Throw Them All Out (16 page)

In late 2009, Buffett made his largest investment ever when he decided to buy Burlington Northern Santa Fe Railway (BNSF). It was not just a bet on the financials of the railroad industry; it was also a huge bet on his friend President Obama's budget priorities. As the
Wall Street Journal
reported, "Berkshire Hathaway Inc.'s planned purchase of Burlington Northern Santa Fe Corp. represents a bet that upcoming Washington policies to improve infrastructure and combat climate change will be a boon to the freight-railroad industry. President Barack Obama has said railroad investment will be a cornerstone of his transportation policies, given the environmental benefits and improved mobility that come with taking cars and trucks off roads."
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Others in the railroad industry saw Buffett's involvement as very helpful, precisely because he was so politically connected. "It's a positive for the rail industry because of Buffett's influence in Washington," explained Henry Lampe, president of the Chicago South Shore & South Bend, a short-haul railroad.
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Buffett bought the BNSF just as the Obama administration was beginning a series of initiatives to rapidly expand the government's commitment to spending on railroads.
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After Buffett took over the company, he dramatically increased spending on lobbyists. Berkshire spent $1.2 million on lobbyists in 2008, but by 2009 its budget jumped to $9.8 million, where it has generally remained. Pouring money into lobbying is perhaps the best investment that Buffett could make.
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President Obama's plans to invest heavily in railroads, including a commitment to high-speed rail, position BNSF to benefit handsomely. In the Seattle area there have already been discussions between local officials and BNSF about either leasing or selling its rail lines for an intercity project. And that's just the start. A map of the BNSF lines around the country overlaps nicely with the government's proposed high-speed rail lines, from Seattle to Florida, California to the Northeast. Buffett is geographically and strategically positioned to profit from those government-funded rail systems, should they be built.

All together, in the stimulus package created in 2009, the federal government set aside $48 billion (of the total $787 billion) for infrastructure improvement, some of which goes to railroads. How much will BNSF benefit? It's nearly impossible to calculate. Type BNSF on the Recovery.gov website, which tracks grants, subsidized loans, and contracts signed under the stimulus, and you find 1,800 entries, including everything from $36 million grants from the Department of Homeland Security to money from the Environmental Protection Agency.

Buffett also owns MidAmerican Energy Holdings, which received $93.4 million in stimulus money. General Electric, of which he owns a $5 billion stake, was one of the largest recipients of stimulus money in the country.

As Buffett often does, he puts his ideas in down-home terms in his famous annual letter to Berkshire investors. He doesn't mention lobbyists, government funds, bailouts, or stimulus grants. "We see a 'social compact' existing between the public and our railroad business, just as it is the case with our utilities," he said in his 2010 annual letter to shareholders. "If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should—and we believe will—understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without it possessing first-class electricity and railroad systems." He further noted that both businesses "require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace, and expand the plant."

The term "social compact" sounds benign. But when did American voters make a compact to turn one of the richest men in America into one of the biggest recipients of taxpayer subsidies?

In August 2011, Buffett vacationed with President Obama on Martha's Vineyard and they discussed the economy. Shortly after that, he agreed to host an Obama reelection fundraiser in New York City, for which contributors could buy VIP tickets for $35,800 to meet Buffett and talk about the economy.
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It has long been known to be Warren Buffett's style to base major financial decisions on a few phone calls. As fellow investor Steven Rattner pointed out, "Warren Buffett has shown that superb investing need not entail the months of due diligence and deliberation that private equity firms typically apply to a deal. Buffett has been known to make successful multibillion-dollar bets on the basis of a few meetings or phone calls."
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That is particularly true if those phone calls are going to Washington.

Warren Buffett is a financial genius. But even more important for his portfolio, he's a political genius.

M
OST CAPITALIST CRONIES
are neither Baptists nor bootleggers. They do nothing illegal, but neither do they claim to be holy. Instead, they quietly lobby Congress, and their fortunes rise and fall on policy decisions rather than market competition. In this chapter, we will consider a wide range of examples, from finance to manufacturing to education.

Perhaps the best investment a hedge fund can make these days is not in a financial wizard but a politician. Hedge funds and financiers are becoming more political than ever before. And political figures and government appointees with no background in finance (former Vice Presidents Dan Quayle and Al Gore, and former Secretary of State Madeleine Albright, for example) have launched their own investment funds. "The former politician/investment guru fraternity appears to be growing," noted one industry observer.
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And former politicians are finding a career that can be even more lucrative than lobbying: providing "political intelligence" to investment funds, based on private conversations with congressional staffers and sitting senators.

In the world of investment finance it is increasingly important to be well connected politically. As briefly mentioned earlier, one study by two economists looked at 351 hedge funds between the years 1999 and 2008 and found that "politically connected" hedge funds—that is, funds that hired lobbyists and made campaign contributions—had a much better rate of return on investments than those which were not. Political connections created "an abnormal rate of return of 1.4 to 1.6 percent per month." The study explained that "connected funds possess an informational advantage in trading politically sensitive stocks." The study also found that when a given hedge fund switched from being apolitical to getting into the political game, its performance increased by an impressive average of 2% to 2.9% per month. The economists also discovered that the more hedge funds gave to political candidates and the more they hired lobbyists, the more they tended to invest in politically sensitive stocks that were influenced by government actions.
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As the authors put it, "Connected fund managers exhibit a bias towards politically sensitive stocks (both in terms of trading and holdings) and they outperform significantly in these political stocks."
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It is commonsensical. The simple fact is that politically connected hedge fund managers and billionaire financiers can make a lot of money based on information gleaned from politicians and government officials. And it is not illegal for a politician to share this information. If an official gets paid directly for it, however, he risks a bribery charge. Former Congressman Brian Baird warned that the financial stakes are so high, "the possibility of direct kickbacks [is] enormous."
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So the payback must be subtle.

Elliott Portnoy, a lobbyist in Washington, says that the biggest field of growth for lobbyists is not in influencing legislation but in obtaining "political intelligence" for hedge funds and large investors. "There are a lot of savvy investors who have realized that there is a lot of money to be made from what Congress does," Portnoy said.
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One congressional staffer was even more blunt when he told the
Wall Street Journal,
"The amount of insider trading going on in these halls is incredible."
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How does this process happen? Consider a 2008 farm bill analyzed by the
Wall Street Journal.
Money managers and hedge funds paid lobbyists big money to track the bill, because the stakes were enormous for ethanol producers, timber companies, and farm equipment manufacturers. "I get a lot of people asking about legislation who appear to be monitoring it rather than lobbying it," a Senate tax staffer commented to the
Journal
about the bill.
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The hedge fund investors can make money no matter how Congress votes—if they receive advance warning.

Access to government information is critical. And being on good terms with the gatekeepers of that information—elected officials, political appointees, and bureaucrats—can make all the difference between getting rich and getting hammered in the market. Consider, for example, the recent interaction between political appointees at the Pentagon and investment advisers that track defense-related stocks. As the
New York Times
reported in February 2011, senior Pentagon officials began meeting in secret with investment advisers in New York to give them information regarding defense-related companies. The message was direct: even with defense cutbacks on the horizon, "the Pentagon is going to make sure the military industry remains profitable." As those officials made clear, the Pentagon was opposed to mergers among large defense companies, but it would encourage mergers among smaller contractors.

This kind of information is critically important to investors. The Pentagon is basically the sole customer of most of these defense companies. What the military says and does will determine who thrives and who dies.

Deputy Defense Secretary William J. Lynn held a private meeting with about a dozen Wall Street analysts in October 2010 and laid out the Pentagon's cost-cutting plans "in astonishing detail," reported the
Times.
The analysts at the meeting were sworn to secrecy; nonetheless, the meeting had a noticeable effect on the market. The Big Five defense contractors—Lockheed Martin, General Dynamics, Raytheon, Northrop Grumman, and Boeing—all saw their stocks rise shortly after that October meeting.

Who was invited to the meeting? Who was excluded? We may never know.
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Early in 2011, a liberal organization called Citizens for Responsibility and Ethics in Washington (
CREW
) released some alarming material concerning the possible market manipulation of stocks involving Steven Eisman, a well-known short seller. Eisman was featured in Michael Lewis's book
The Big Short
for making huge profits by betting against the subprime mortgage market just before the 2008 financial meltdown.

The research by
CREW
caught the attention of Republican Senator Tom Coburn, who called for an investigation. According to documents unearthed by
CREW
, Eisman was advising the Department of Education, discussing problems associated with for-profit colleges. At a meeting with senior officials on April 26, 2010, he went so far as to compare the schools to subprime mortgage lenders. Two days later, one of the officials at the meeting, Deputy Undersecretary Robert Shireman, delivered a speech in St. Paul, Minnesota, in which he drew the same comparison. After his speech, the share prices of for-profit education companies Career Education and the Apollo Group dropped 12% and 6%, respectively. On May 26, Eisman himself delivered a speech titled "Subprime Goes to College," again making the comparison. After the speech the share prices of the for-profit companies ITT Education Services and Corinthian Colleges each declined 3%. In June, Eisman testified before Congress and delivered the same message.

All of this coincided with government action that called for tough new regulations of for-profit colleges. Of course, there is nothing wrong with officials at the Department of Education getting briefings and making speeches. But why would the department listen to a short-selling investor who is no expert on education? Eisman has refused requests to reveal whether he was shorting for-profit college stocks during this period, but given that that is his day job, members of Congress on both sides of the aisle have called for an investigation.
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Or consider the suspicious trading activity around the Obama administration's decision to tap the Strategic Petroleum Reserve (SPR) during the summer of 2011. CNBC looked at trades made shortly before the release of some of the nation's stockpiled oil and discovered that there was a curious spike in trading. Dennis Gartman, a hedge fund manager who also publishes the
Gartman Letter,
constructed a timeline of the trade activity and concluded: "When presented this information in this simple but elegant format, how can we not believe that someone in a position of some authority did indeed know what was in the works regarding the SPR?" His comments were echoed by Ross Clark, an investment adviser at CIBC Wood Gundy: "Call me a cynic, but there appears to have definitely been money made on inside information. As a rule of thumb, some of the best opportunities occur by trading opposite the headline news once prices stabilize."
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Human nature being human nature, such actions are not unique to the Obama administration. Traders, speculators, and investors seek out friends in both political parties. And politicians, political appointees, and bureaucrats see the value in helping out wealthy friends and contributors in the hope that the favor will be returned when they need it. But what has changed in recent years is the amount of money involved, and the power of the federal government to move markets and make people very rich.