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If there is one living human being who is as well revered and respected as Lord Jesus, it is Warren

Buffet. A journalist will be taking biggest risk of his career if he ever dared to write anything
against him. “Just shut up and go for another theme, any theme, except him” his editor would say.
Such is the sway of one of the most legendary investor and humble richest person on this planet.

I am taking a chance today, writing against his latest investment in Goldman Sachs ($ 5 billions)
and General Electric ($3 billions). This is yet third time in his career that Mr. Buffet has gone
against his own self imposed discipline – not to invest in any company he does not understand.

He made his first error when he invested in troubled Solomon Brothers in early 90s. He finally
came out with little profit after spending fortune and management time. He is repeating mistake
this time by investing in Goldman Sachs.

He erred again in acquiring General Re. Here again, he lost fortune and
still owns the troubled baby.

The third and most disastrous mistake he made was this year – by
investing into Goldman Sachs and General Electric. It is not the names
in which he invested – they were no doubt the blue chips - it is the
manner in which he invested into them seriously jeopardizing the
interests of Berkshire Hathway shareholders. He was overawed by the
power, pursuit and personality of Henry Paulson, the Treasury
Secretary during Bush Administration and ex- Goldman Sachs
CEO/Chairman. He simply allowed Paulson to prevail over his trusted
vision and wisdom. Paulson simply forced him to accept the structure
of his investment that was detrimental to him and Berkshire
shareholders. It is discussed later.

Buffet did not understand the monster of derivatives that was the
downfall of Solomon Brothers. He still went for the golden knife in the
name of Goldman Sachs. It is the nature of knife to hurt someone
Anil Selarka (Kalidas) ©2009 Warren Buffet – An Investor turns Moneylender Page 2 of 5
regardless of its material – steel or gold. A knife is a knife – it ultimately cuts and kills. In a world of
massive derivative collapse, he went for a pioneer of those derivatives – Goldman Sachs and
another derivative colossus – financial arm of General Electric, a venerable name which is often
gloated over and grossly overestimated.

Being a biggest investor in the world, he knows practically all leading Investment Bankers, banks
and brokers. A first mistake every investor makes is to accept the advice of his broker or
investment banker on face value. Most investors do not buy the stocks, but the words of the
advising broker. If you want to buy say stock A (say IFCI in India) for sheer value, but your broker
advises you buy stock B (say, ICICI in India), you will buy the stock B. In short, you did not buy the
Stock B but the word of your broker. If you buy some unknown stock at the instance of broker,
you are buying that broker’s confidence. That is, you bought broker’s word, not the stock.

It is the brokers who make the markets. They induce the enthusiasm in certain counters by active
market making and increasing volume. The invitations are then sent out in the form of Broker’s
research, overweighting or underweighting, future projections and showing you the moon at
times. Why the markets are in bad shape today? Because most of the leading brokers or
investment banks have gone bankrupt or are nearly bankrupt– Bear Stearns, Bank of America,
Citigroup, JPMC, Lehman, Merrill, Goldman, Morgan Stanley, UBS, RBS, Barclays etc. The list is
unending. They have no capital to make the markets or engage into pre-emptive proprietary
trading. The rules are simple – If there are no brokers, there is no market.

God usually gives two chances. A person suffers two heart attacks and survives. The third is a fatal
one. We as human also give two chances to wrong doer. If he errs third time, we admonish, punish,
severe the relationship or dump the errand boy. Warren Buffet made the third error by investing
into GS and GE.

Let us see how he was duped by Henry Paulson and how he could have avoided the future mishaps
in early stages of investment in same counters by taking proper precautions he was capable of. He
is an investment genius – he knows that but he was not aware of. If he ever reads this article, he
would realize what he missed and where he erred.

Buying Perpetual Preferred shares with convertible warrants – an ignominious route.


When an investor becomes very rich, he develops the tendency of looking for higher yield. His
large cash holding does not fetch him enough interest in practically “Zero” interest environments.
Often, I hear from the large investors – we are not getting good yield on our Bank deposits,
Certificate of Deposits or Corporate bonds. Where do we place our money now? Their patience is
wearing thin, because low interest regime simply continued for far too long, 16 years in Japan and
8 years in USA. This is why insurance giant like AIG risked out the free premium money into
monetary misadventure and lost hundreds of billions of dollars for one simple reason – to earn
better yield. These guys for the sake of 1 to 2% extra yield, forked out 100 in risky derivative and
leveraged investments.

An Investor like Warren Buffet used to have great patience in his younger days. He would wait for
extra ordinary opportunity, no matter how long he had to wait. It was more like a hunter that
waits in the bushes to trap the tiger. It was more like Chairman Mao of China’s philosophy or
policy of winning a war – “Withdraw your self from everywhere as much deeper as you can, and
let the enemy come in. When the enemy is deeply entrenched into your territory, then only pounce
on him.” In investment parlance, Chairman Mao would have said, “Withdraw your investments
from everywhere; let the stocks or markets recede as deep as they can into your territory (buying
Anil Selarka (Kalidas) ©2009 Warren Buffet – An Investor turns Moneylender Page 3 of 5
range); then only grab them on your terms. However, advancing age is taking toll on him. He is
now 78. He did not have luxury to wait for too long. His patience was wearing thin. And that forced
him into errors. By his own analogy, he did not wait long enough at the beach to let the tide
recede to see who was swimming naked. Instead he reached out few steps into the sea to grab the
swimmers who would have otherwise drowned to death.

In short, he did not wait for massive return. He was enticed by 10% yield on Preference shares.
Instead of being a hunter, he became hunted. He lent $ 8 billions just to earn 10% yield when the
dictated FED rates were only 0.5%. He never asked himself why such blue chip companies like
Goldman Sachs or General Electric should pay 10% when the borrowings from FED could be had
at less than 1%. In fact, he became a “Moneylender” from being an investor for most of his life.
This was the biggest casualty of credit crisis. Let us see how he invested insecurely and he could
have invested with full security of his massive investment., nearly 25% of his Net Worth.
Warren Buffet’s Gamble in Investment
Goldman Sachs and General Electric
Details /Type His Unsecured Investment Solution: Secured Investment
Goldman General Elec Goldman General Elec
Sachs Sachs
01 Date of Issue/Deal
02 Amount Invested $ 5 Billions $ 3 Billions $ 5 Billions $ 3 Billions
03 Route adopted Preference Preference Convertible Convertible
shares Shares Bond Bond
04 Maturity of Instrument Perpetual Perpetual Limited period Limited Period
05 Considered as Unsecured Unsecured Fully Secured Fully Secured
06 Liquidity of Instrument Less than 20% Less than 100% 100%
20%
07 Possible Premium or -10% to -50% -10% to -50% + 30% to 300% +30% to 300%
discount in Secondary
Market
08 Preference in Last Last First First
liquidation
09 Coupon 10% 10% 10% 10%
10 Other Attached Convertible Convertible Bonds already Bonds already
Instrument Warrant Warrant Convertible Convertible
11
12 Conversion Price $115 - Fixed $22.25 - Fixed $115 Variable $22.25 -
or 20% below Variable or 20%
MP at any time below MP at any
time
13 Conversion Period Not known First 5 years During life of During life of
First 5 years? the Bond the Bond
14 Buy Back option for Yes, at any time Yes, after 3 None None
Issuer (Callable) @ 10% years @10%
premium premium
15 Overall Security Least Least Most Most
16 Overall Return 10% Interest 10%
10% Premium
? Capital
Appreciation
17 Overall Attractiveness Least Least Best Best
Anil Selarka (Kalidas) ©2009 Warren Buffet – An Investor turns Moneylender Page 4 of 5
It will be observed that Warren Buffet has for some strange reason adopted the route of
“Perpetual Preferred Stock” against conventional Convertible Bond approach. Following are the
essential difference and risk involved:

“Perpetual Preferred Shares” PPS and “Convertible Bonds” CB– the major difference
It is simple. The PPS is part of the capital whereas CB is a debt. Under the law, debt has precedence
over the capital of any form – PPS (Perpetual Preferred Shares) or ES (Equity Shares). In the event
of liquidation of the issuer, the debt holder has priority over PPS and ES.

I remember of United Airlines, which when liquidated, gave nothing to shareholders. Entire equity
was cancelled – preferred and ordinary equity. After writing off the existing capital, the company
was handed over to debt holders who got the controlling interest in the form of new equity.
Before liquidation, the stock of UAL traded in few cents and after liquidation, when all existing
shareholders were wiped out, the new stock issued to debt holders rose close to $50 per share.

When Mr. Buffet could have got the same benefits, had he asked to contribute by way of CB rather
than PPS, why did he chose to adopt more risky form of investment via PPS?

Low Marketability of PPS versus CB


Perpetual Preferred Shares always have very low form of liquidity. Because they are “perpetual”
that is , the company is never supposed to redeem then and pay off the holders, they trade at a
very deep discount. When I was a bond trader, I have handled trades of the perpetual of banks like
HSBC and Standard Chartered Bank at discount of 25% in good market to over 52% in bad market.

In essence, the PPS will lose the value instantly by 25% to 50% the moment it trades in secondary
market.

An investor should see, before he invests, how he would be able to cash in his investments in case
of need. In this kind of bad market, there will be no buyers for GS or GE PPS. If some one makes a
market, it may trade at 20% to 50% discount, even if the interest coupon is 10%. When a
company’s existence is at stake, which investor is going to trust that company whether it would
pay interest @ 10% in time?

CB on the other hand, trade very actively in the market. They have limited life like 10 or 15 years.
The holder is having assurance that the company will have to pay off the debt at the end of expiry
of its tenure. This is why the CB trade at 30% premium the moment they are issued as against
discount in case of PPS.

Further, in case of CB there is only one instrument, whereas in case of PPS with Warrants
attached, there are two papers – PPS itself and Warrants. This again restricts its marketability
because both papers could trade separately.

Negative covenant for payment of dividend for companies under debt default
PPS holders are not entitled to receive the dividend (10% in present case) if there is a debt default.
Most of the debt instruments have “negative covenant” binding the company not to pay dividend
on equity or preferred shares if there is a “default on debt”. Thus, in case of default on GS and GE
debt, who are heavily leveraged, Mr. Buffet would not get even 1% dividend in case of some
default.
Anil Selarka (Kalidas) ©2009 Warren Buffet – An Investor turns Moneylender Page 5 of 5
Had he opted for CB, he would have been entitled to interest payment @ 10% periodically. If there
is default, the CB will get priority in payment of interest over PPS dividend.

In short
Warren Buffet appear to have made very serious mistake in structuring his investment of $ 8
billions in the form of PPS. He stands to lose immediately $ 4 billion minimum at market value. He
was obviously influenced by the charisma of Henry Paulson who structured the deal for him and
also for US government. Mr. Paulson was an expert Investment Banker at Goldman Sachs, He
knows pretty well the difference between PPS and CB and their respective priorities. Even then, he
duped US Government and Warren Buffet into unacceptable deals in the form of PPS which
seriously endanger the securities running into hundreds of billions of dollars for US government
and over $ 8 billions for Mr. Warren Buffet.

As I have said before, the people do not buy the stocks or bonds – they just buy the broker’s words,
promises or confidence.

By listening to Paulson, both US Government and Warren Buffet (his investment vehicle –
Berkshire Hathway) have become victim to hard selling tactics. They exposed themselves to
enormous risks. US tax payers will have to pay through their nose almost 2 trillions shelled out by
the Treasury and FED, although official disbursement under TARP was only $ 350 billions out of $
700 billions. Paulson had proved to be a “parasite” while he was the Treasury Secretary. Future
generation of United States will never pardon him for his unnoticed crime at the moment.

It looks like that Mr. Buffet is on downward hill. A book called “ Warren Buffet Speaks“ (290p )
may be of interest to the readers of this blog. It is free and downloadable as PDF or viewed on
screen on clicking that link Warren Buffet Speaks or full link
http://www.scribd.com/doc/7674709/Warren-Buffet-Speaks

After reading, you may as well ask why not Mr. Warren Buffet himself read it again. There is no
need to change the time tested methods that worked for him all along.

Anil Selarka (Kalidas)


Hong Kong
January 31, 2009 (Article Ref: 0901-023)
http://anilselarka.com

Document Details (Without this Box)


Main Statistics Pages 5 ; Words 2,387; Characters (no spaces) 11,273; Characters (with spaces) 13,601
Paragraphs 141 ; Lines 322
Document Ref Number 0901-023 Date 09.01.31 Author Anil Selarka Screen Name Kalidas
Official Title Warren Buffet – An Investor turns Moneylender Copyrights © 2009 Anil Selarka (Kalidas)
Key Words Buffet, Credit Crisis, Bankruptcy, Crunch, US Economy, Obama, Bush, Paulson, Bernanke, Fed, Treasury,
US dollar, Deficits, Bail out, global crisis, General Electric, Goldman Sachs
Photo Credit Buffet Caricature – Businessweek

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