David Sokol knows how Buffett and Munger think. He knows what would be attractive to them.

So, even if the initial comments from Buffett were negative on the purchase of Lubrizol, Sokol, having more data, could be confident, because once the full data were available to Buffett and Munger, the deal would likely be done.

Sokol has been one of Buffett’s CEOs for awhile.  You think he can’t recognize another man who would be a good fit for Buffett?  I suspect he knows the pattern intuitively.  Buffett likes managers who think as he does; Sokol knows what sort of manager that is; once Buffett talked to the CEO of Lubrizol, the deal would be done.

With that as background, I fault Sokol for buying a lot of shares of Lubrizol, knowing that he would recommend the purchase to Warren, where the odds were in his favor that Warren would buy.  This also takes into account the goodwill that Sokol has with Buffett and Munger, given his management of MidAmerican, and his turnaround of NetJets.  Don’t think that that means nothing, even if Buffett says otherwise.

My view is that it was unethical, but not illegal, for Sokol to recommend the purchase of Lubrizol without disclosure of the size of his position in Lubrizol.  Mere mention of a position is not enough, unless it was a small position.

Yes, Sokol could not force the purchase, but he could have not brought it to Warren, in which case he would have made or lost money off of operations.  By buying, and then recommending the stock to Buffett, he raised his odds of a successful outcome.  That is a way of misusing your influence within the organization that you serve, which is unethical.

UPDATE 9:30 AM 3/31

Kid Dynamite did a post on this, and asked me to comment.  Here it is:

You have not misinterpreted me, KD. But in the cold light of morning, I have thought of one more issue… why is Buffett so loosey-goosey with things that ought to be mandatory disclosures for avoiding potential conflicts of interest?

Every firm I have worked for, and even now at the current small firm that I run, there were/are mandatory disclosure rules. My promise to clients is that I get the same results they do, win, lose or draw.

Regardless, it highlights a weakness in Buffett’s highly qualitative way of managing his company and managers. You not only have to avoid breaking the law; you have to avoid the appearance of breaking the law, or even the “fairness code,” however defined. And, he has said as much to his managers in his biannual memo to them:

The priority is that all of us continue to zealously guard Berkshire’s reputation. We can’t be perfect but we can try to be. As I’ve said in these memos for more than 25 years: “We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation.” We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.

Sometimes your associates will say “Everybody else is doing it.” This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody offers that phrase as a rationale, in effect they are saying that they can’t come up with a good reason. If anyone gives this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.

If you see anything whose propriety or legality causes you to hesitate, be sure to give me a call. However, it’s very likely that if a given course of action evokes such hesitation, it’s too close to the line and should be abandoned. There’s plenty of money to be made in the center of the court. If it’s questionable whether some action is close to the line, just assume it is outside and forget it.

And Buffett implicitly confirms such a view by accepting Sokol’s resignation, with no hint that he tried to argue him out of it, as he did twice before. Implicitly, Sokol’s unethical behavior led to him leaving Berkshire Hathaway — one can try to dress is up otherwise, but it fails the smell test.

This should be a short post.  QE2 — for the most part, the Fed has bought shorter nominal (non-inflation protected) Treasury notes.  Now, we knew from the beginning that the Federal Reserve would buy the grand majority (94%) of its nominal bonds 10-years and shorter.  Also, 97% of the bonds would be nominal, and only 3% TIPS.  That makes some sense, because the Treasury bond market has an average maturity of around 5 years, and the Fed’s intended purchases of nominal bonds work out a little longer than that, at 6.5 years.

With TIPS the Fed left itself free to do whatever it wanted with respect to maturity.  So far, the NY Fed has done ten purchases of TIPS — $16.1 billion worth, which would indicate they are 89.5% of the way to their (perhaps approximate) $18 billion dollar target.  Let me summarize in a graph the purchases of TIPS to date, together with the targets for nominal Treasury purchases:

Average maturity for TIPS purchases is 14 years, versus 6.5 for nominal bonds.  As you can see in the graph, below seven years, more nominals are bought than TIPS, and vice-versa above seven years.  TIPS purchases are also concentrated in on-the-run 10- and 30-year bonds, which constitute 37% of all TIPS purchased.  On-the-run bonds are the ones most recently issued, and more actively traded.  They may have a disproportionate effect on the market as a whole.

What are we to make of this?  It’s not as if the Fed is avoiding longer nominal bonds; their purchase profile is longer than that of the Treasury market as a whole.  But with TIPS, the Fed is buying a disproportionate amount of the long end.  Why?  Possible reasons:

1) Maybe the Fed is no brighter than the average schmo,  and can’t bring itself to buy many bonds with a negative yield versus the CPI.

2) Perhaps the Fed anticipates higher inflation in the distant future, and is purchasing a small hedge.

3) Maybe the Fed is trying to make long-term inflation expectations look high, for reasons that are not obvious to me.

I lean toward reason 2.  Reason 3 is dumb.  Reason 1 is too easy; the Fed has made so many errors in the past — but that doesn’t mean that will continue to do so.

The correct answer is not known with certainty; the main thing I want to highlight is that the Fed is disproportionately purchasing long TIPS.  If you can tell us why, please comment so that we all might benefit.