What Buffett really said about the SEC Goldman Sachs

Investigation
Posted on 08 May 2010. Tags: Berkshire Hathaway, Buffett, Goldman Sachs, Munger, SEC
What Buffett really said about the SEC Goldman Sachs Investigation
(From the Berkshire Hathaway Shareholders Meeting 2010)

Buffett:
Abacus was made the subject of an SEC investigation. Theres been misreporting, non-intentional obviously, but
there has been a misreporting of the nature of the transaction, in the majority of the reports that Ive read. This
will take a little time, but I think its an important subject. I would like to go through that transaction first and
then well get to have further questions.

There were four losers, I will focus on two of them. Goldman Sachs itself was a loser, but they didnt intend on
being a loser. They intended to sell a portion of the transaction, but were unable to sell. The main loser in terms
of actual cash value was a very large bank in Europe by the name of ABN AMRO. They subsequently became
part of the Royal Bank of Scotland.

Why did they lose money? They lost money because they, in effect, guaranteed the credit of another company ACA.
ABN was in the business of judging credits, deciding which credits they would accept themselves and which credits
they would guarantee. In effect, they did something in the insurance world called fronting, which really means
guaranteeing the transaction of another party. We have done that many times at Berkshire, we get paid for it.
People may not want the credit of XYZ insurance company, but they say theyll take a policy of XYZ company, if
we (Berkshire) guarantee it. Berkshire has been paid a lot of money over the years and Charlie you can remember
years back in the 1970s when we lost a lot of money because we guaranteed some not so honest people and we lost
a lot of money, Lloyds of all things, but they found ways not to pay it.

So ABN agreed to guarantee about $900 million worth of credit for ACA. That is in the SEC complaint that
they received about 17 basis points, that is 17 hundredths of one percent. They got it about $1,600,000 and the
company they guaranteed went broke, so they had to pay the $900 million. It is a little hard for me to get terribly
sympathetic.

ACA was a bond insurer and they started out as a municipal bond insurer. ACA, MBIAall those companies
started out insuring municipal bonds. It was a big business insuring municipal bonds and then all of a sudden
their margins started to get squeezed so instead of accepting lower profits they got into the business of insuring
structured credits and other kinds of activities. I described their activities a couple years ago as being a little bit like
Mae West who said, I was like snow white, but I drifted. Almost all of these bond insurers drifted to make a
little bit more money.

ACA did it, they all did it, and they got into trouble, every one of them.

Is there anything wrong with bond insurance? No, but you better know what youre doing. Interestingly enough,
when these other guys got in trouble we (Berkshire Hathaway) got into the municipal bond insurance business and
reassured things that were almost identical to what ACA and others had insured, the difference being we thought we
knew a little bit more about what we were doing and we got paid better for what we were doing and we stayed
away from things we didnt understand.
Heres something we did ensure to give you a better idea. Let me describe a deal to you.

A large investment bank came to us a couple of years ago (Lehman Brothers). At the time we were not insuring
bonds regularly, but we were insuring the bonds of a local utility in Nebraska and insuring the bonds of the
Methodist Hospital about six miles from here. We made the agreement that if the Methodist Hospital could not
pay the liabilities of its bonds that we would pay. The total issue was between $100 million $200 million. Now
a couple of years ago, Lehman came to us and asked us to take a look at this portfolio.

(Projection of a slide displayed of several states and related amounts to be insured.)

As you can see theres $1.1 billion for Florida and only $200 million for the state of California

Lehman asked us to insure the bonds of these states for the next 10 years and if any of these states dont pay then
wed have to pay. I looked at the list and we had to decide (a) whether we knew enough to insure them and (b)
what premium to charge. It was that simple. We didnt have to insure them, we could just say forget it, we dont
know enough to make the decision. But we knew enough to make the decision and collected about $160 million to
insure those bonds.

This gets to the crux of the SECs case against Golden.

Lehman came to us with this list, we didnt create them, another party came to us. From a buyers perspective there
are about 4 possibilities to consider.

Lehman Brothers might:

(1) own these bonds and want protection against the credit
(2) they might be negative on the bond market and effectively be shorting these bonds.
(3) a customer of Lehman that owns these bonds may have wanted to buy protection against the credit.
(4) or a customer of Lehman might be negative on these bonds and wants to short them.

We dont care what scenario exists. It is our job to value the risk of these bonds
and to arrive at a proper premium. If Ben Bernanke were on the other side of the trade it wouldnt make any
difference to me. If I have to care about whos on the other side of the trade I should not be in this business.

So, in effect, we did with these bonds exactly what ACA did with the bonds that were presented to them, but ACA
was presented with a list of about 120 and they decided theyd insure about 50 of them, then went back and
negotiated to insure 30 more. So they insured only a handful of the total list, whereas we looked at the list and took
the list and was totally the other guys list.

In the case of the Abacus transaction it was a negotiation. In the end the bonds that were included in the Abacus
transaction all went south very quickly. That wasnt so obvious that they would go south in 2007 as you can see by
studying something like the ABX index, but the housing bubble started blowing up in 2007. Now there could be
problems in states we insured, there could be pension obligations or other problems and maybe the guy going short
knows more about that than we do, but thats our problem. In the case of ACA they had teams of people looking
at these bonds and at Berkshire we only had a couple people. if I lose a lot of money on our transactions Im not
going to go to the other guy and say you took advantage of me. If its John Paulson, Im not going to complain.
No one forced me to enter into these contracts, we made the decision to do so.
I think the central part of the argument is that Paulson knew more about the bonds than the bond insurer did and
my guess is that ACA employ more people than John Paulson. In retrospect it just turned out to be dumb bond
insurance. I dont see what difference it makes whether it was John Paulson on the other side of the deal or
someone else.

Id like to get Charlies comments from a legal perspective and I havent really spoken to him too much about this,
charlie.

Munger:
My attitude is pretty simple. This was a 3-2 decision by the SEC, under circumstances where they normally
require unanimous consent. if I would have voted, I wouldve been one of the two not the three who voted to move
forward against Paulson.

Buffett:
Ive heard something about the ACA deal claiming that investors were taken advantage of, but ACA was the parent
company of the bond insurer that entered into the deal with Paulson. ACA lost money because they were bond
insurer.

Responding to a question about Berkshires Investment in Goldman Sachs

Preferreds.

Buffett:
Ironically the negative publicity to Goldman is probably in our best interest in certain ways, because we have $5
billion in preferred stock that pays us $500 million year. Golden has the legal right to call these preferreds at
110% of par. Anytime they want to send Berkshire 5.5 billion, they can, and we would turn around and put that
money in some very short-term security, which would probably under todays conditions yield something very small,
so every day that Goldman does not call their preferreds is beneficial to us. Goldman pays us $15 every second, so
as we sit here tick, tick, tick, tick $50,000 We dont want that to go away. These ticks occur at night, on
weekends

We love the Goldman investment.

Advice to Goldman:
When some kind of transgression is found or alleged we go by the motto
(1) get it right
(2) get it fast
(3) get out
(4) get it over

But, get it right is number one. If you dont have your facts right youre going to get killed. I do not hold the
allegations against Goldman as significant, but if it leads to something more serious, Ill look at the situation at
that time.

With respect to the Abacus situation I dont see much of an argument. We trade with Goldman but we dont hire
them as investment advisors. We make our own decisions. They could very well be selling short securities they sell
us. They dont need to explain to us what their doing. Their operating in a non-fiduciary capacity and we know
that.