A vintage Warren Buffett-ism for the modern CeFi meltdown

By meg0 | One Two Ten | 14 Jul 2022

The Warren Buffett-ism about "swimming naked when the tide goes out" has recently seen a resurgence. Understanding the origin and meaning of this saying helps explain why it keeps popping up in reference to the current CeFi collapse. Plus, a semi-relevant side story about a guy who just might be the worst CEO in traditional banking history.

The origin story of this Buffett-ism

Warren Buffett has recycled the "swimming naked" reference into different Berkshire Hathaway letters to the shareholders. He used it in February 2002 in reference to insurance operations that were experiencing massive losses due to risky underwriting practices, which were exposed after the September 11th terrorist attacks. However, my personal favorite is the variation he used in his February 2008 letter to the shareholders regarding the housing market crash, because it is full of personality:

You may recall a 2003 Silicon Valley bumper sticker that implored, “Please, God, Just One More Bubble.” Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA – house price appreciation – would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. 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.

Warren Buffett

A pseudo-aside about John Stumpf, CEO of Wells Fargo

Immediately before that quoted paragraph, Warren Buffett included a quote from John Stumpf, who was CEO of Wells Fargo at the time. In hindsight, this is hilariously absurd.

It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.

John Stumpf, CEO of Wells Fargo

Stumpf began working at Northwestern National Bank in 1982, which eventually merged with Wells Fargo in 1998. Over the years, he worked his way up the corporate ladder, eventually being named Wells Fargo president in 2005 and elevated to CEO in 2007. In 2010, he also became chairman of the board.

He was in the driver's seat when Wells Fargo was busted in 2016 for opening unauthorized customer accounts, which was thought to have started as early as 2005, coinciding with when he became president. Roughly a month after news of that scandal broke, Stumpf retired. In January 2020, he agreed to a lifetime ban from the banking industry along with a $17.5 million fine for his role in the scandal. In February 2020, Wells Fargo agreed to pay a $3 billion fine to resolve its criminal and civil liabilities associated with the scandal.

The next Wells Fargo scandal broke in 2018, which entailed fraudulently overcharging customers for foreign exchange services from 2010 to 2017, which was yet another scandal that occurred during Stumpf's tenure as CEO. In September 2021, Wells Fargo agreed to pay a $72.6 million settlement, about half of which was paid as restitution to impacted customers, with the remainder paid to the United States as civil penalties under FIRREA and as asset forfeiture.

John Stumpf testifying to the Senate Banking Committee (source)

The meaning of this Buffett-ism

Warren Buffett is illustrating that you don't really know or appreciate the risks that companies are taking until they are tested by adverse conditions. In a literal sense, when the tide goes out, all of the things that were previously hidden below the surface become exposed. This particular Buffett-ism is a corollary to the saying that "everyone looks like a genius in a bull market."

And to me, the "swimming naked" Buffett-ism perfectly describes what's happening in CeFi right now. Once everything started crashing down and the tide went out, these companies were exposed --- for taking risks that were far beyond what they had disclosed, combined with wildly insufficient risk management.