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Berkshire Hathaway
Re: The Price of Easy Money

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By RaplhCramden
November 3, 2005

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The problem is that prolonged comfort has conditioned financial institutions globally to price their financial contracts with inadequate risk premiums. If pain is the mother of wisdom, does not comfort make us stupid? In debt, derivatives and real estate, lending institutions are experiencing low default rates and so continue to hand out money fearlessly, default rates are low because money is easy to get.

If comfort causes financial institutions to underprice their risk, pain causes financial institutions to overprice it. Risk markets consist of a lot of players, some of whom think risk is expensive, some of whom think it is cheap. This is a tautology: without the disagreement there would be no market, the price moves until the disagreements balance.

There is a moralistic tone it seems to me in your post, that underpricing is somehow worse than overpricing. But if the bogey is productivity, increases in value, then overpricing is just as bad as underpricing. The man who is overinformed by the memory of pain fails to participate in creating more value just as effectively as the man who is uninformed by the memory of pain.

There is for all of the above maladies one simple physic and is not a soft landing, what the world needs now is a recession not because pain is good but because it is necessary.

Suppose we fail to have a recession for the next 20 years, risk premiums go lower or stay low, and finally 20 years from now there is a recession. How is that possibly worse than having a recession now, and then having higher risk premiums for the next 20 years, taking away from the next 20 years of production growth because more of a fee must be paid to risk buyers?

What a recession is necessary for is to prove the people who claim risk is underpriced correct. Without a recession sometime soon, the risk is correctly priced, and the economy correctly allocates less capital to risk premiums and more to other production enhancing investments.

It's pay me now or pay me later Easy money is a drug peddled by the foolish and the longer we indulge the worse will be the hangover.

The symptoms of encroaching addiction are inflation. Inflation is antiproductive when it is unpredictable, predictable inflation is virtually irrelevant.

I would love to see the federal deficit closed. But you have to realize that such closure would be accompanied by LOWER INTEREST RATES, EASIER MONEY. The idea that the deficits suck money out of the system is correct, seems to me. If the deficits stop sucking money out of the system, money will be even cheaper for the other participants. Seems to me. Almost a paradox. If you want harder money, then the fed better borrow MORE.

It is not so much that I am predicting a bear market; it's that I yearn for one.

I don't know that you are wrong. I don't think that you are right.

It does seem to me that you have an emotional predilection towards more expensive risk. Can you make a theoretical case that risk is too cheap? Does your case go beyond in some important way the ebb and flow of opinion that must always exist in a trading market? I.e., is the system doing something wrong, or is it doing what it always does, brokering the differences of opinion?

Are you in cash? My financial adviser is heavier in cash then he has ever been. If you are, how would you answer the question: is your yearning for a recession at all influenced by the fact that it would prove you right?

I yearn for a recession about the same way that I yearn to have a bully who has me cornered to finally just hit me and take my wallet, just so I can find out if I am going to die, or just lose my wallet this time. Of course, there is a fantastic case to be made for "delaying the inevitable" since it is only proven inevitable when it happens.

R:


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