Dear Mr. Buffett

Here is another book review I wrote for the Nashville Business Journal:

1) “Don’t lend money to people who cannot pay you back” – Warren Buffett

2) “If you do not understand something, do not invest.” – Warren Buffett

Imagine the pain, frustration, and financial losses we could have avoided if our financial institutions simply abided by the two rules stated above.

In her latest book, Dear Mr. Buffett, Janet Tavakoli, an expert on structured financial products and a consultant to hedge funds, institutional investors, and financial institutions, takes readers on a wild ride through the financial crisis that has crippled our economy.

Ms. Tavakoli uses her friendship with the legendary investor Warren Buffett to tell the story of how and why we got ourselves into the mess we are in. Tavakoli and Buffett first met in 2005 when Tavakoli flew 1,200 miles for a lunch meeting with the “Oracle of Omaha.” They have developed a genuine friendship since this first lunch meeting, and Tavakoli’s book is full of correspondence with Buffett over the last four years regarding the state of the financial system. Readers will be unsurprised to learn that neither Buffett nor Tavakoli were surprised when our financial system imploded.

At its core, this is a finance book for financially inclined people. At times, unless you are one of those financially inclined people, the acronyms and financial jargon will frustrate you. You will feel confused. You will feel lost. However, before you are through with this book, you will understand that confusion is exactly why Tavakoli wrote this book.

This book is really a book on the power of clear and simple thinking. Currently, our financial system is dominated by MBAs, PhDs, and other kinds of financial “scientists” armed with sophisticated statistical models promising to erase risk and maximize reward. These models have allowed the financial community to create amazingly complicated financial instruments, such as CMBSs, RMBSs, CDOs, ABCPs, and Credit Swaps, which even the smartest and most sophisticated “modelers” (Tavakoli’s term for investors, bankers, and financial advisors who use models as their primary rationale for their investment decisions) cannot understand. As Tavakoli points out, “A model will calculate the wrong answer to nine decimal places, but it cannot tell you it is the wrong answer.” She also notes that “Modelers manipulate a large body of data, without knowing how to interpret the results.”

As a counterpoint to this sophisticated confusion, Tavakoli offers Warren Buffett, the old, experienced sage who scoffs at the mistakes of the young and reckless men and women who run Wall Street and corporate America. Buffett has the brains and skills to best any Harvard MBA working at Goldman Sachs. However, as Tavakoli demonstrates throughout the book, good investing and sound management practices are not about high IQs or fancy models. Good investing is about following a few basic financial principles, like the ones listed at the beginning of this review, and sticking with them through booms and busts alike.

Tavakoli, with the help of Buffett, has even developed her own “MY THEORY OF EVERYTHING IN FINANCE” to keep her focused on the fundamental principles of investing and evaluating financial instruments and businesses. Her theory is:

The value of any financial transaction is based on the timing of cash flows, the frequency of the cash flows, the magnitude of cash flows, and the probability of receipt of those cash flows.”

There have been countless books written about Warren Buffett and his investing principles. In many respects, this book is no different than those that have come before it. But in one unique, fascinating way this book stands out from the crowd. Tavakoli paints a tale of almost mythical proportions of Buffett vs. Wall Street, and, as a reader, you can’t help but pick a side. In fact, Buffett recently made a $1 million bet with Protégé Partners, a hedge fund management group based out of New York, that a collection of five hedge funds selected by Protégé could not outperform (taking fees into account) the S&P 500 over the next ten years. The winner will donate the $1 million to a pre-selected charity. After reading this book, I think you will have a pretty good idea of who will win this one.

At its heart, this book is really about the consequences we have all faced of ignoring the simple and straightforward rules Buffett has used his entire life to enrich himself and those smart enough to follow his lead.