inc’s private equity arm.
It was a bet that natural gas prices would rise, allowing the company to charge more for electricity.
Instead, natural gas prices plunged, causing losses at the company’s coal-fired plants, and making a lengthy bankruptcy the most likely outcome.
Buffett said that unless natural gas prices soared, Energy Future will “almost certainly” file for bankruptcy this year.
Berkshire is a US$286 billion conglomerate better known for owning businesses such as Geico car insurance and the BNSF railroad, and stocks such as Wells Fargo & Co and Coca-Cola Co.
But it also invests more than US$29.3 billion in fixed income, and Buffett said his bond investments usually do well.
He did not rank Energy Future in his history of bad investments in Saturday’s letter.
In his annual letter in 2008, he called his US$433 million purchase of Dexter Shoe Inc in 1993 “the worst deal that I’ve made” because he used Berkshire stock rather than cash for the acquisition, and because Dexter lost its competitive strengths.
“Fortunately, my blunders usually involved relatively small acquisitions,” Buffett wrote on Saturday.
“Our large buys have generally worked out well and, in a few cases, more than well. I have not, however, made my last mistake in purchasing either businesses or stocks. Not everything works out as planned.”
Buffett is part of an elite group of investment managers I track regularly every quarter. You can scroll through Berkshire Hathaway's holdings by clicking here.
I am back from Jamaica where I had a great time enjoying the sun, beach and fun in Negril. I highly recommend Jamaica but if you go, stay a nice hotel like the Riu where security is tight and you won't be pestered on the beach by a bunch of bums selling you everything from cocaine to bracelets and aloe vera (that was the only annoying thing but it was minor).
Also, if you go to Jamaica and want to tour sites you need to contact Jimmie who runs Jimmies Culture Supreme Tours. He is the absolute best tour guide to have in Jamaica and I felt very safe when he was around (nobody bothered us when he was there). You can contact Jimmie directly at 1-876-866-9388 and tell him Leo from Montreal endorsed him. Here is a pic of Jimmie, the coolest cat in Jamaica (I love the way we greeted each other: "Respect mon" and he replied "Every time"):
Below, the Oracle of Omaha talks to CNBC's Becky Quick on why it's not wise to hold cash during a war. You should also watch an interview with Buffett's three Ts.
I would love to meet up with Warren Buffett one day to discuss pensions, inequality and the jobs crisis. I also invite him to attend a pension conference HOOPP and others are hosting in Toronto on March 17th, discussing the benefits of defined-benefit plans. I'll be there and so will some of the leading pension experts in the world.