Where Buffett Has His Money Now
One word: asbestos. How the world's most famous investor is playing a loosely regulated market.
Despite some rocky days in the market recently, no figure has emerged from the 2008 presidential campaign with more gilding than Warren Buffett. “Obviously the powers of the treasury secretary have been greatly expanded,” Tom Brokaw said to Senator John McCain during the first presidential debate. “[He is] the most powerful officer in the Cabinet now…Who do you have in mind to appoint to that very important post?” In a moment of deference and apparent weakness, McCain immediately confessed to Buffett-envy. Buffett was on the Obama team, McCain acknowledged, but he’d be delighted to draw on the legendary Nebraskan’s advice.
One thing in particular stands out in Buffett’s conduct over the last couple of years before the recent financial crisis: amassing extraordinary amounts of cash. Observers have been puzzled. What is Buffett preparing to buy? wonder BusinessWeek and The Wall Street Journal. Like any skilled investor, Buffett holds his cards close to the vest. He is not prepared to share his acquisition plans with the media. But in retrospect it’s pretty obvious that Buffett hasn’t been motivated by any specific shopping list. Rather, he has been anticipating a serious collapse of the market, putting himself in a position to step in and scoop up depressed assets when the market hits bottom.
Buffett has not only been one step ahead of the market, but also has been one step ahead of the regulators.
One of Buffett’s most intriguing and unremarked upon maneuvers has been to acquire large amounts of long-term insurance exposure relating to asbestosis litigation claims. These claims present a particular challenge to insurers, especially foreign insurers, because the exposure stretches over many decades and is difficult to value. Many of them have therefore been anxious to clear the claims off their books. But in Buffett, they’ve found one very eager buyer.
Here are just a few of Buffett’s transactions relating to asbestos claims:
- On October 20, 2006, Buffett acquired $9 billion in assets from the British insurer Equitas in exchange for an assumption of Equitas’ asbestosis-linked claims.
- In March 2007, Buffett acquired the UK business of Sampo Insurance of Japan, which is also thought to be heavy with asbestos claims.
- In January 2008, Buffett entered into a complex transaction with Swiss Re under which he acquired 20 percent of the company’s property and casualty insurance for the coming five years. He also went into the market to acquire a 3 percent stake in Swiss Re directly. Transactions of this sort are often a trial run for a future acquisition.
- On January 9, 2008, Reuters reports that Buffett had acquired $5 billion in connection with a deal from Bermuda-based St George Re under which he would assume their asbestosis exposure.
In the business press, these immensely complex transactions were largely reported as an expansion of Buffett’s impressive international reinsurance business. Most press accounts focused on the assumption of liabilities. There is nothing inaccurate about that characterization, but it is only half of the ledger sheet. The transactions could just as easily be viewed from the perspective of the assets Buffett was acquiring. Indeed, he “simplified” the Equitas transaction in these terms in a letter to Berkshire-Hathaway shareholders: “We said that if Equitas would give us $7.12 billion in cash and securities, we would pay all of its future claims and expenses up to $13.9 billion.” The benefit the transaction brought to Buffett was, as he properly stressed, the collection of cash, which he would have to reinvest. The offsetting obligation to pay claims is contingent, unfixed and off on the horizon. The same strategic objective appears to have been realized in the other major transactions.
Taken collectively, these deals suggest that Buffett has a more aggressive view about the potential exposure the asbestosis claims present than do the foreign insurers who are putting their claims to him. As for the claims themselves, it may be that he has a different read on the actuarial data, or that he thinks the process of tort litigation reform in the United States will produce more modest awards. But this remains speculation, since the internal analysis underlying Buffett’s strategy is tightly guarded. Still, Buffett is careful to limit his exposure when he acquires these claims. In the Equitas transaction, for instance, he provided that claims over $13.9 billion would still have to be covered by Equitas. Thus the transaction was all geared to assuming a specific layer of liability, avoiding an open-ended assumption. Reinsurance transactions of this sort are not easily understood outside the insurance industry. In the modern financial world vast sums in cash and assets change hands in just these sorts of deals, often drawing little attention from the public, the markets, and the regulators. Buffett’s own fortune has been put together in large part on the international reinsurance market. He has not only been one step ahead of the market, but also has been one step ahead of the regulators, because the international reinsurance market is arguably the most weakly policed zone of the global financial markets. While the mainstream press has described the “subprime” market as the singular cause of Wall Street’s current malaise, those in the know recognize that this is only part of the failure of regulation. Creative cash management through reinsurance deals is vastly more consequential and draws far less attention.
In short, these deals are significant because in acquiring the insurance exposure the investor also gains the insurer’s associated assets. This helps explain why, as the collapse of the American financial institutions set in this fall, Buffett was sitting on an enormous pile of cash—estimated at $50 billion or more. He has been accumulating this cash since the fall of 2006—and batting down irritation from Berkshire-Hathaway shareholders over his failure to make investments all the while. Those shareholders who complained are now slowly recognizing their error.
Curiously, one of Buffett’s first plays post-crash has been to acquire $5 billion in stock in Goldman Sachs, with an option to acquire another $5 billion. The investment comes just as the venerable investment firm has achieved unprecedented preeminence on Wall Street. Goldman Sachs’ links to the Bush administration—former executives include Treasury Secretary Henry Paulson, White House chief of staff Josh Bolten, and bailout czar Neel Kashkari, among others—are so extensive that Wall Street reverberates with suggestions that financial regulation is being outsourced to it; hence its current moniker, “ Government Sachs.” Buffett rides close to the seat of policy decision-making, always keeping a few steps ahead of the marketplace as a whole, and whispering into the ear not of the lowly regulators, but of those who control them. No investor could ever hope for a more favorable position.
Did Buffett foresee a collapse in time to start assembling a mountain of cash for a big shopping spree as the market bottoms out? In retrospect, that’s exactly how things appear. Notwithstanding an ostentatious “buy” recommendation he delivered in mid-October, Buffett’s own actions suggest that he doesn’t think the market has made its turnaround—not yet, anyway. He did take a $3 billion slice of GE Capital a week after his investment in Goldman, in a move seen as an effort to bolster confidence in the US market. “ G.E. is the symbol of American business to the world,” he said. Meanwhile, Buffett is still heavy with cash. When he does start spending it, no one doubts his appetite for shopping. “I can spend money faster than Imelda Marcos when things are right,” he once famously remarked.
[Wednesday, as The Daily Beast featured “Where Buffett Has His Money Now,” was a bad day on the markets for Warren Buffett and Berkshire-Hathaway. The stock’s value fell 12 percent in a single day—and Thursday it was off a further 7.7 percent. What caused the drop? Right now, Buffett’s firm is off 45 percent for the year, which is exactly the fall reflected for the S&P 500, so the drop brings Berkshire-Hathaway’s performance closely into line with that of the bluechips generally, particularly companies such as American Express and Wells Fargo, in which it has substantial holdings. It reflects a sense that the Sage of Omaha is not immune from the woes facing the market generally.]
Scott Horton is a law professor and writer on legal and national security affairs for Harper's Magazine and The American Lawyer, among other publications.