Buffett’s Split Personality?

“Do I contradict myself? Very well then I contradict myself, (I am large, I contain multitudes.)
Walt Whitman, “Song of Myself” ―   Walt Whitman

Contradictions do not exist. Whenever you think you are facing a contradiction, check your premises. You will find that one of them is wrong. — Ayn Rand

Below is an unusual article (from www.marktier.com) on the split between Buffett’s private and public beliefs.  Interestingly, when Buffett was growing up his father, Howard Buffett, was an advocate for the gold standard, low taxes and extremely limited government.  Thoughts on this article?

6 January 2012     Warren Buffett’s “Split Personality”

How Warren Buffett’s investment and political philosophies just don’t get along with each other.

Economic Franchise

Warren Buffett became the world’s richest investor by following a clear and straightforward investment philosophy. Intriguingly, though, his political convictions contradict the investment principles that made his fortune. For example, he refused to invest in companies which can’t control their prices; he looks for what he calls “an economic franchise.” His definition, from his 1991 Letter to Shareholders:

“An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation.” [emphasis added] This produces what he calls a “moat” — a barrier that hinders competitors who want to invade their turf.

Nebraska Furniture Mart — probably the world’s biggest furniture store located in, of all places, Omaha, Nebraska, and 100% owned by Buffett’s company, Berkshire Hathaway — keeps its costs and prices so low that national furniture chains simply avoid Omaha entirely. Coca-Cola, of which Buffett is the biggest shareholder, has such a powerful brand name that only Pepsi is in the race for second place.

By the same token, Buffett avoids “commodity businesses” like agricultural products, where producers are at the mercy of the market. And (until 1999) he shunned businesses whose retail prices are regulated.

An Energy Czar for California

In 2000-2001, California suffered severe rolling blackouts across the state. Pacific Gas and Electric Company went bankrupt and Southern California Edison almost did as well.

The cause? The state had deregulated wholesale prices, but left retail prices fixed (This is an example of a HAMPERED or price-controlled market). When wholesale prices zoomed 800%, Californian utilities had to buy power out-of-state to resell in California at the lower, regulated prices. A recipe for financial disaster.

Buffett’s reaction to the California energy crisis is an example of the dichotomy between his investment principles and his political views. When asked for his solution, he replied: “California needs an energy czar.”  (More centralized, bureaucratic control? How would Buffett’s company managers like to be micro managed from a person/group without aligned profit motives?)

California already had one — the reason there was an energy crisis!

And…with an energy czar regulating and dictating every aspect of the energy business, how much money do you think Buffett would invest in utilities in California?

Quite clearly, none.

What’s more, in a world where every investor acted like Buffett, nobody would have invested in Californian utilities.

Logically then, it follows from Buffett’s investment principles that the solution to California’s energy crisis was the deregulation of retail prices as well (politically impossible at the time). Only then would Buffett and investors like him be willing to put up the money needed to resuscitate California’s ailing utilities.

By rooting for an energy czar, obviously Buffett hadn’t connected the dots.

Interestingly, when Buffett made this “recommendation,” he’d recently added the gas and electric utility, Mid American (with zero exposure to California at the time), to Berkshire’s portfolio of “outstanding companies.”

Had he changed his spots? No, he’d lowered his standards. He had to. With billions of dollars to invest, gone were the days when a See’s Candies or Nebraska Furniture Mart could make a difference to Berkshire’s net worth. He now needed to find “elephants” where he could sink billions of dollars at a time. When he only had millions at his disposal, he’d never have looked twice at companies like Mid American or Burlington Northern.

To Tax or Not to Tax

Buffett calls taxes a “drag” that Berkshire must overcome to “justify its existence.”

This has been his attitude since he started his first investment partnership in 1956. Indeed, back then, one way he persuaded doctors and other professionals to invest with him was by stressing the tax benefits they’d get.

Today, he says he likes to hold his investments “forever” … so capital gains tax, payable only when an investment is sold, is also delayed “forever.” In his 1989 Letter to Shareholders he gave an example showing how just delaying capital gains could multiply Berkshire’s returns 27-fold, concluding that the government would gain in exactly the same ratio when capital gains taxes were ultimately paid, “though admittedly, it would have to wait for its money.”

He also prefers companies to distribute money to shareholders by buying back stock rather than paying dividends. Shareholders must pay taxes on dividends, which are paid from profits that have already been taxed at the corporate level. Stock buy-backs, by raising the value of the remaining shares, increase the shareholders’ wealth free of the dividend tax.

That double taxation is one reason Berkshire Hathaway doesn’t pay dividends. It’s also a reason why, when Buffett buys a company, he wants a minimum of 80%. Then, dividends to Berkshire are taxed at a lower rate.

If taxes are a drag on Buffett’s investments, surely they’re a drag on everyone’s? If Buffett and Berkshire are better off with minimal tax rates, wouldn’t everyone else be too? So you’d expect Buffett to support pretty much any proposal to cut taxes, right?

If you did, you’d be wrong.

“Voodoo Economics”

Buffett’s underlying political belief is that the rich should pay more tax than the poor, both absolutely and as a percentage of their income.

Indeed, in an op-ed for the New York Times Buffett complained that the previous year he’d paid only 17.4% of his income in tax, compared to an average of 36% for the 20 staff in his office in Omaha. He recommended the government raise his taxes, and those of the other super-rich.

He does not, however, put this belief into practice by voluntarily making up the difference between the tax he must pay and the amount which, according to his beliefs, he would deem “fair.” Indeed, his personal affairs are arranged the same way as Berkshire’s: to pay the least tax possible.

A case of “do as I say, not as I do.”

Shortly after becoming president, George W. Bush proposed slashing the tax on dividends. Buffett’s reaction? “Voodoo economics” that uses “Enron-style accounting,” saying it further tilts the scales towards the rich.

Maybe. But the widespread ownership of stocks in America today (through mutual funds and pension plans) means that the rich are not the only beneficiaries of a lower dividend tax.

And by opposing such a tax cut, he clearly contradicts a significant element of his investment philosophy, which implies it is iniquitous to tax corporate profits again when they’re paid out to shareholders as dividends. Indeed, if every company followed Berkshire’s lead and paid no dividends, the government wouldn’t collect any taxes on dividends at all.

Buffett also opposes abolishing the estate tax: he believes that you shouldn’t get “a lifetime supply of food stamps just because you came out of the right womb.”

Buffett has arranged his personal affairs accordingly. When he dies, his children certainly won’t be poor. But they will only have enough money so that, as he puts it, they’ll “feel they could do anything, but not so much that they could do nothing.”

Most of his wealth is going to the Bill & Melinda Gates Foundation. As it’s a non-profit organization the bequest will be — guess what? — tax-free!

It is clearly more important to Buffett that Berkshire Hathaway, his creation — his “baby” — survives his death, than remaining true to his political beliefs, no matter how sincerely they are held. After all, Berkshire Hathaway might not live on if a chunk of his controlling shareholdings had to be sold off to pay estate tax.

However, by requiring the Gates foundation to spend his annual donations immediately, he’s practicing what governments do so well: consuming capital, not investing in the future.

And he often ignores the overall context, as he did when he was an advisor to Arnold Schwarzenegger during his campaign to become Governor of California.

Buffett told the Wall Street Journal he thought California’s property taxes were “too low.” He compared the property tax he paid on his home in Laguna Beach, California with the tax on his home in Omaha. He paid twice as much property tax in Nebraska, even though his home there is one-eighth the value of his house in California.

Is that “unfair”? Not when — unlike Buffett — we look at the total context. When you add income tax, sales tax and all the other taxes Californians pay, they’re stung by the state for much more Nebraskans. Californians get a break on property taxes — and absolutely nothing else.

An American Liberal

Politically, Buffett tends to support government action to correct what he sees as society’s inequities.  And he believes that the rich should pay for it.

Yet, he arranges his own affairs to avoid government intervention wherever possible. Indeed, when price controls in New Jersey made it impossible to earn what Buffett considers a decent return of capital, one of his insurance subsidiaries turned in its license and shut down its operations there. With Buffett’s hearty approval.

His comments on business and investing draw on 55 years of proven and tested knowledge and experience.  His political recommendations have no such pedigree.  They are an expression of his beliefs unalloyed by experience.

Indeed, one would think that his experience in creating, from nothing, a highly successful, almost debt-free Fortune 500 company with outstanding managers and (until recently) one of only eight corporate AAA credit ratings in the United States would lead him to be skeptical of the ability of governments to solve any problem.

After all, in almost every respect governments exhibit qualities 180 degrees opposite to Berkshire Hathaway: they lose money every year; run up more debt every day; hardly ever kill programs that are known failures; and if governments have a higher credit rating than Berkshire Hathaway, it’s not from a gilt-edged reputation but from the knowledge that they can always make repayments by collecting money at the point of a gun — or by printing it.

Something else often missing from government is a principle central to Buffett’s style of doing business: integrity. “In evaluating people [to hire or work with],” Buffett says, “you look for three qualities: integrity, intelligence and energy. And if you don’t have the first, the other two will kill you.”

While Buffett might enjoy playing golf with politicians like Bill Clinton, he’d have to break one of his fundamental principles to ever put one of them on Berkshire’s payroll. Mark Tier

Have a question or a comment?

Well……I never quite bought the howdy doody act, but I respect Mr. Buffett as an investor and human being.  His public proclamations on economics seem Daffy.

20 responses to “Buffett’s Split Personality?

  1. By the way, whom would you bet on in the cartoon up above?

  2. There are many Buffett detractors, and a lot of what they say verges on the rabid. Having said that …

    I sometimes suspect that Buffett doesn’t say what he means, and that he has hidden agendas. He sometimes – only sometimes – says thing that sound a little naive, which I find it impossible to reconcile with his extreme intellect and worldly wisdom. I can’t recollect any particular examples offhand, though.

    After the housing crisis, he became involved in its distressed debt, explaining how he would make a lot of money. I sat there thinking “well, you know, you’ve basically just said that you intend to profit from other people’s personal misery. There are people who are going to lose their houses and go bankrupt, whilst you’re saying you can get a dollar for 50 cents”.

    Then there’s Washington Post, which appears to be mostly propped up by Kaplan, the for-profit education establishment. Eisman called these for-profit schools “morally bankrupt”. It is impossible to believe that Buffett wasn’t aware of the unethical nature of these institutions.

    • Ive noticed he isn’t very concerned with the ethical implications of any investments. But he is bluntly open about this. In an interview a few years back, Becky asked him if he considered the fact that a Chinese oil company was funding war in an African country before investing. He said no pretty fast and very bluntly.

    • Thanks Mark.

      Interesting……………if those for-profit institutions are “morally bankrupt”, then what do we call publicly-funded universities?

      I don’t know if anyone buying distressed debt is profiting from others misery, they are actually supporting the debt market. Without their purchases, the prices would decline even further.

      If markets move money from capital misallocators to good capital allocators, then society as a whole benefits. Close down buggy whip factories and put those resources into making cars, for example–a higher valued use.

      My goal is to try to separate out politics/personal from economic laws. Economic laws are like a force of nature–they can’t be repealed only mitigated for awhile. I once threatened to sue a local politician for not raising the minimum wage to $10,000 an hour. He was running on a platform to raise minimum wages to help the “poor.” I said if raising the minimum wage by $1 would help people then how could he not raise the wage to $10,000 an hour or $1 million an hour to allow EVERYONE to be rich. Absurd
      Thanks for your thoughts.

      I will try to throw a few more punches in the comments section because I am disappointed I have yet to receive a death threat.

      • Hmmm, well I think there’s a difference between efficient capital allocation and outright crookedness. The people who took loans on teaser rates clearly didn’t appreciate that they were almost bound to default on them. You could justify it as it being their “fault”, but the lenders are culpable, too. They knew, or ought to have known, of the problems ahead. So, we have a situation whereby people were duped into buying houses that they couldn’t afford, and come the day of reckoning, these people became bankrupt and their houses repossessed. There was therefore a mass transfer of wealth.

        You can’t say that a loan shark is a “good capital allocator”, as if morality and ethics are completely irrelevant factors.

        The thing about for-profit institutions is not that I say that they are inherently evil per se, but that they grew to become hideous monstrosities. You should read about some of the tactics that they adopted – the whole thing stinks. Students unwittingly took on loans that they couldn’t afford which they were unlikely to repay, and these institutions took money from the government. In the end, it wasn’t about education, it was about cashing in on government schemes. The institutions rationalised everything just fine, of course, saying that they gave opportunities to people who wouldn’t have benefited otherwise. Those are just convenient excuses. The education provided was poor, and the students were not smart enough. Buffett would have known this, I don’t think there could be any doubt about that.

        • Good points………people will easily rationalize according to their incentives–incentive-based bias.

          A main lesson here is incentives matter for better or for worse.

          I looked at for profit education Companies like Apollo, Strayer, etc., but their customer demand is government subsidized so I could not
          figure out how to normalize earnings. What can’t continue will end. Student debt is actually still going UP!
          All those companies, of course, show up as Magic Formula stocks because they have low EV/(EBITDA-MCX) or EV/EBIT and high ROIC.

          • “All those companies, of course, show up as Magic Formula stocks ”

            Do you follow the Yahoo Group magicformulainvesting? It makes for interesting reading sometimes, and is low-volume. At the end of last year they noted:
            “Clearly MFI has been struggling for the past 18 months. I have
            identified 4 clear groups that have gotten crushed:
            1. Chinese RTOs
            2. Education
            3. Nursing Homes
            4. Solar-Related Stocks”

            It just goes to show that there’s sometimes no difference between being contrarian, and being wrong. Chinese RTOs seem to be a perennial problem. I’m actually following some Chinese stocks quoted in the UK. I think everyone should study them, actually, because they can give lessons as to what to avoid. “Always invert”, and all that.

  3. I really love your blog. But I disagree with the conclusions of this post. First, you start with your personal political beliefs (the ayn rand quohanley idea a hint) and try to show how buffets beliefs should really be like yours. As. we all know if we did that with investing, we would lose before even starting. What if we start with Buffett? This is an unusual person who believes in doing something for the greater benefit of society and has devoted his entire wealth to this cause. He is arguably the best capital alocators of many generations so it only seems practical that he allocates the donation rather than the government. But as he recommends with stocks that the vast majority of investors are better off with index funds, sure there might be some exceptions but the vast majority of people should pay taxes instead of trying to allocate money for society’s benefit on their own.

  4. Yes, Warren has contradictions. But besides Ayn Rand, who thinks they don’t?

    In one of his Wesco talks, I believe Charlie Munger once referenced the Fitzgerald quote, “The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.”

    It is the ability to work though contradictions without necessarily resolving them that will help us the most in life and investing.

  5. Dear Dan:

    Thanks for your comments and especially your disagreement with my conclusions. I enjoy dissent, and I want you to speak as free as him
    to say exactly what is on your mind:
    http://www.youtube.com/watch?v=DP2PlE41wpE&feature=related
    But, next time point out specifically where the logic is wrong in my argument or else you will be objecting like this: http://www.youtube.com/watch?v=Dx32b5igLwA.
    If you show me how Buffett can be for franchises and being able to raise prices at will with See’s Candies, but not speak out against price controls that destroy businesses, I will post.
    It is true that I favor rational thought and individual rights; Buffett, Munger and Rand ALL believe in the power of rational thought. But–I also espose–if there is any coersion by the government in the lives of peaceful, freely exchanging adults that would be unjust/immoral because society benefits from freedom within the rule of law and property rights and suffers from tyranny. Drug laws and wars would fall under immoral govt. cohersion.
    Thanks.

  6. Hi John,

    I also love your blog. Thank you for creating such a valuable platform for discussion.

    I don’t deny that Buffett has contradictory beliefs, like all of us. However, I think that he has been unfairly criticized as inconsistent in the press for preaching that his tax rate should be higher, but not voluntarily paying more tax. So, I’ll stick up for him here.

    The article says “[Buffett] does not, however, put this belief into practice by voluntarily making up the difference between the tax he must pay and the amount which, according to his beliefs, he would deem fair… A case of do as I say, not as I do.” I do not think that Buffett is being inconsistent in this particular case.

    I think that you can be completely consistent in obeying the current laws, while at the same time advocating for a change in the law. I believe that this is likely how Buffett views the tax issue. He will obey the current laws, but thinks they should be changed. Said another way, I don’t see a contradiction in advocating for a gasoline tax, but then not voluntarily paying such a tax if the rest of the county doesn’t want a gas tax.

    Just my two cents.

    Tom

  7. Your comment makes logical sense. You may disagree with a law but you follow it. I will post an interview of Mr. Buffett talking more about these issues.

    For the life of me, I can’t understand his support of the Federal Reserve while knowing the causes and the ravages of inflation. His father was a huge supporter of the Gold Standard and limited government.

  8. Here is an article everyone should read, especially the people who think we should give more money to the government.

    http://www.yolohub.com/economy/34-shocking-facts-about-u-s-debt-that-should-set-america-on-fire-with-anger

    I don’t see why anyone thinks we should be taxed higher they dont spend the money we give them now well.

    Both parties are full of idiots, and The Fed has only exascerbated things.

    • Certainly if we were on a Gold Standard, there would be no way our debt would be close to the level it is now. The Federal Reserve has helped a 96% decline in the value of the US dollar since 1913 and presided over massive booms and busts. The Fed isn’t the only culprit, but it allows for the US debt to be monetized without transparency and voter consent.

      A more fundamental question is what do we want our government to do for us? What is the purpose of a government? The more property rights are respected and the less coersion in the society, the richer and more peaceful it is compared to tyrannical societies. This has held true since the Roman Empire to Castro’s Cuba and Chavez’s Venezuela. The empirical and theoretical evidence is overwhelming. The problem is when people confuse economics (human action or the science that studies the production of wealth under a system of division of labor) with politics. Remember, governments can’t create they can only use force. Now we do need governments to protect the sanctity of contracts and property thus force under a rule of law is moral to protect individual’s rights.

      Taxes may be considered destruction of wealth since they money taken from productive citizens is transfered into projects like bridges or work projects. People do not see the unseen effects of what COULD have been created by the wealth taken from the productive citizens. The money went to build a bridge but a citizen could have put the money that was taken from him to a higher use for HIM. Subjective value at work.

      Now, of course, if you are a politician who desires power you want to have more control, bigger centralized government that takes from all and gives to all so as to buy votes. Sound familiar?

      • “Taxes may be considered destruction of wealth since they money taken from productive citizens is transfered into projects like bridges or work projects.”

        I’m not keen on that argument. Maybe “for him” a bridge somewhere he never drives is no good for him, but transport infrastructure is good for everybody generally, including him. At the micro level, someone is relatively better off, someone is worse off, but overall, we’re practically all better off.

        Also, what about public healthcare? You could say “well, just let the poor die, they’re obviously not contributing sufficiently economically” – but sheesh John, I’d hate to live in your world. I don’t think you’d like it, either.

        Also, what about monopolies? Would you really let them charge prices unhindered?

        In the end, I believe that all ideologies have flaws. All of them! Not one exception. It’s not that many ideologies aren’t a basically good idea, it’s just that when you take them to their ultimate extremes, you usually end up with insanity.

        • OK, a lot to respond to but I need much more time than I have now. Your points are the legitimate counterpoints. But since our focus is on valuation/strategic analysis let’s focus on monopolies and set aside my political or economic opinions.

          Can Microsoft or Coke charge whatever price they want to? What stops Coke from charging $500 per gallon of Coke syrup? If the market is unhampered by government coersion (licenses required for example), then what keeps competitors out? We will focus on monopolies as we move along in our strategy sessions.

  9. Really enjoying your work here, but regarding Buffett I think a different perspective might make it easier to resolve. Buffett is a vicious competitor, and investing is a game with a set of rules. To win Buffett takes maximum advantage of those rules. To do any differently would put him at a disadvantage.

    However, Buffett can take maximum advantage of the rules to win, while disagreeing with the rules themselves. That is completely rational. For example, just because your team is stuck in the American league and you hate the DH rule does not mean that you don’t take maximum advantage of it. To do anything else would put your team at a huge disadvantage and possibly risk injuring your pitcher (a valuable asset). Everyone plays by the rules, not what they wish the rules were. In that way, you don’t then become a hypocrite when you lobby with the commissioner of baseball to change the DH rule.
    Buffett believes a different set of rules would be better for the whole system, and he is not shy about talking about them. Still, it does not make him a hypocrite and is not contradictory to behave according to the rules of the system, while having a negative opinion of those rules.
    Thanks again for all the great material.

  10. Yes, very well said Pete!

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