What Warren Said

In the aftermath of the 2007-08 Global Financial Crisis, the US government established the Financial Crisis Inquiry Commission (FCIC) which was tasked with understanding what went wrong.

In 2010, they interviewed Warren Buffett to seek his thoughts on a range of issues. The format was the FCIC asked questions and Buffett answered.

Buffett’s interview ran 2 hours and 103 pages and there is plenty of wisdom in there. I have selected some of his comments regarding the US property market and his thoughts on how the property bubble formed and burst.

There are some insights to be gleaned for all investors whether it be stocks or property or bonds or any other asset class.

Over the next few weeks, we will post segments to the blog so you can read his thoughts and use his wisdom to assess whether, 15 years on from the GFC, there are markets today that reflect his concerns.

We think there is.

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BONDI (Interviewer): As I mentioned at the outset, we’re investigating the causes of the financial crisis. And I would like to get your opinion as to whether credit ratings and their apparent failure to predict accurately credit quality of structured finance products, like residential mortgage-backed securities and collateralized debt obligations, did that failure, or apparent failure, cause or contribute to the financial crisis?

BUFFETT: It didn’t cause it, but there were a vast number of things that contributed to it. The basic cause, you know, embedded in psychology –- partly in psychology and partly in reality in a growing and finally pervasive belief that house prices couldn’t go down and everyone succumbed –- virtually everybody succumbed to that. But that’s –- the only way you get a bubble is when basically a very high percentage of the population buys into some originally sound premise and –- it’s quite interesting how that develops –- originally sound premise that becomes distorted as time passes and people forget the original sound premise and start focusing solely on the price action.

So every -– the media investors, the mortgage bankers, the American public, me, my neighbor, rating agencies, Congress –- you name it -– people overwhelmingly came to believe that house prices could not fall significantly. And since it was biggest asset class in the country and it was the easiest class to borrow against, it created probably the biggest bubble in our history.

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Our Thoughts: Buffett is one to talk in generalities rather than specific when dealing with investing. The main point he makes is the idea of groupthink, something we teach in our Wells Program. Importantly he emphases that bubbles can start with a "sound premise".  But what makes sense - house prices rise over time - may well not make sense all the time. Hence why we also teach investors about market cycles. A house can be a bargain at $150,000 but be very overvalued at $550,000.

He also mentions the common belief of groupthink participants that the house prices simply wouldn't fall (since they always go up) and that investors along with everyone else forgets about value and just focuses on price action.

And finally, the ease of borrowing contributes to the bubble. He discusses leverage and other factors which we will detail in the coming weeks.