Known as the “Oracle of Omaha,” Warren Buffett is one of the most successful investors of all time. He runs Berkshire Hathaway, which owns more than 60 companies, including insurer Geico, battery maker Duracell, and restaurant chain Dairy Queen.
He first bought stock at age 11 and first filed taxes at age 13. Since 1965, the S&P 500 has delivered annualized returns averaging 9.7%, including dividends. During the same time period, Berkshire Hathaway has generated an average stock price gain of 20.8% per year, or slightly more than double that of the S&P 500. That’s the power of sustained outperformance, and is the primary reason Warren Buffett is one of the world’s richest people today.
Warren Buffett, the 86-year-old investor, is a folk hero as much for his plain-spoken wisdom as for his business prowess. For many, he’s a symbol of middle-American values, widely beloved for his plain-spoken ways, his humor, his modest living, his attachment to Omaha, and his simple and down to earth hobbies. The media loves reporting on his “quirky” habits, such as him eating the same $3.17 meal from McDonald’s for breakfastevery day or the fact that he still lives in the same five-bedroom stucco house in Omaha, Nebraska that he bought for $31,500 in 1958 ($250,000 in today’s dollars).
Warren Buffett was one my my heroes growing up, and I still admire his business savvy and his ability create wealth in all economic circumstances. He was my introduction to value investing through his relentless promotion of his mentor, Benjamin Graham, and his book, The Intelligent Investor.
However, despite his reputation as a folk hero of American capitalism, Buffett does not always practice what he preaches. In many cases, his actions are at odds with his well publicized advice and carefully crafted media persona. This is important because Buffett has become a very vocal advocate of various public policies and social issues. In many cases, these ideological stances appear to be more about increasing his wealth than genuinely championing a cause.
Berkshire Hathaway Tax Avoidance
Warren Buffett famously complained, “My friends and I have been coddled long enough by a billionaire-friendly Congress.” But his company, Berkshire Hathaway, hasn’t paid any taxes in years, instead building a $62 billion liability in deferred taxes while using “hypothetical amounts” to dress up its reporting to the SEC. Meanwhile, the company’s stock has been growing for 50 years at an annual rate of well over 20 percent.
Barron’s describes the Berkshire model as a process of buying other companies and holding the profits as a type of long-term capital gain. Says Barron’s: “It seems that Buffett and his businesses are serial deprivers of tax revenue to the U.S. Treasury. Yet that does not deter him from loudly advocating higher income tax rates for others.”
Buffett set up Berkshire Hathaway because corporations get more favorable tax treatment for dividends than individuals. Buffett issued stock in Berkshire Hathaway so that he could control the company that’s effectively wrapping paper for the huge stock and business holdings he owns.
He retains corporate income from the various holdings in his massive conglomerate. In fact, Buffett likes to buy companies that are currently paying a dividend to their investors. Warren Buffett then stops it, removing the millions of dollars in taxes that were going to the IRS. That income then goes to purchasing still more companies with large dividend payments, which he often halts.
When lobbying for higher taxes, he has used as a prop his secretary, who he claims pays a higher rate than his “17.4 percent.” What he tends to gloss over, however, is that this is because he pays himself a salary of only $100,000, choosing instead to receive more wealth in the form of dividends and capital gains.
All of this is may be legal, and even his fiduciary obligation to his shareholders, but it makes it hard to take his calls for tax reform seriously when he holds himself to a different standard. The following example with his Burger King — Tim Horton’s deal illustrates the hypocritical call for every other business who operates in the US to pay taxes to the US, while utilizing the very same inversion deals to increase his own wealth.
Burger King-Tim Horton’s Corporate Tax Avoidance
While Buffett supported President Barack Obama’s denouncing of a tax code that allows him (and Obama) to pay a lower effective tax rate than the Buffett’s secretary, the Burger King-Horton’s deal would seem to be a grander corporate version of tax avoidance.
In the months leading up to the 2012 US Presidential Election, President Barack Obama, eager to bash Republican businessman Mitt Romney without actually coming across as anti-business, recruited billionaire Warren Buffett as his supporter. Obama championed Buffett’s “Buffett Rule,” which held that millionaires and billionaires should pay more as a percentage of their income than the middle class.
No one really disagreed with the idea behind Buffett’s rule, but Obama beat Romney over the head regarding tax “unfairness.” Obama wanted the rich to pay a higher share of their income, and after he won election in 2012, the Bush tax rates for the highest income earners expired.
Fast forward to 2014. Buffett is helping Miami-based Burger King finance a purchase of Canada-based Tim Horton’s, doughnut-and-coffee shop.
However this deal is unique because once Burger King closes the deal with Tim Horton’s, the burger chain will “invert” itself. That means, they will declare their headquarters to be in Oakville, Ontario, where Tim Horton’s is based — not Miami.
Day-to-day, this doesn’t change anything. No stores will close. Branding of each company will remain intact. But it means the corporate tax that Burger King pays will be significantly reduced, because it is now paying corporate taxes to Canada and not the United States. This translates to a corporate tax reduction from 39.1 percent in the United States to Canada’s corporate rate of 26.3 percent.
Just months before this transaction, Buffett himself spoke out against such moves, telling an interviewer that corporate taxes relative to GDP were falling fast in the US, and adding: “We [Berkshire Hathaway] do not feel we are unduly burdened by federal income taxes. It does get a little annoying to us when we see other people paying far lower tax rates while engaging in the same sort of businesses we are engaged in.”
President Barack Obama has previously said companies that leave US shores are “basically renouncing their citizenship and declaring that they’re based somewhere else, just to avoid paying their fair share [of tax]”.
The Buffett Rule never passed Congress but Obama continued to refer to it and upped his calls for a major tax reform to stop other corporate inversions.
Bashing Derivatives and Wall Street
For years, Buffett had been complaining about financial derivatives. In 2002, he made the famous assertion that derivatives are “financial weapons of mass destruction”; in 2003, he called derivatives “unattractive” and moaned about related losses; in 2004, he compared the derivatives market to hell; in 2005, he mocked the way contracts are structured and compared the dangers of derivatives trading to Hurricane Katrina.
He provided perhaps the most stunning rebuke of derivatives and their supporters in 2008. He began by simply stating: “Derivatives are dangerous,” but went on to compare them to contracting a venereal disease with a philandering sexual partner.
“It’s not just whom you sleep with, but also whom they are sleeping with,” Buffett warned.
But in 2010, Buffett lobbied agressively against any attempt to rein in the “dangerous” and unregulated derivatives market. He wanted to be exempt from any rule that would require broker-dealers to clear such deals in an open market, or post higher capital to cover related losses. It’s not that Buffett doesn’t necessarily support the broader measures. He just thinks Berkshire shouldn’t be required to pay up for contracts it already brokered.
His argument — or his campaign donations — was apparently so convincing that the senator from his home state of Nebraska, Ben Nelson, was the only Democrat to join Republicans to help block debate on financial-reform legislation. Nelson also succeeded in getting the Agriculture Committee to exclude existing contracts from the derivatives bill it approved.
Shortly after, at Berkshire’s annual shareholder meeting, Buffett also issued a passionate defense of Goldman Sachs and its CEO Lloyd Blankfein. It’s ironic because Goldman Sachs is facing fraud charges from the SEC, and a Justice Department investigation of criminal wrongdoing for structuring just the type of derivative contracts that Buffett has argued against. Would Buffett be so supportive of Goldman and its behavior if he didn’t hold a $5 billion preferred stake in the firm?
Buffett’s annual letters read like guides for the common American investor, but his recent actions suggest an entitled double standard: It’s okay to hammer everyone else with reforms that will help the system; just don’t hammer Berkshire Hathaway.
“We are delighted that we hold the derivatives contracts that we do,” Buffett said in his 2009 letter to Berkshire investors. “To date we have significantly profited from the float they provide. We expect also to earn further investment income over the life of our contracts.”
Buffett has similarly defended Wells Fargo, his largest single investment, through one damaging scandal after another. In 2016, the bank was caught signing up customers for around 3.5 million fake accounts. Since then, Wells Fargo has also been fined for issuing clients unwanted insurance and home-warranty products, falsifying records to increase fees on mortgage applicants, overcharging foreign-exchange clients to ring up bonuses, initiating secret changes to mortgage terms for homeowners in bankruptcy, and repossessing the cars of service members while they were on active duty. The federal investigations and fines over this misconduct continue to roll in.
Millions have been harmed by this mix of rank incompetence and outright fraud. But with the five biggest commercial banks — Wells Fargo, Bank of America, Citigroup, JPMorgan Chase, and US Bancorp — controlling nearly half of all assets, as well as robust branch and ATM networks, it can be inconvenient or even impossible not to use their services.
Last August, Buffett called Wells Fargo “a terrific bank…. There were some things that were done very wrong there, but they are being corrected.” In October, he got tougher, blaming Wells Fargo’s board of directors for failing to “remove the stain” on the business and pondered clawing back five years of compensation. However, this seems quite disingenuous since Buffett had supported the very same board members for reelection just months earlier.
A Berkshire Hathaway shareholder noted that Buffett has famously said that if you find yourself in a “chronically leaking boat,” it would be more productive to devote energy to “changing vessels” than “patching leaks.”
“At what magnitude of leakage would Berkshire consider changing boats?” the shareholder asked Buffett about Wells Fargo. Given the massive amount of fraud and unethical conduct at Wells Fargo, it is telling that Buffett has stood behind many of its executives. Buffett himself has championed an ethical standard that goes well beyond “lawfulness,” which seems inconsistent with his dedication to Wells Fargo executives.
2008 Financial Crisis and Government Bailouts
Berkshire Hathaway, in which Buffett owns 27 percent, according to a proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money. The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.
To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee.
Without FDIC’s debt guarantee program, even impregnable Goldman would have collapsed.
And this excludes the emergency, opaque lending facilities from the Federal Reserve that also helped rescue the big banks. Without all these bailouts, the financial system would have been forced to recapitalize itself.
Banks that couldn’t finance their balance sheets would have sold toxic assets at market prices, and the losses would have wiped out their shareholder’s equity. With $7 billion at stake, Buffett is one of the biggest of these shareholders.
Buffett even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had “confidence in Congress to do the right thing” — to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb.
In a telling letter from Buffett to Berkshire shareholders this year:
“Funders that have access to any sort of government guarantee — banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella — have money costs that are minimal,” he wrote.
“Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that … are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.”
Given his public statements about ethics and not enriching himself on the public’s dime, it seems hypocritical to lobby for bailouts, make trades seeking to profit from these bailouts, and then to complain that others obtaining the same bailouts puts his company at a disadvantage.
Elsewhere in his letter he laments “atrocious sales practices” in the financial industry, holding up Berkshire subsidiary Clayton Homes as a model of lending rectitude.
Conveniently, he neglects to mention Wells Fargo’s toxic book of home equity loans, American Express’ exploding charge-offs, GE Capital’s awful balance sheet, Bank of America’s disastrous acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs’ reckless trading practices.
And what of Moody’s, the credit-rating agency that enabled lending excesses Buffett criticizes, and in which he’s held a major stake for years?
If we learn one lesson from the financial crisis, it’s that banks should carry substantially more capital than may be necessary. You would think Buffett would agree. He has always emphasized investing with a “margin of safety” — so why shouldn’t banks lend with one?
Yet he mocked Tim Geithner’s stress tests, which forced banks to replenish their capital. Why? Is it because his banks are drastically undercapitalized? The more capital they’re forced to raise, the more his stake is diluted.
He points to Wells Fargo’s deposit funding model being more robust than investment banks’, but that’s no excuse for letting tangible equity dwindle to three percent of assets. At that low level, the capital structure would have collapsed were it not for bailouts.
Additionally, the strength of Wells Fargo’s funding model is a result of FDIC insurance, among the government subsidies Buffett complains about in his letters that year.
Access to Low Cost Index Funds for Employees
For years Buffett has been an advocate of low-cost index funds. And yet, as a recent ProPublica investigation discovered, many of the subsidiary companies of Buffett’s conglomerate, Berkshire Hathaway, do not offer low-cost index funds as options in workers’ retirement accounts. Allan Sloan, the lead author of the ProPublica report, succinctly captured the palpable irony: “The most successful investor of our age, who advises average investors to buy low-cost index funds. . . presides over a company where many employees don’t have a chance to invest as he suggests.”
The merits of investing in index funds have been well established, but are worth summarizing. Index funds are intended to mirror the basket of stocks in — and match the performance of — a stock market benchmark, such as the S&P 500. Unlike active funds that are overseen by fund managers who make frequent trade, index funds are passively managed and hold investments for longer periods of time. This means that most have lower management and transaction costs than actively managed funds. As Buffett himself argues, “costs really matter in investments. If returns are going to be seven or eight percent and you’re paying one percent for fees that makes an enormous difference in how much money you’re going to have in retirement.
Buffett is such a huge believer in index funds that in 2007 he wagered $1 million that the Vanguard S&P 500 index fund would outperform a portfolio of actively managed hedge funds over 10 years when all fees and expenses were included (Buffett was correct).
Given Buffett’s index fund gospel, you’d expect the retirement plans at companies within the Berkshire Hathaway family to feature myriad low-cost index funds and a dearth of high cost, actively managed funds. But ProPublica’s investigation unearthed the exact opposite.
An examination of the investment plan options offered to workers to save for retirement at 50 of the 63 Berkshire subsidiaries, found that “many offer little or nothing in the way of index funds.” Instead, the report found that the available plans vary considerably across the companies and consist of high-cost funds that provide less-than-stellar growth for workers’ hard-earned retirement money.
For example, while Berkshire-owned BoatUS employees have access to S&P 500 index funds, the fees they pay are fifteen times higher than those paid by employees at other Berkshire-owned companies such as NetJets, GEICO, and Clayton Homes. More egregiously, Buffett-owned Borsheim’s Fine Jewelry “offered employees 71 investment options, virtually all of which (other than 10 Vanguard target date retirement funds) consisted of actively managed funds.”
You’d think someone as financially savvy as Warren Buffett would leverage the collective power of all Berkshire companies to receive better fund options and pricing. However, instead of taking this approach and looking for opportunities to pass the savings to his employees, Buffett appears to leave each company to negotiate its own plan. While this fits with his laissez-faire style, the implications for his employees are severe and negative, potentially costing them thousands of dollars in retirement savings.
Ultimately Warren Buffett is a capitalist and he has done a fantastic job enriching himself and his shareholders. I have no issue with this and perhaps I am holding him to too high of a standard. But my issue is that Buffett is uniquely positioned to lobby for better public policy, but he’s chosen to spend his considerable political capital protecting his own holdings or advancing public policy that is masked as sincere attempts at reform but is actually advancing his own interests at the expense of millions of Americans.