Uber-investor Warren Buffett‘s 2004 performance letter to Berkshire Hathaway, Inc‘s shareholders was published over the weekend. While citing such diverse characters as W.C. Fields and Jesus Christ, Mr. Buffett accepted blame for a drop in Berkshire’s 2004 earnings. Here is a prior post about Mr. Buffet’s letter from last year.
Mr. Buffett candidly admitted the following:

My hope was to make several multibillion dollar acquisitions that would add new and significant streams of earnings to the many we already have, But I struck out.

As a result, Berkshire’s change in book value increased only 10.5% in 2004, lagging behind that of the S&P 500-stock index’s 10.9% return, a performance that Mr. Buffett characterized as “lackluster.” However, it’s important to remember that Berkshire generated that return while remaining quite liquid — the company has $40 billion in cash reserves earning a small return, but putting the company in an enviable position to make acquisitions. Unfortunately, Mr. Buffett commented that there are currently “very few attractive securities to buy,” continuing a theme that was also used in last year’s letter.
Mr. Buffett’s currency investments allowed him to include the quote from W.C. Fields in his report. Inasmuch as Berkhire’s bets nearly doubled in 2004 to $21.4 billion, Mr. Buffet quoted Mr. Fields’ famous comment to a a beggar’s approach: “Sorry, son, all my money’s tied up in currency.”
Mr. Buffett also criticized U.S. policy makers for the growing current-account deficit and warned that net ownership of U.S. assets by foreign countries over the next decade will amount to about $11 trillion if account deficits continue at current levels. He did not explain why he thought that it was a bad idea for foreigners to overpay for U.S. assets.
Somewhat surprisingly, Mr. Buffett’s letter did not mention investigations by state and federal regulators into transactions between insurance clients and Berkshire’s General Re and other company reinsurance subsidiaries. Those investigations are examining whether some companies have used finite-risk insurance to hide financial obligations and make their results appear stronger than they actually are. You know, sort of like the criminalization of structured finance transactions of Enron fame.
Mr. Buffett also quoted Scripture in defending the independence of Berkshire’s board, which includes several Buffett family members and their friends, including Microsoft Corp.’s Bill Gates. Mr. Buffett contends that the board members’ substantial holdings in their own companies’ stock aligned them with the interests of other shareholders, and then cited Matthew 6:21, in which Jesus is quoted as saying “For where your treasure is, there will your heart be also.” Mr. Buffett concluded that “measured by the biblical standard, the Berkshire board is a model.”

The venerable Louisiana bank, Hibernia Corp., has agreed to be acquired by McLean, Va.-based Capital One Finance Corp. in a $5.35 billion deal that allows one of the nation’s leading credit card issuers finally to enter the retail banking industry. With a market value of approximately $20 billion, Cap One is nearly five times Hibernia’s size.
Hibernia is a Louisiana institution that established in the post-Civil War years. It became best known during the Great Depression, when the late Louisiana Governor and demagogue Huey Long leaned on Hibernia and other banks to finance huge public works projects for the construction of bridges, roads and other infrastructure in Louisiana during the 1930s. Hibernia has more about $22 billion in assets, about 300 branches and operations in Texas, Louisiana and Mississippi.
Cap One’s acquisition is a clear response to a shrinking market share in the credit card business, where competitors such as Bank of America Corp. have invested billions in new products over the past several years. That’s why your and my teenage children continue to receive so many solicitations for credit cards in the mail. Acquiring a retail bank will give Cap One low-cost retail deposits, which it can then use to generate loans at more profitable interest rates to its borrowers.
Hibernia’s banking operation will will fit nicely into Cap One’s business, which also provides financial services such as health insurance and personal loans. Cap One was also attracted to Hibernia’s presence in the Texas banking market, which is growing much faster than Louisiana’s market. The deal is is expected to close by the third quarter of this year. Hibernia shareholders will receive $33 for each of their shares, split into roughly half cash and half Cap One stock, which means that Hibernia stockholders will receive about a 24% premium on their shares’ $26.57 price on the New York Stock Exchange as of this past Friday.

You know, some things are just different in Manhattan.

Temple University mathematics professor John Allen Paulos, author of Innumeracy (Hill 2001) and the more recent A Mathematician Plays the Stock Market (Basic 2003), wrote this insightful Wall Street Journal ($) op-ed yesterday in which he describes how even a bright mathematics professor who knows better can get caught up in the irrational exuberance of a stock bubble:

Bernie Ebbers’s testimony yesterday that he emphatically was not aware that his accountants were cooking WorldCom’s books while he was CEO brought back unpleasant memories of my disastrous “relationship” with the man. It began in 2000, when I received a small and totally unexpected sum of money. I considered it “mad money,” a term that, in retrospect, seems all too appropriate. Nothing distinguished the money from my other assets except this private designation, but being so classified made my modest windfall more vulnerable to whim. In this case it entrained a series of ill-fated, and much larger, investments in what WorldCom’s ads called “the pre-eminent global communications company for the digital generation.”

Professor Paulos goes on to explain how his limited research into WorldCom validated his interest in the stock, so he bought a few shares. And then:

After buying the initial shares, I found myself idly wondering, Why not buy more? I didn’t think of myself as a gambler, but I willed myself not to think, willed myself simply to act, willed myself to buy more shares of WCOM, shares that cost considerably more than the few I’d already bought. Usually a hard-headed fellow, I nevertheless succumbed to confirmation bias, looking disproportionately hard for what made my investment look good and essentially ignoring everything that made it look bad. This wasn’t difficult, given the stellar reports and strong buy recommendations that analysts kept bringing forth. In any case, I fell in love with the stock and saw every drop in its price as bringing about an even better buying opportunity. So-called averaging down (buying more shares when the price drops) is often indistinguishable from catching a falling knife, and in my case the result was thoroughly bloody hands.

Unfortunately, Professor Paulos found his initial bias toward the WorldCom stock hard to shake:

I’d grown tired of carrying on one-sided arguments with TV and online commentators as they delivered relentlessly bad news about WorldCom. So, in late fall 2001, some six months before its final swoon, I contacted a number of them and, having spent too much time in the immoderate atmosphere of WorldCom chatrooms, I chided them for their shortsightedness and exhorted them to look at the company differently.
Finally, out of frustration with the continued decline of WCOM stock, I even e-mailed Bernie Ebbers in early February 2002, suggesting that the company was not effectively stating its case and quixotically offering to help in any way that I could. WorldCom, I fatuously informed him, was well positioned, but dreadfully undervalued.
Even as I was writing them, I knew that sending these electronic epistles was absurd, but it gave me the temporary illusion of doing something about the free-falling stock. The realization that doing so had indeed been a no-brainer was glacially slow in arriving, and I didn’t dump it until April 2002, after it had lost almost all value. I gradually woke from this nightmarish infatuation with WorldCom to wonder how it had transformed me from a prudent investor in low-fee index funds into a monomaniacal speculator in a single dubious company.

Mr. Paulos concludes by answering his own question in the context of the ongoing sriminal trial of Mr. Ebbers:

Whatever the [Ebbers] trial’s outcome, however, I’ve long since come to a verdict on my behavior: guilty of stupidity in the first degree. No jail term, just a very substantial fine.

Yet, the ever-insightful Professor Ribstein notes in this post that attempting to deter this type of investor bravado through government regulation really just ensures that such irrational exuberance will eventually reappear:

A cause of the recent frauds is investors’ belief that they can outguess the market. Unfortunately, this erroneous belief is perpetuated and entrenched by court decisions and regulation that convey the impression that the markets are, again, safe for this foolish activity.

Quoting from a draft of his paper, Market v. Regulatory Responses to Corporate Fraud, 28 J. Corp. L. 1 (2002, Professor Ribstein observes:

Corporate frauds arguably were facilitated because there was too much investor confidence, as indicated by investors’ willingness to ignore what the market knew about questionable accounting and to not question firms’ extravagant claims about unproven business plans. Overselling regulation might perpetuate this misjudgment and mislead investors back into the same complacency that contributed to the recent frauds.

In a deal that may well be the equivalent of Custer’s last stand for department-store retailing, Federated Department Stores Inc. — the owner of Macy’s and Bloomingdale’s — has agreed to buy its longtime and smaller rival May Department Stores Co. for about $11 billion. May is the owner of Houston’s venerable chain, Foley’s.
Federated will pay about $36 a share in cash and stock, and assume about $6 billion in debt, to buy May, which also owns the Marshall Field’s and Lord & Taylor chains. Although the proposed merger will create a huge company of nearly 1,000 department stores, the deal underscores the critical condition of department-store retailing, which has to undergo a transformation to survive in the brutal American retailing market. Big-box retailers such as Wal-Mart Stores Inc. on the low end and upscale stores such as Neiman Marcus Group Inc. on the high end are squeezing the profits of big department chains, which have been losing market share steadily over the past 25 years.
Although Federated operates only one Macy’s store in Foley’s home base of Houston, divestitures are still expected to occur, particularly in the 94 malls across the nation in which Federated and May both maintain locations. The merger is subject to regulatory approval, which is expected given the deteriorating condition of the department store-retailing sector.
Update: Dylan has interesting inside observations about May in this post.