Friday, February 20, 2009

Featured Book Look: Dear Mr. Buffett by Janet Tavakoli

"Only when the tide goes out do you discover who's been swimming naked," Warren Buffett once observed. Janet Tavakoli's book Dear Mr. Buffett is less about the Oracle From Omaha than the various naked swimmers in the recent financial markets. The essence of her argument is that the recent financial turmoil is not the result of unpredictable black swan events; rather, it is the consequence of out and out malfeasance on the part of those who take risk and those who are charged with regulating it.

"At its core," Tavakoli observes, "the mortgage crisis is no more sophisticated than a schoolyard swindle, and the SEC is the principal." She effectively contrasts the imprudent use of leverage across investment banks, government sponsored enterprises, and hedge funds with the value investing philosophy of Warren Buffet, driving home the point that much of our recent economic activity has been destructive of wealth. "Price is what you pay," Buffett explained, "Value is what you get." Our recent financial system, Tavakoli asserts, has paid high prices for little value.

Her book is an excellent, readable overview and explanation of what's gone wrong and also a warning about what may be to come. She explains:

"As long as Wall Street enhances revenues with leverage to prop up kingly bonuses, as long as there are few personal consequences for CEOs (and board members and other top executives) for shoddy risk management, as long as CEOs are allowed to walk away with millions, nothing will change. The fact that shareholders are wiped out is no deterrent, and moral hazard will live on (p. 206)."

Indeed, Tavakoli maintains, we have compounded such moral hazard by putting billions of taxpayer dollars at risk in bailouts without clear, effective accountability.

To be sure, even value investing undergoes painful drawdowns during bear markets. It is only after those downdrafts that portfolios reveal the value purchased for the price. Buffett has advised that people only buy things that they'd be happy to own if markets closed down for ten years. That may well be good advice for those looking to be well positioned in the next decade; if so, the bear market will have fulfilled its function and returned wealth to its rightful owners.

I will be periodically reviewing interesting blog sites and trading-related books as part of a new feature to this blog. All reviews are initiated by me and uncompensated. If readers have suggestions of sites and books worthy of review, by all means email me at the address listed in the "About Me" section of the blog page.