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Dear Mr. Buffett, Dear Mr. Munger, my name is Oliver Krautscheit, and I'm from Frankfurt, Germany. The mortgage crisis led to inconsistent pricing in capital markets. Loans are trading at deep discounts, but at the same time, stocks do not reflect this. My question is: when will this end and how do you exploit market imbalances ?
Well, when market imbalances arise , there are always ways to take advantage of them, but we'll leave the fun of finding them to you. But there have been some really significant imbalances, and I've brought some numbers for your entertainment on what we've done recently, even though it doesn't really matter to Berkshire.
I mean, Berkshire will make extra money from this. This doesn't require much thought, but it illustrates how dramatic the changes have been, and what I brought up concerns tax-exempt money market funds. There were 330 billion of them. This is a large sum, 330 billion. They relied on the repricing of almost all first-class municipal bonds every 7 days.
They held these auctions, everything was very carefully organized so that people could have their money, as they believed, instantly available in a tax-free instrument. And they were widely advertised. Here is an example that involved them being provided with various municipal issues. It turned out to be a release from the Los Angeles County Museum of Art.
Just look at this. On January 24, it was selling at 3.15%. January 31—4.0%. February 7—3.5 %. February 14—8%. How can a short-term, tax-exempt bond sell for 3.5% one week, then 8% the next week, on Valentine's Day , and 10% the next week? Now it is back to 4.2%. These are huge imbalances in the market.
This is madness. It would be one thing if it were some small thing, but this happened to securities worth billions and billions of dollars. It even happened...we get these sheets of quotes every day. And this sheet appears to be from Citigroup. And they re-evaluated them every 7 days. And you will see in them that there are many releases involved.
The same issue appeared on multiple pages because it represented different auctions, even though they were handled by the same broker at the same time. On one page you will find the issue we were betting on, and it turns out that we offered 11.3%. On one page we bought them at 11.3%. On another page for the same issue, we gave 11.3%, and someone else gave 6%.
So, the same issue from the same broker at the same time was sold at 11.3% and 6 %. These are signs of extreme imbalance, and you encounter this from time to time. You could see this after the Long-Term Capital Management crisis in 1998. You found something similar in the stock market in 1974 and so on.
And these are great times to make some serious money if you... there are certain things we can't fathom. I see an ad in the Wall Street Journal about auctions being held for some esoteric mortgage-backed securities. If you had enough time, you would probably be able to spot the ones that were grossly misjudged.
We don't do that. We simply don't have time for this. We were able to do four… we have about 4 billion in this now. When we're done , we'll make some extra money in a couple of months. It won't be significant compared to the size of Berkshire, but it's something that's very easy to do. Maybe by putting a lot of effort into smaller issues, you could find something in this mortgage chaos, and it's already gone beyond subprime lending.
This spilled over to all A categories and Option ARMs, and all that stuff. It's possible that there are great opportunities out there that Charlie and I won't notice because we simply can't keep track of so many things. Charlie? Yes, it's interesting how short-lived these opportunities to take advantage of imbalances often are.
Some idiot hedge fund bought unlimited municipal bonds at, you know, incredible margins. It seems they bought 20 times more municipal bonds than they could afford with their own money. Borrowing the rest of the money. And these securities were dumped on the market because of margin requirements. Municipal bonds suddenly became mispriced in America.
But the imbalance was very short-lived. So you But very extreme. But very extreme. So if you can't think quickly and act decisively, it's no use. You are like a man standing by a stream trying to spear a fish , and the fish only swim past once a week, once a month, or once every ten years. And you have to be in place to quickly throw that spear before the fish swims away.
It's a pretty demanding business if you do it right. But there were times, I mean, there was a three- or four-month period in 2002 in the junk bond market where really incredible things happened, and on a large scale. So, uh, yeah , it happens about twice a century. Yes. Which means that he and I only had four or five such opportunities. Let's move on to number four.
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