(John Kemp is a Reuters columnist. The views expressed are his own)

Warren Buffett’s acquisition of the remaining 77.4 percent of Burlington Northern Santa Fe (BNSF) railroad his Berkshire Hathaway does not already own looks like a strategic bet that America’s future energy needs will be met, in large part, through a massive expansion in coal-fired power generation coupled with carbon capture and storage (CCS).

Coal is the most important item moved on BNSF’s railroads. It accounted for almost half the tonnage moved by BNSF in the first nine months of the 2009 (214 billion revenue ton miles out of a total of 444 billion) and a quarter of the company’s revenues ($2.7 billion out of a total of $10.4 billion).

BNSF’s track and rights of way are perfectly positioned to benefit from a massive expansion of the country’s coal-fired output in the next 20 years, coupled with CCS technology to curb the carbon-dioxide emissions.

BNSF controls the crucial rails linking the massive domestic reserves of the Powder River Basin, the Northern Great Plains, the Western Interior Basin and the Illinois Basin east to the main industrial centres of the Midwest and west to the major electricity demand centres in southern California.

* http://pubs.usgs.gov/of/1996/of96-092/Comp/main.gif
* http://www.eia.doe.gov/cneaf/coal/reserves/chapter1.html#fig1
* http://www.bnsf.com/tools/reference/division_maps/?menu=5&submenu=0
* http://graphics.thomsonreuters.com/109/US_ENRGY1009.gif

Warren Buffett is back as the nation's financial conscience, publishing an op-ed in yesterday's NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that's a message with which I wholeheartedly agree. My problem with Buffett's piece is that he makes a good argument and then totally undercuts it in his conclusion:

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

This have-your-cake-and-eat-it-too approach is typically what we get from Paul Krugman: Yeah, debt is a problem and has to be dealt with long-term, but in the meantime we should jack up deficit spending in order to boost growth. To paraphrase St. Augustine, make us fiscally and monetarily prudent, just not yet. Ben Bernanke said something of that sort in a speech. He was trying to be funny.

The problem, it seems to me, is that rising GDP and employment---i.e. "recovery"---is not compatible with de-leveraging, which is what Buffett is talking about.

When consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.*

Consumers de-lever, government re-levers.

Private consumption and government spending now drive something like 80% of GDP. It can't keep rising unless consumers, the government or both continue borrowing huge sums.

The goldilocks economy Buffett describes, in which we can have "recovery" without increasing debt, is a fantasy.

My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.

What Buffett should have said? Suck it up folks, we've no choice but to learn to live with less.

------

P.s.: I think Buffett actually knows this, but being asset-rich, he's boxed in. Deflation hammers the value of all non-cash assets, so he has to support monetary/fiscal stimulus in order to preserve his own and his shareholders' wealth.  Hence the opening of the piece, which lauds the "wisdom, courage and decisiveness" of the Bush and Obama administrations in the face of collapse, and the end of the piece, which says their emergency measures continue to be necessary. He maligns the effects of stimulus, but he's stuck supporting it.

*The "Paradox of Thrift" this is called, a particularly problematic economic theory used to justify heavy government borrowing.

When I was 14, Warren Buffett wrote me a letter.

It was a response to one I'd sent him, pitching an investment idea.  For a kid interested in learning stocks, Buffett was a great role model.  His investing style -- diligent security analysis, finding competent management, patience -- was immediately appealing.

Buffett was kind enough to respond to my letter, thanking me for it and inviting me to his company's annual meeting.  I was hooked.  Today, Buffett remains famous for investing The Right Way.  He even has a television cartoon in the works, which will groom the next generation of acolytes.

But it turns out much of the story is fiction.  A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company's stock holdings would have been wiped out.

Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money.  The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee. (Click chart to enlarge in new window)

Without FDIC's debt guarantee program, even impregnable Goldman would have collapsed.

And this excludes the emergency, opaque lending facilities from the Federal Reserve that also helped rescue the big banks. Without all these bailouts, the financial system would have been forced to recapitalize itself.

Banks that couldn't finance their balance sheets would have sold toxic assets at market prices, and the losses would have wiped out their shareholder's equity.  With $7 billion at stake, Buffett is one of the biggest of these shareholders.

He even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had "confidence in Congress to do the right thing" -- to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb.

Keeping this in mind, I was struck by Buffett's letter to Berkshire shareholders this year:

"Funders that have access to any sort of government guarantee -- banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government's umbrella -- have money costs that are minimal," he wrote.

"Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that ... are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be."

It takes remarkable chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.

Elsewhere in his letter he laments "atrocious sales practices" in the financial industry, holding up Berkshire subsidiary Clayton Homes as a model of lending rectitude.

Conveniently, he neglects to mention Wells Fargo's toxic book of home equity loans, American Express' exploding charge-offs, GE Capital's awful balance sheet, Bank of America's disastrous acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs' reckless trading practices.

And what of Moody's, the credit-rating agency that enabled lending excesses Buffett criticizes, and in which he's held a major stake for years?  Recently Berkshire cut its stake to 16 percent from 20 percent.  Publicly, however, the Oracle of Omaha has been silent.

This is remarkably incongruous for the world's most famous financial straight-shooter. Few have called him on it, though one notable exception was a good article by Charles Piller in the Sacramento Bee earlier this year.

Buffett didn't respond to my email seeking a comment.

What saddens me is that Buffett is uniquely positioned to lobby for better public policy, but he's chosen to spend his considerable political capital protecting his own holdings.

If we learn one lesson from this episode, it's that banks should carry substantially more capital than may be necessary.  You would think Buffett would agree. He has always emphasized investing with a "margin of safety" -- so why shouldn't banks lend with one?

Yet he mocked Tim Geithner's stress tests, which forced banks to replenish their capital. Why? Is it because his banks are drastically undercapitalized?  The more capital they're forced to raise, the more his stake is diluted.

He points to Wells Fargo's deposit funding model being more robust than investment banks', but that's no excuse for letting tangible equity dwindle to three percent of assets.  At that low level, the capital structure would have collapsed were it not for bailouts.

And by the way, the strength of Wells' funding model is a result of FDIC insurance, among the government subsidies Buffett complains about in this year's letter.

To me this feels like a betrayal.  There's a reason he's Warren Buffett and not, say, Carl Icahn.

As Roger Lowenstein wrote in his 1995 biography of Buffett, "Wall Street's modern financiers got rich by exploiting their control of the public's money ... Buffett shunned this game ... In effect, he rediscovered the art of pure capitalism -- a cold-blooded sport, but a fair one."

But there's nothing fair about Buffett getting a bailout, about exploiting the taxpaying public for his own gain.  The naïve 14-year-olds among us thought he was better than this.

What would Ben Graham say?

– Jonathan Ford is a Reuters columnist. The views expressed are his own –

The credit crunch has exposed many one-time financial heroes as having feet of clay. Even the great Sage of Omaha, Warren Buffett has fallen from grace.

The shift in mood has been brutal. The price of shares in the Sage’s investment company, Berkshire Hathaway, has more than halved since last September. Meanwhile, his one-time iron-clad balance sheet now looks rather frail. The credit default swap market is saying that the company’s vaunted AAA rating is so much baloney. Berkshire’s bonds are trading close to junk levels.

The pain is largely self-inflicted. It stems from Buffett’s decision to raise $4.9 billion by writing put options that insured buyers against falls in the value of several large global stock indices, including the S&P 500 and the FTSE 100. These he sold to a range of unknown counterparties between 2006 and the end of last year. The indices in question have slumped putting the Sage potentially on the hook for an AIG-style payout. On a mark-to-market basis, the positions were $10 billion underwater at the end of 2008, giving a $5.1 billion loss after the premium is accounted for.

Why, one might ask, did Buffett make such a bet? This is, after all, the man who has railed in the past against over-the-counter derivatives, describing them as “financial weapons of mass destruction”.

In broad terms, the Sage says that it’s all OK because he, unlike others, knows what he is doing. The options were sold dearly so the chance of a big loss is, he thinks, acceptably low. Stocks tend to rise in line with nominal GDP, especially over the long run. In any case, any payouts only have to be settled when the options expire between 2019 and 2028, which is quite a way out in the future.

Buffett has also argued that the Black-Scholes formula, used to value options, overstates his likely future liability against the puts (an argument that, incidentally, were he really to believe it, would logically lead him to keep writing and selling puts ad infinitum).

So that’s alright then.

Investors have no choice but to trust the Sage if they continue to hold the stock as they don’t have the information to make their own assessment. Intriguingly, many of them seem to be exiting. Perhaps they don’t like the slight whiff of hubris and hypocrisy in the air. It is hard to escape the perception that, for all the talk of value, the Sage sold many of these derivatives mainly to provide a kicker to spruce up the returns from his sagging stock portfolio.

There is also something worrying about selling puts on the stock market and using the proceeds to buy, um, stocks. It’s in effect a double-or-quits bet and if it goes wrong, the Sage is in double trouble. His liabilities will shoot up just as his asset portfolio is shrinking.

But it may also be that investors are spooked by yet another aspect of this trade. Call it the demographic question. Presumably, when Buffett’s counterparties handed him the $4.9 billion in return for his puts, they did so on the assumption that his shrewd investing would ensure that Berkshire would be around to pay whatever it owed under the contracts over the next 10 to 20 years. But by the time the bills arrive, the Sage will be between 89 and 98 years old (depending on expiry date), and his partner Charlie Munger in the even more impressive 95-104 range. God knows who will be running Berkshire then, or indeed whether the stock portfolio will be up to the task of meeting the firm’s liabilities — especially if stock prices fall further than expected and stay down for longer.

This uncomfortable demographic truth may also have occurred to the unknown entities that bought the put options. Under the deal they struck, Berkshire doesn’t have to post more margin if the markets move against it, meaning the put owners are shouldering a hell of a lot of counterparty risk. One explanation for Berkshire’s ballooning credit default spreads then could always be that they are busy buying credit protection on the company for themselves.

— James Saft is a Reuters columnist. The opinions expressed are his own –

By James Saft
NEW YORK (Reuters) - Some time before the end of the year it is a good bet that stock markets will throw off their gloom and begin a powerful rally of as much as 15 or 20 percent.

Some time one to three months after that it is a good bet that the prospect of a deep global recession and shockingly bad earnings will send them right back down again to make new lows. Rallies in the midst of bear markets can be sustained, powerful and feel very much like the ones that often mark the beginning of a real recovery.

So, why should we believe that we could get an early, if transient, Christmas present from the stock market?

Global markets are more scared, tired and depressed than at any time in my reasonably long memory, excellent breeding conditions for a rally. Given that most people are now on the same side of the debate, it would not take terribly much by way of money being committed to developed market stocks to send them higher. There may even be some momentum investors left who will pile on if a rally can get just a little traction.

The Vix index of stock market volatility hit a record high of 89.53 last week while the ratio of bulls to bears is at a several year low. And stocks have absolutely cratered — the S&P 500 index is down more than 40 percent this year and was heading lower at the time of writing.

Secondly, in historical terms valuations are as good as they have been in quite a while and increasing numbers of stocks are appealing to even the most hard-bitten value managers.

Perhaps most compelling, bear market rallies are simply what often happens in these circumstances. Nothing, not the housing market, nor the Roman Empire nor Alan Greenspan’s reputation keeps going in a straight line in one direction.

“Whether they are bull or bear, markets move in waves,” said Albert Edwards, the famously bearish global strategist at Societe Generale in London.

“You typically get three or four rallies by 25 percent within a bear market. And even though I think the S&P is going to 500 we should get a fairly healthy bounce at some stage.”

Edwards, who has been not just bearish but structurally bearish and who in September predicted a crash, has started to put a toe back into the water, raising his weighting of equities within a diversified portfolio.

He is still underweight equities, but has moved away from more extreme levels.

ARGUMENTS OF AUTHORITY

And it’s not just him. Both Warren Buffett and famed value investor and long time bear and bubble detector Jeremy Grantham have recently become more positive on equities, to varying degrees and in Grantham’s case with a proviso that we will ultimately go lower.

I hate arguments of authority; a long string of them have got us where we are today. The deal must be safe, the ratings agency called it AAA. It must be sensible to borrow five times my earnings to buy a house that just tripled in value, after all the bank is willing to lend me the money. The Fed must know what it is doing.

But that said, the arguments that we may have a rally soon, even an evanescent one, are pretty good.

Grantham looked at 28 bubbles which met his criteria since 1920, all of which, including now the recent bubble in the stock market, reverted to the trend line of growth. Earlier in October, he called S&P at 900 good value and said he would be a steady buyer, though he says he is reconciled to buying too soon. He acknowledges that in the largest bubbles, 1929, 1965 and Japan’s in 1989, the market overcorrected by substantial amounts. He thinks the index, which was trading on Monday at around 880, will bottom at between 600 and 800.

Given that reverses are always part of market trends, and especially given that few awful things in life are as terrible as they seem when first the shock sets in, I do think it is reasonable to expect a rally. It could be quite powerful and will immediately get strategists and talking heads reminding us that large portions of bull market gains usually come in the first few weeks of a recovery.

But though I wouldn’t bet against such a rally, I also wouldn’t buy it a season ticket. Let’s all hope that the financial system doesn’t fall over, but let’s not confuse it remaining standing with a recovery.
Analyst expectations for earnings in the developed world are still at laughable levels. And though everyone laughs at them, stocks still get sold off when they disappoint.

The ongoing deleveraging of the Western economies has further to go and anyone with any sense will admit they don’t really know what this crisis may throw up.

So, prepare yourself for a bit of holiday season cheer, but remember that a long lean period usually come after.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –