The New York Times reports that Berkshire Hathaway Inc. (NYSE: BRK.A) Warren Buffett's annual letter includes some important observations about the state of the securities markets. The one I found most eye opening was that companies are using unrealistically high assumptions about pension fund returns to boost their reported earnings.
Here are three themes I found most interesting:
- 8% pension fund return assumptions. Buffett said that many companies assume their pension funds will earn 8% a year from investments, a return he deems unlikely given the low level of interest rates, but one that lets them report higher profits now. Buffett notes that by the time those managers need to lower those assumptions to be more realistic, they'll be long gone from their jobs -- along with their bonuses.
- Ending of Home Price Appreciation (HPA) exposes financial folly. Buffett coined a new acronym, HPA, to highlight a familiar point. People were willing to take on risky mortgages because they assumed that their houses would rise in value. He noted that "As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out - and what we are witnessing at some of our largest financial institutions is an ugly sight."
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