Rippling Secondary, Tertiary Effects

No end in sight to market woes say Trichet, Buffett

I'll talk about the United States. I don't think the effects of the credit crunch are far from over at all. I think there will be rippling secondary, tertiary effects. - Warren Buffett

Confessions of a Short Seller

The consumer is spent up, not pent up, and more levered than during any period in history. That's one of the structural problems facing the economy. At the same time, job growth is declining and real disposable incomes are pressured as inflation literally is eating away at the consumer's buying power. It is frightening that the consumer has entered this economic downturn with the most levered position in history. On top of that, we're facing four consecutive months of job losses. We've seen the depreciation of the two most important assets, home prices and equities. Consumer confidence is at a 26-year low. The availability of credit continues to be a problem that will plague the economy for a while. Inflation, the cruelest tax of all, is rising as energy and food prices, in particular, are soaring. And the first-quarter GDP report contained a number of ominous signs that the consumer is spent up while the housing depression continues apace.

It is frightening and justifiably so.

More than anything, I'm short Berkshire because of Buffett's recent investment-style drift. In the past five years, Buffett frequently called derivatives "financial weapons of mass destruction." Yet, very much out of character, he immersed himself in several large and thus far unprofitable derivative transactions, leading to an unrealized $1.6 billion pretax loss in the first quarter. I'm also short Berkshire because the salad days for insurance, which is the cornerstone of Berkshire's business, are over. Also, Berkshire's premium valuation seemingly has been a byproduct of the credit crisis, and the perception of the company as a safe haven. Berkshire's shares might underperform as some of the deflated financial companies regain their footing. And Buffett is substantially exposed not only to financials -- he owns large positions in Wells Fargo [WFC], Bank of America [BAC] and American Express [AXP] -- but also to a weakening housing market through his ownership of Clayton Homes.

Buffett has also been saying that the salad days are over. I saw him speak at great length about future investment returns yesterday.

I continue to watch real yields die. There's way too much money chasing too few ideas. A small fraction of that money has taken an interest in commodities. Heaven help us if the trend continues. Money that flows there hurts the "real" part of real returns for everyone else.

Meanwhile, there's way too much debt. A small fraction of that debt has decided eating at home is cheaper than eating out. Heaven help us if the trend continues. We're a service economy. People better keep wanting service.

Want really scary though? I think Ben Bernanke likes looking at the averages in a spreadsheet. I think that's why he didn't see the housing bubble coming. Averages don't show an accurate picture (one foot in boiling water and one foot in a freezer is not a comfortable experience). If you combine way too much money and way too much debt things can look fairly tame overall. Just one problem. The people with money keep seeing their money grow (after inflation). The people with debt keep seeing their debt grow (after inflation). I strongly suspect that both trends are unsustainable and are dependent on one another.