White House Chronicle

News Analysis With a Sense of Humor

Who’s Afraid of Regulation? Not Warren Buffett

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So Warren Buffett has bought himself a railroad: Burlington Northern Santa Fe, to be exact. Crafty fellow.

Buffett famously invests in easy-to-understand large companies with a strong competitive advantage that generate cash and above-average return on capital. He has not been dazzled by the computer age. Computers, though, have had a dazzlingly disruptive effect on one of his investments: The Washington Post Company, for which Buffett serves as a director.

By his own account, Buffett finds newspapering scads of fun, connecting with journalists. Because The Post Co. bought Kaplan, Inc., the educational services outfit, Buffett and other Post investors have been spared some of the pain that falling advertising and circulation have inflicted across the industry.

Even as he was enjoying newspapering, Buffett appears to have had his eye on more solid industries. In 2000, he paid $1.7 billion to acquire an 85-percent stake in utility MidAmerican Energy Holdings Company, and later acquired the rest. Now he is paying $26.3 billion to acquire all of Texas-based Burlington Northern Santa Fe.

It would appear that in these investments, these dull industrial cornerstones, Buffett has chosen government oversight over technological vulnerability.

Both utilities and railroads are government regulated and subject to the vagaries of public policy. But they are both necessary, and therein lies Buffett’s comfort factor. Electric utilities are not known for their gyrations, nor are railroads. Indeed, both have been largely shunned by hedge funds because they lack volatility.

Buffett, it would seem, is not balked by government or its impact, through regulation, on whole classes of businesses. Electricity companies are heavily regulated at the state and federal level–and in other ways, including pollution control, fuel mix and return on equity. Similarly railroad safety, service and return on equity are dictated by regulators.

Since the heady days of deregulation in the 1980s and 1990s, despite the conservative dialectic, the electric utility industry, in particular, has discovered regulation by the government to be both a burden and a godsend. Government stifles but it also succors.

Wall Street is conflicted about regulation. While it loves the security regulation brings to electric utilities, gas distribution companies and railroads, which makes their debt an attractive investment, it fears the extension of the government’s embrace to other industries and to itself. Wall Street would love, for example, to see the airlines back under the government’s wing–as would the carriers themselves.

While the political class is consumed with the machinations of Congress, and the activism of President Barack Obama, Buffett is tacitly declaring his apprehension about disrupting technologies: computers and their progeny, like the Internet and wireless communications. Buffet is voting for investments that cannot be moved to China and cannot, by today’s reckoning, be rendered obsolete by technology.

Washington is awash with analysts, pundits, reporters and strategists aggregating and disaggregating, dicing and slicing the smallest morsel of political change. Yet, since the end of World War II, technology has had as much claim on change as politics. The three great political events of this time have been China’s conclusion that communism and capitalism can abide together; India’s final realization that protectionism was holding it back; and the collapse of the Soviet Union. Did the end of the British Empire matter? Not really.

By stealth, technology has been changing the world, wiping out whole areas of endeavor and creating new ones. Thanks to the green revolution between 1950 and 1984, the world has been better fed. Thanks to the microprocessor, we have been gadgetized–from the way we enjoy music to the ease with which we stay in touch by telephone. Thanks to the jet engine, the world has been opened to all who can afford to fly. And thanks to new technologies, medicine posts successes daily.

But it is the computer that has changed everything, for good and otherwise. It is the computer that has robbed us of our privacy, but has put the great libraries of the world at our fingertips. It has made writers of us all, even while undermining traditional journalism.

So while we are parsing electoral tidbits, technology is the real shaping force loose in the world.

If you cannot embrace it, try and get to some safe, predictable high ground, like Buffett. He is known as the Oracle of Omaha for good reason. –For the Hearst-New York Times syndicate

When Peer Pressure Took the Hand of Greed

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I once asked the chairman of Wells Fargo how his bank had gotten sucked into dubious Third World loans. “Greed,” he responded. “Just greed.”

 

He might have added another motive: peer pressure. We think of peer pressure as the force that gets kids into trouble, but business is as subject to it as teenagers are.

 

When a lot of states deregulated their electric utilities in the 1990s, these formerly conservative companies went on an international binge. They started buying up utilities around the world with a passion—a passion often fed by the fear that they were being left out of the great global bonanza. Some believed that they would not be able to hold up their heads at the meetings of the Edison Electric Institute unless they could discuss their latest acquisition in a faraway land. From Brazil to Indonesia, American electric utilities were into globalizing and loving it.

 

Of course, most of these investments went sour. The expected profits were as often as not consumed by currency variations, confiscatory local taxes and dishonest politicians, who sought to extract bribes from the operators as soon as the ink was dry on the contracts. Many American executives did not know anything about local conditions. For example they were unaware that in much of Latin America, and parts of Asia, up to 50 percent of the electricity is stolen. Governments are powerless to stop the theft for fear of social upheaval.

 

Helping the electric utilities make their mistakes were the investment banks. Mergers and acquisitions, are the mother’s milk of investment banking. The banks often found the deals, researched them and took them to the American companies. Their reward: giant fees.

 

One of these investment houses was the now bankrupt Lehman Brothers. At the height of the madness, as the publisher of The Energy Daily, I was invited to give a lecture to Lehman clients. The audience was half Lehman executives and half newly-minted internationalists. I told them the truth about investing in other people’s infrastructure: It looks good on paper, but it does not work in practice because you will be resented as an absentee landlord. Populist politicians will run against you.

 

On the face of it, this was not what they wanted to hear. They wanted wilder music and stronger drink. One major utility executive who was also something of a king-maker in the Democratic Party told me I did not know what I was talking about. He was invested in Pakistan, and thought it was a great place to do business,

 

Yet privately, the Lehman executives were glad I had called for a reality check. One managing director told me: “We should take their passports away.”

 

As investment after investment went south, many of the utility travelers came to wish they had stayed at home. Lehman, other investment banks and their lawyers knew better, but those lovely fees were irresistible.

 

The utility madness was not earth-shaking, but it was symptomatic of how investment banks regarded money itself as the client not the fee-payers.

 

About this time the world became aware that an obscure and arcane branch of finance, derivatives, was growing and attracting not financiers, but mathematicians and physicists to slice and dice away from prying regulators, troublesome politicians and curious journalists. The linkage between collateral and loans was obscured. A change in the regulations in 2004 enabled investment banks to borrow or leverage their assets by 30-to-1 when it had been 12-to-1. No worries. The market would discipline itself, said the players.

 

Mortgages were the new financial manna. You could package them and sell them around the world. But Wall Street was not satisfied with the volume of mortgages being written in the old-fashioned way and thousands of mortgage brokers started loosening the criteria, until there was really no threshold for getting a mortgage.

 

Now the party is over and the administration of George W. Bush, a conservative, is nationalizing a large chunk of the financial markets. He is also tying the hands of the next president, and there is still no transparency. The only thing that is clear is that the taxpayer will pay.