Recommendation From Warren Buffett!

Lazy Saturday once more.

LOL! And a thousand apologies for the cheesy and misleading title.

To understand what had cause the current financial crisis, here is the letter that Warren Buffett recommended during Berkshire Annual meeting.

JP Morgan Chase 2008 Shareholder Letter

• III. FUNDAMENTAL CAUSES AND CONTRIBUTIONS TO THE FINANCIAL CRISIS
  
  After Lehman’s collapse, the global financial system went into cardiac arrest. There is much debate over whether Lehman’s crash caused it – but looking back, I believe the cumulative trauma of all the aforementioned events and some large flaws in the financial system are what caused the meltdown. If it hadn’t been Lehman, something else would have been the straw that broke the camel’s back.
  
  The causes of the financial crisis will be written about, analyzed and subject to historical revisions for decades. Any view that I express at this moment will likely be proved incomplete or possibly incorrect over time. However, I still feel compelled to attempt to do so because regulation will be written soon, in the next year or so, that will have an enormous impact on our country and our company. If we are to deal properly with this crisis moving forward, we must be brutally honest and have a full understanding of what caused it in the first place. The strength of the United States lies not in its ability to avoid problems but in our ability to face problems, to reform and to change. So it is in that spirit that I share my views.
  
  Albert Einstein once said, “Make everything as simple as possible, but not simpler.” Simplistic answers or blanket accusations will lead us astray. Any plan for the future must be based on a clear and comprehensive understanding of the key underlying causes of – and multiple contributors to – the crisis, which include the following:
  
  • The burst of a major housing bubble
  • Excessive leverage pervaded the system
  • The dramatic growth of structural risks and the unanticipated damage they caused
  • Regulatory lapses and mistakes
  • The pro-cyclical nature of virtually all policies, actions and events
  • The impact of huge trade and financing imbalances on interest rates, consumption and speculation
  
  Each main cause had multiple contributing factors. As I wrote about these causes, it became clear to me that each main cause and the related contributors could easily be rearranged and still be fairly accurate.
  
  It was also surprising to realize that many of the main causes, in fact, were known and discussed abundantly before the crisis. However, no one predicted that all of these issues would come together in the way that they did and create the largest financial and economic crisis of our lifetime.
  
  Even the more conservative of us, and I consider myself to be among them, looked at the past major crises (the 1974, 1982 and 1990 recessions; the 1987 and 2001 market crashes) or some mix of them as the worstcase events for which we needed to be prepared. We even knew that the next one would be different – but we missed the ferocity and magnitude that was lurking beneath. It also is possible that had this crisis played out differently, the massive and multiple vicious cycles of asset price reductions, a declining economy and a housing price collapse all might have played out differently – either more benignly or more violently.
  
  It is critical to understand that the capital markets today are fundamentally different than they were after World War II. This is not your grandfather’s economy. The role of banks in the capital markets has changed considerably. And this change is not well-understood – in fact, it is fraught with misconceptions. Traditional banks now provide only 20% of total lending in the economy (approximately $14 trillion of the total credit provided by all financial intermediaries). Right after World War II, that number was almost 60%. The other lending has been provided by what many call the “shadow banking” system. “Shadow” implies nefarious and in the dark, but only part of this shadow banking system was in the dark (i.e., SIVs and conduits) – the rest was right in front of us. Money market funds, which had grown to $4 trillion of assets, directly lend to corporations by buying commercial paper (they owned $700 billion of commercial paper).
  
  Bond funds, which had grown to approximately $2 trillion, also were direct buyers of corporate credit and securitizations. Securitizations, which came in many forms (including CDOs, collateralized loan obligations and commercial mortgage-backed securities), either directly or indirectly bought consumer and commercial loans. Asset securitizations simply were a conduit by which investment and commercial banks passed the loans onto the ultimate buyers.
  
  In the two weeks after the Lehman bankruptcy, money market and bond funds withdrew approximately $700 billion from the credit markets. They did this because investors (i.e., individuals and institutions) withdrew money from these funds. At the same time, bank lending actually went up as corporations needed to increasingly rely on their banks for lending. With this as a backdrop, let’s revisit the main causes of this crisis in more detail.

You need to read the rest of the letter in detail to understand the main causes Jamie is talking about here. It's a real good read.

For example Jamie talks on how and why JP Morgan fared better. See page 10.

• We didn’t write option ARMs (adjustable rate mortgages) because we did not think they were a consumer-friendly product. Although we made plenty of mistakes in the mortgage business, this was not one of them.

And on CDOs.

• We never built up the structured finance business. While we are a large player in the asset-backed securities market, we deliberately avoided the structured collateralized debt obligation (CDO) business because we believed the associated risks were too high. Structured finance in its most complicated forms, such as “CDO-squared,” has largely disappeared after unleashing a myriad of problems on the financial system. They will not be missed.

And lastly, the financial commandment!

• We avoided short-term funding of illiquid assets, and we essentially do not rely on wholesale funding. (Of our $1 trillion of deposits, approximately $300 billion is referred to as “wholesale,” but it essentially is comprised of deposits that corporate clients leave with us in the normal course of business – i.e., they are “sticky” and not like brokered certificates of deposit or “hot money” that move on a whim for one basis point.) Simply put, we still follow the financial commandment: Do not borrow short to invest long.