Last Saturday, Warren Buffett was asked why an investing strategy he used with such success in the last recession – extending billions of dollars of financing to desperate companies, at very high interest rates – is not on his menu today.
His answer reveals the degree to which governments and central banks, including the Bank of Canada, have been successful at protecting the financial system against the impact of the COVID-19 recession and preventing a repeat of what happened in late 2008 – at least so far.
Mr. Buffett is in his 90th year, but the mind of history’s greatest investor is as sharp as ever, as is his joy in talking, in plain English and with incomparable insight, about the economy and the markets. At this past weekend’s Berkshire Hathaway annual meeting, he spoke for the better part of four hours. No charts, no graphs, no PowerPoint. It was riveting.
One shareholder wanted to know why Mr. Buffett was not acting as the lender of last resort for companies locked out of credit markets, as in 2008. Back then, as the tide went out and much of the corporate world was caught without swimming trunks, Berkshire set up shop on the beach.
As a result of Mr. Buffett’s cash infusions, some big enterprises with good long-term fundamentals but severe short-term liquidity problems survived.
Simply put, Mr. Buffett, taking full advantage of his borrowers’ desperation, made them offers they could not refuse.
He loaned Goldman Sachs US$5-billion through preferred shares carrying a 10-per-cent interest rate; the deal included US$5-billion in warrants for Goldman equity, plus a penalty if the preferred shares were redeemed. He made loans with similarly lucrative terms to General Electric, Harley Davidson, Dow Chemical, Swiss Re and Bank of America.
So why isn’t Berkshire doing likewise today?
Because, as Mr. Buffett explained, the opportunity simply isn’t there. Companies aren’t at his door begging for the privilege of borrowing at exorbitant rates. And they aren’t because the world’s major central banks have taken action to prevent credit markets from freezing up, and to ensure that low benchmark interest rates are filtering down to the rest of the market.
“This is a very good time to borrow money,” Mr. Buffett said, “which means it may not be such a good time to lend money. But it’s good for the country that it’s a good time to borrow money. Not good for Berkshire, particularly.”
In 2008, Berkshire’s cash infusions sent a signal of confidence in the economy, but Mr. Buffett said Saturday that, while he was happy if his investments were taken as signs of confidence, that’s not why he made them. He made them to make money.
His strategy, he said, “was not designed to make a statement, it was designed to take advantage of very attractive terms. They were terms nobody else was willing to offer at that time because the market was in a state of panic.”
In 2008, almost nobody wanted to lend. Although central banks such as the U.S. Federal Reserve and the Bank of Canada had cut their headline interest rates, that wasn’t being immediately felt in corporate credit markets. In a moment of irrational pessimism, otherwise solid companies found it impossible to get financing. As one of the few sellers of money in a frantic sea of buyers, Mr. Buffett could name his price.
How is 2020 different? In March, “the debt market was frozen or in the process of freezing,” Mr. Buffett said. However, “that changed dramatically when the Fed acted.”
The Federal Reserve, in concert with the Bank of Canada and other central banks, rolled out not just low benchmark interest rates, but also quantitative easing and other interventions to push those rates down into the economy and to keep credit markets flowing.
It’s why, although there are many companies in trouble – Mr. Buffett unloaded his entire stake in the airline industry – there are no low-risk borrowers begging him for high-rate financing.
It’s a reminder that, just as a Hollywood sequel doesn’t have the same script as its predecessor, no two recessions are exactly alike. But there’s always lots of plot continuity.
Which is why it’s a good thing that the incoming governor of the Bank of Canada didn’t just see the last movie at the theatre. As the Bank’s No. 2, Tiff Macklem was on the set, and in the assistant director’s chair, for the entire production.
We’ll have more on this later this week.