Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street [ハードカバー]

This is the book that Wall Street and Washington do not want you to read. Many books will be written about the credit crisis but it is hard to believe that any will match this real time fast-paced expose. Tavakoli's 2008 book, Structured Finance, details the credit meltdown for finance professionals, and in this book she explains it in a way that everyone can understand. I agree with George Goodman aka Adam Smith who writes on the book jacket that that contrasting the madness with Warren Buffett's good sense is appropriate. He wrote Money Gameand identified Buffett as a great investor in the 1960's, before most people had heard of Warren Buffett. He also wrote a more recent book called Supermoney (Wiley Investment Classics). Contrasting the recent financial madness with Buffett's sensible warnings makes this book compelling, because it proves that the phrase "every one was doing it" is false.

Tavakoli wrote the first book ever published about credit derivatives in 1999 and exposed hidden risks that worked in favor of investment banks but against nave investors. That led to Warren Buffett inviting her to Omaha, and this book begins with that lunch. Tavakoli then uses his value investing philosophy and contrasts that with the subsequent market madness.

There are a lot of hindsight bias plagued pundits who now claim to have spoken up, but if they gave any warning at all it was of the variety of "the sky is falling," with no specific understanding of what was happening. Some claim the events were unpredictable, but Tavakoli uses logic and facts, plus documented evidence that she said so back in the day, to explain that it would and did happen. She spoke out specifically and publicly about CDOs and wrote an early book, and the only book, to discuss the high degree of fraud and continued potential for fraud. In April 2005, she warned the IMF about credit derivatives and overrated CDOs and posted the clip on her web site. In January 2007, she wrote an article to a risk magazine saying risk managers at investment banks, and she mentioned some by name, should get out and sell the overrated securities. In February 2007 she wrote a letter to the SEC saying AAA ratings for many structured products were grossly misleading and the rating agencies should have their special status revoked for structured products. She issued a direct challenge to AIG's June 2007 accounting statements. It's all in the book plus much more. She also knew a lot of the people whose names made the news and interacted with them through the meltdown. One manager of the Bear Stearns hedge funds even tried to get her to change her public stance against their proposed initial public offering, which failed because she spoke out. Those facts make this book on the global meltdown unique, the only explanation from a pro who spoke out in a specific way in real time.

Janet Tavakoli, a well-known expert in the world of credit derivatives and structured products (yes, those toxic assets) has written a remarkably entertaining and insightful book in which she combines Mr. Buffett's wisdom and advice with her own views about the credit crisis. Tavakoli's previous books, all about highly technical topics, allowed her to show only one set of skills, albeit an important one: her ability to explain technical issues in an accessible manner. In Mr. Buffett, however, a book for the general public that contains no formulas or equations, she demonstrates that she can write not only with clarity but with wit. Her prose is agile and precise, and her words punch her victims always fatally, and not once, but just in case, many times. Hints of this refreshing style were somehow present, although not totally in the open, in her previous book (Structured Finance & Collateralized Debt Obligations). Despite the subject matter she managed to include comments about triboluminescense, sexual positions, and the Nogorno-Karabakh dispute while making reference to characters as diverse as Michael Moore, Richard Feynman, Shakespeare and Paul Marcinkus.

Mr. Buffett started with an invitation by The Sage of Omaha to Tavakoli in June 2005 ("Be sure to stop by if you are ever in Omaha and want to talk credit derivatives") after she had mailed him a copy of her latest derivatives book. Knowing that she would never have any reason to be near Omaha, Tavakoli volunteered a few days to visit. Shortly thereafter, she flew from Chicago (where she lives) to have lunch with Mr. Buffett in a place "with no décor but good food." That started a dialogue between the two of them (through subsequent phone calls, e-mails, and letters) that seems to be still going on.

In a sense, Tavakoli's book is more about the current crisis rather than Mr. Buffett, although there is enough about him to satisfy the Buffett-curious reader. He comes across as a deceptively affable man who advises her not to neglect her love life, enjoys and values gossiping, reads financial reports the way a teenager reads Playboy, and believes there is no difference between value and growth stocks. This came as personal relief because I always failed to see the difference between them no matter how hard all the mutual funds prospects I have seen try to make that point. On a more serious note, Mr. Buffett seems not to take the Efficient Market Theory (or dogma?) too seriously. Not a surprise if you think that his track record as investor is a living proof of the fallacy of the theory. More important, Buffett reminds us of the danger of leverage: anyone can show great investment returns with leverage (inflated revenues, he calls them). It is when things go the other way, and leverage magnifies the mistakes, that you can really see who has been swimming naked.

But the backbone of the book (and its most interesting aspect) is the critique and analysis of the current financial crisis that Tavakoli intertwines cleverly within her own dialogue with Mr. Buffett. She makes a convincing case that at the root of the present crisis there was a bad combination of dishonest executives and bankers under the surveillance of incompetent, and probably equally dishonest, regulators.

For example, the chapter about the backdating of stock options scandal, although not strictly related to the credit crisis, makes you wonder about the character of the people running corporate America: in the 2006-2007 timeframe more than 120 U.S. companies were under investigation for accounting irregularities; 85 ended up amending their earning statements. She is very critical of the role played by the Office of the Comptroller of the Currency (OCC), which invoked an obscure 1862 provision to undermine the states' ability to police predatory lending. This decision, she believes, had a very negative effect on mortgage origination standards and their subsequent re-packaging by investment bankers. Additionally, she castigates the Securities and Exchange Commission (SEC) for failing to oversee the investment banks. And when it comes to the rating agencies, which blessed some of these securitizations with AAA ("very safe") ratings, she employs the term "financial astrology". Enough said! Ironically, Mr. Buffett, who through its investment company (Berkshire Hathaway) owns almost 20% of Moody's stock, has admitted to her that this is one investment he is not proud of.

Tavakoli also paints a disturbing picture when she describes the collapse of two Bear Stearns investment funds (she received a "thinly veiled threat" by the fund manager after she was quoted in the press saying something he did not like); when she explains how the well-connected Carlyle group got help from the Fed while a less plugged-in fund, Peloton, was let go; and when she shows that her initial assessment of AIG, Merrill, and Citigroup losses (all made in late 2007 and early 2008 and in contradiction with the information released by those companies at the time) was ultimately right on the money. The list of financial and ethical shenanigans is long and compelling, full of juicy anecdotes, and supported by solid data and well-articulated reasoning. Although is fun reading about these issues it is quite depressing to think about them: you get the sense that the story is more in tune with the doings of a corrupt military dictatorship in a third world country rather than the oldest democracy in the world.

Much has been said about the acronyms used to describe the financial instruments involved in this crisis: CDOs, SIVs, CPDOs, ABS, MBS, CDS, ABCP, etc. Ironically, the list of government entities which, in her view, have something to apologize for is almost as long: SEC, FED, OCC, FDIC, FHFA, OTC, OFHEO, etc. To what extent these regulatory entities, which sometimes overlap, but also leave voids, will survive in a global market is something to ponder. The case for one regulatory body with wide international authority is becoming stronger as the case for state-level bodies become more dubious. Although Tavakoli does not make these two points explicitly, one wonders.

Some readers might feel turn off by a few Warren-and-I type of statements that seem a bit self-serving. And a case can be made that perhaps many investors deserved what they got because in their greedy quest for unreasonable returns they overlooked basic principles of prudence --a point that does not come across very strongly in the book. Lastly, Chapter 13 (The Fogs of War, Religion and Politics), a very interesting chapter in its own right, is probably better suited to be dealt with in a separate (next?) book. That said, these are minor sins in an otherwise excellent book.

The following paragraph, which appears close to the end of the book, summarizes the main thesis,
"Washington is supposed to provide a strong national defense; but we were attacked from within our borders-sometimes by those charged to protect us. Washington failed in one of its more important duties, Washington failed to protect our money."

Further down she adds, "Homeland security requires a secure homeland currency." I doubt that anyone would be left indifferent by these provocative, but well-argued, points.

There is no free lunch they say, at least according to most economists. And certainly lunch with Mr. Buffett is far from free ($ 2.11 million, according to eBay, June, 2008). Clearly, Tavakoli made a good decision when she accepted Mr. Buffett's lunch invitation. However, for the rest of us, who are unable to pony up the two million or unlikely to get invited by the great investor, this book is a very good substitute.

I am not a finance professional, and my understanding of financial markets, especially derivatives, is basic, but I was riveted by DEAR MR BUFFETT. Much of it is because of Ms. Tavakoli's writing style: clear, accessible, and witty. Where definitions are needed, she supplies them, and her documentation is suburb. Despite the complexity of her topic, it was an easy read. In fact, she makes such a persuasive case that I came away from the book wondering why more experts didn't see the meltdown coming. At the same time, it was reassuring to know that Mr. Buffett's (and Ms. Tavakoli's) financial philosophy, ie not buying something unless you can pay for it, investing with caution, has prevailed. I would recommend this book to any investor -- large or small -- who's seeking direction for the future.