Four Reasons The Recession May Be Easing

Is Warren Buffett Wrong? Four Reasons The Recession May Be Easing
Buffett Resumes U.S. Takeover Hunt As Rivals Drop Out

By Heidi N. Moore, WSJ | 13 March 2009

Nouriel Roubini is known as Dr. Doom, but Warren Buffett is giving the dour economist a run for his money. Getty Images

President Obama’s favorite deal maker has offered more morose pronouncements on the recession. You might recall that in April 2008, after the fall of Bear Stearns, Buffett predicted the recession would be worse than feared. This week, he upped the ante, calling the recession "an economic Pearl Harbor," and suggesting it would last for five more years, or longer than World War II. (Of course, Buffett may be going by the old saw that a recession is when your neighbor loses your job and a depression is when you lose yours; the Oracle lost over $5 billion last year in the worst performance in his 44 long years in the business.)

We haven’t seen any shantytowns spring up or people pushing wheelbarrows full of money to buy bread, so, feeling in a generous mood, Deal Journal brainstormed four reasons why Buffett could be, this time, entirely too bearish.

The Pain Already Feels Deep: The market is always looking for something called "capitulation." Even though Dow 5,000 isn’t out of the question, Doug Kass, founder of Seabreeze Capital Management, thinks a market bottom was hit March 2, writing, "My contention…is that the serious problems have been more than fully discounted in the world’s equity markets. Moreover, while many have grown increasingly impatient with the new Administration’s piecemeal strategy toward addressing the banking industry’s toxic assets, a cohesive deal, under the leadership of Lawrence Summers, will soon be forthcoming and will be effective."

The Administration Knows What the Problem Is: In the Great Depression and in Japan in the 1990s, economies suffered when leaders tried different tacks to solve their problems but committed too little capital to solving the underlying causes. But to judge from Treasury Secretary Timothy Geithner’s appearance on Charlie Rose last night, the administration knows the depth and causes of the issue: "What typically happens is people understate the severity of it. They wait too late to act. When they act, they do too little. And that makes the crisis deeper, causes more damage, makes fiscal problems worst, deficits larger in the longer term, causing more damage than necessary, and ultimately, costs more to fix it. So the basic strategy underlying what the president is doing is to move as quickly, with as much force as comprehensibly as possible." More importantly, the run of disasters seems to have slowed down, which means solutions don’t have to take just 48 hours.

The Tide Is Turning Against the Biggest Bugaboo in Finance: Mark-to-market accounting has lost its last friend on Wall Street in James Dimon, J.P. Morgan's chairman and chief executive. Many Wall Streeters have blamed their woes on accounting rules that require banks to take new hits on troubled assets every quarter– and, in the words of Shakespeare’s Macbeth, the line of such assets stretches out to the crack of doom. Proponents of such accounting dismiss such complaints, believing they are the equivalent of, say, thinking that looking in mirrors causes pimples.

In a speech today, Dimon said the accounting rule had been taken "to a ridiculous point." His compatriots running banks would agree: Wall Street has argued that it is meaningless to take troubled assets and "mark to market" if there is no market. In October, Congress eased the rules by giving banks some leeway in determining the values of these assets, but no bank wants to be in a gray area.

The drumbeat for a repeal started last fall. Dimon, the CEO of a bank that has suffered less than others, has an opinion that carries weight. In addition, Ben Bernanke suggested easing accounting rules yesterday.

The Bond Markets Are Healthier: Looking at every major bond index, "in every case the credit markets are in better shape than five months ago when the S&P was 30% higher," Kass says. The TED spread, a key indicator of the bond markets that compares three-month Libor yields to three-month T-bills, has shrunk to 1.10 percentage point from 4.63 in October. The High-Yield Spread— which compares the yields on 10-year junk bonds to 10-year Treasurys–has pulled back to 16.25 points from 19.08 points in October. The corporate bond markets saw record issuance in January and near-record in February, marking the most active months for investment-grade corporate bond issuance among American companies since 1995, according to Dealogic data, with a total of around $300 billion raised.

Dimon, too, sees a recovery on the way. What’s behind Dimon’s optimism? The bond markets, for one thing. Deal Journal has chronicled the resurgence of the bond markets in January and February, and our Dow Jones Newswires colleagues Joe Bel Bruno has this update. "There are modest signs of recovery and healing out there," Dimon said. It makes sense: if the crash was based on the loss of credit lines, the fact that some, at least, are being extended should be an encouraging sign.

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Buffett Resumes U.S. Takeover Hunt As Rivals Drop Out

By Betty Liu and Erik Holm | 12 March 2009

March 12 (Bloomberg)— Billionaire Warren Buffett, who took a four-country tour of Europe less than a year ago in search of takeover targets, now says buying opportunities are presenting themselves in the U.S. With a smaller pot of money remaining to fund deals, prices waning and bidders dropping out, Buffett’s Berkshire Hathaway Inc. no longer needs to look overseas for acquisitions, Buffett said in a Bloomberg Television interview, portions of which will be broadcast today and tomorrow.

"The way things are going, there’s a lot of things that may be happening in the United States," Buffett said."The odds favor" a domestic deal for Omaha, Nebraska-based Berkshire, he said, while allowing that "I could get a call tomorrow about some company in the U.K. or Germany." The statement is a reversal for Buffett, who spent four days at press conferences and meetings in Switzerland, Germany, Spain and Italy last May to drum up potential buyouts when U.S. opportunities were scarce. With rival bidders cut off from funds by the credit crunch and benchmark stock indexes down more than 40 percent from a year ago, Buffett, 78, can use Berkshire’s $25.5 billion cash hoard to buy into companies almost uncontested at discount prices.

Buffett committed some of the cash in July to buy $3 billion of preferred shares of Dow Chemical Co., helping fund the takeover of Rohm & Haas Co. in a deal that will pay Berkshire 8.5 percent annually. He spent $8 billion on preferred shares of General Electric Co. and Goldman Sachs Group Inc. that pay 10 percent, selling a portion of Berkshire’s holdings in Johnson & Johnson, Procter & Gamble Co. and ConocoPhillips to fund the deals.

Acquiring Corporate Debt

Last month he agreed to buy convertible notes from Swiss Reinsurance Co. worth 3 billion Swiss francs ($2.6 billion), and has made smaller deals to buy debt in firms including motorcycle-maker Harley-Davidson Inc., luxury jeweler Tiffany & Co. and Sealed Air Corp., the maker of Bubble Wrap shipping products, commanding yields as high as 15 percent. "Frankly, when we had $45 billion, the threshold wasn’t as high for the first deal as it would be subsequently," Buffett said. "I’m open for business, but it’s got to be the best business in town."

Since Berkshire’s Goldman Sachs investment was announced Sept. 23, the investment bank’s share price has fallen from $125.05 to $97.25. GE’s share price has fallen from $25.50 the day before the Oct. 1 deal announcement to $9.57 today, leaving warrants that were awarded to Berkshire as part of both agreements underwater. The strike price on the Goldman warrants is $115, and GE’s $22.25.

Wanted a ‘Kicker’

"I wanted a possible kicker," he said, adding that he didn’t know if Berkshire would make money by exercising the warrants in either company. "I think the odds are reasonably good we do them. Maybe we’ll do it on one and not the other, but in the end I was satisfied with the preferred I was getting."

Shares of Fairfield, Connecticut-based GE have plummeted on concerns the firm’s finance unit may need cash. GE cut its dividend for the first time since 1938 to save cash, and the company has announced plans to inject $15 billion into the finance unit to buffer against potential losses. GE and its finance arm lost its top-level AAA credit rating from Standard & Poor’s today.

"They’ve got the earnings power to work things through," Buffett said. GE Chief Executive Officer Jeffrey Immelt is "a terrific manager that has a business that has lots of tough sledding ahead."

Derivative Bets

Berkshire’s own stock has dropped 35 percent in the past year, compared with the 43 percent drop in the S&P 500 Index. Berkshire shares, the most expensive on the New York Stock Exchange, rose $2,000, or 2.4 percent, to $85,700 at 4:15 p.m. in composite trading.

The shares have declined on concern that Buffett’s bets on derivatives will hurt Berkshire’s profit. The firm is backing contracts tied to corporate junk bonds, municipal debt and the performance of stock indexes on three continents, with liabilities of more than $14 billion as of Dec. 31. Berkshire will sell more of the derivatives, which have brought in more than $8 billion, Buffett said. "Oh, we’ll continue; we'll do anything that I think I understand and where I think that the odds strongly favor making money, which doesn’t mean you make money every time."

Berkshire Buyback

Buffett, who has never split the stock or paid a dividend, said it’s "always a possibility" that Berkshire would repurchase its own shares. "If we were ever going to buy our own stock, I would write to shareholders," Buffett said. "We would only do it if we thought we were buying it for less than it was worth, and I’d want them to know ahead of time, so we won’t be doing it tomorrow or next week. You can’t rule it out."

Buffett formally notified shareholders Berkshire would buy back stock once during his 44-year tenure as CEO, in March 2000. Before he bought any, the shares rose 24 percent as investors interpreted the move to mean the stock was undervalued, former Morgan Stanley analyst Alice Schroeder wrote in her Buffett biography, "The Snowball."

Seeking A Better Deal

Buffett said Berkshire’s Geico auto-insurance subsidiary is breaking sales records as customers switch coverage to save money. "It’s not because we’re advertising more, and it’s not because our price differential compared to our competitors has changed," Buffett said. "It’s something in the American psyche, where the guy who didn’t care about saving a hundred bucks on his auto insurance a year ago is coming to us now."

Other Berkshire units that sell carpeting, bricks and real estate haven’t fared as well. Profit at the firm’s furniture stores, jewelry shops and candy business declined 34 percent to $91 million in the fourth quarter. "The change in the American consumer’s behavior in the last six months is like nothing that’s ever happened," Buffett said. "They won’t go in our jewelry stores. They’ve got the money, but when Valentine’s comes along, they think: ‘I still love my wife, you know, but I’ll just tell her this year.’"