May 7th, Pasadena California.
(As is standard, no recording equipment was used to reproduce these notes. My high school typing teacher gets all the credit. As a result, these notes are recollections only – not quotes, and should not be relied upon. –PB)
CM: Testing, can you hear in back? Mr Denham has an announcement.
Denham: We ask you not to use your video recorders, thanks.
CM: Welcome to the 49th annual meeting of shareholders of Wesco Corp. Please register to vote at entrance. Anyone wishing to speak, state name, wait for microphone. List of shareholders, 96% of outstanding proxies received. Election of directors? All in favor? [Aye]. Motion is carried.
Six nominees are elected. There will be a long Q&A preceded by Socratic solitaire conducted by the Chairman. Meeting is adjourned.
We now begin Q&A, starting with a long game of Socratic solitaire. During questions, do not ask what we are buying or selling. Any other question is fair game, but we don’t agree to answer them.
Because many of you have come from such a long distance, I will talk before I take your questions. I will address two topics, general investment climate [and learnings from Berkshire Hathaway]. We normally avoid [discussing the general investment climate] like the plague. Most assets are priced to a level where it is hard to get excited. It is hard to get 4% yield on a nice apartment, and it doesn’t include replacing the carpets. Bonds of strong corporations are 4% yield. Corporate equities are paying 2% pa, growing 4% per year. Such a world isn’t the one that made all of you able to come to the meeting. Last generation has been in hog heaven – some bumps, but it had easiest time getting ahead. In the eighteen years that preceded hog heaven, the purchasing power of Yale’s endowment went down 60%. They were getting real investment return of 0%, negative. It is not at all impossible that brilliant investors like Yale get bad results in the future.
People are used to laying money aside and investing in standard fashion, and become quite comfortable. It is easy to forget that this isn’t guaranteed. Many have recognized this, but for those running pensions it is difficult [to adjust down assumptions] —like the agony of raising taxes or not looking good as CEO of a company. Some of them wonder if they have signed up for something too hard when running a defined pension plan. That crowd doesn’t want to go to a 4-5% assumption, because the pain of the money needed to correct the plan is large. Bonds pay 4%, so they go to alternative investments with profit sharing. They solve the problem by giving ‘reasonable return’ and sell hedge funds and venture capital fund, mid-stage, late stage, private equity, etc etc etc. They do complex trading strategies, private equity in Africa. They buy timber. [audio system malfunctions] Evidently that machine didn’t like the remark. People go into alternatives, and this has worked very well so far. A lot of university endowments have done it – and that is game we are in. If natural return is 5%, getting it to 9% is very unlikely to work well long term. It’s going to be difficult for people to have high real returns from deferring consumption. The reason my generation did so well was kind of a fluke, and won’t necessarily continue. There will be lots of chicanery in future. Many claim alpha – but really they are just taking earthquake risk. At end of year, when there is no earthquake, they take the money. This is a dishonorable way to invest. It is always easier to get felicity by reducing expectations instead of seeking extreme results.
We have plenty of scandals coming. Lots of rot has gotten into system. It has caused unpleasantness. What is next? I suggest the derivative trading books of the world are next. The accounting allowed in derivative books has been god awful. The morals and intelligence has been god awful. ‘I’ll be gone and you’ll be gone’ is phrase they use. What is buried in those books is dangerous, with clearance risks with optimistic assumptions that the accountants allowed. I was at Salomon when interest rate swap accounting was changed. They had a matched book. They were making $7mil, 25m over 18m. Both sides wanted to mark trades profitably. They couldn’t retain derivative traders if they didn’t have bad accounting. There is a lot of Gresham’s law here, where the bad practice drives out the good.
If you run a good bank, and testosterone bank around corner pressures you, there are tremendous pressures to conform. Everyone starts replicating. If every university puts 2% into timber, that can go on a long time. But it is self-fulfilling. When it comes to the unwind, when they all want to get out. A lot of things rely on momentum. Valuations make everyone look good for a while.
We have seen consequences in this mortgage meltdown, not pretty. The amount of knavery and folly revealed in last eighteen months has been unbelievable. I will ask a question, then I will attempt to answer it. Why did this happen? Greed, envy, and terrible accounting was part of it. There was a general lack of conservatism. The engineering mindset that everything must withstand great stresses was thrown out for ‘if music is playing, you gotta dance’. I don’t feel compulsion to dance, to join the crowd.
One of my favorite stories is boy in Texas, when the teacher asked the class the following question. There are nine sheep in pen, and one jumps out, how many are left? Everyone got it right, and said eight are left. The boy said none are left. The teacher said you don’t understand arithmetic, and he said ‘no you don’t understand sheep’. Sam Goldwin had a saying – ‘include me out’ – it is one of my favorite expressions.
People were distributing stuff that they wouldn’t buy themselves. It is the structure of the modern world. Favorite philosopher: Frankl. He said the systems have to be responsible. People who are making decisions must bear results of decisions. In Rome, the builder and designer stood under the bridge when the scaffolding was removed. In parachutes, you pack your own chute. Capitalism works that way too. At a restaurant, owner is bearing the consequences. If he slips, he doesn’t do well. Frankl would be pleased with restaurant business, and not pleased with investment banking. They sell, take the money, go home – it doesn’t work. And people wouldn’t get by if accountants didn’t bless it. When I was at Salomon, I was on the audit committee. A group came and said that we want to change our accounting, and where our credit is terrible – we want to report automatic profits – ie, to buy counterparties out cheaply because they want to sell. I told them that ‘You will have that accounting over my dead body’. I won that battle, but I lost the war.
Post Enron, accountants made mandatory that where the worse your credit gets the more profits you make. In the old system, the liabilities are always 100% good – it’s the assets you have to worry about. Accountants have thrown it out. They have made it standard. If you ask accountants about it, they say it is so complicated we won’t get to it in 3 yrs. They want something simple to do. A silly procedure and silly result doesn’t bother them as long as it is in some book. That is not wisest way to run a profession.
Legal profession comes in for own opprobrium. Knavish people were deliberately blind. They didn’t want to wrestle punch bowl away from a couple burly drunks. I had a friend who once proposed a rule at the partnership that they would fire one client per year on moral grounds. They would get rid their most venal and dangerous client once a year. That proposal went down in flames. There is a certain amount of deliberate blindness. If you want to prevent, you must have whole lines of activity that people are not allowed to engage in. [more problems with sound system] We are in shadow of Caltech and we can’t get the sound system right. Envy effects corporate compensation. People want to be paid like movie stars rather than archbishops. I don’t think it is necessary. Most would occupy top position at lower compensation rate. It is terrible to civilization. It brings extreme envy into population at wide. In Britain, they took taxes so high that anyone with property was leveled down to growing their own tomatoes. It was not good, very counterproductive. It was matter of envy. The working population required it and it was reaction to envy effects. It is not good to have the results we have had.
If we turn to Berkshire Hathaway, we have faults, but some of standard faults we deliberately avoid. Someone recorded what we would have had if Warren had paid himself 2&20. We would have had much lower taxes, so some other shareholders would have been better off, but Warren would have had 3x what he has now. Would world have been better if it had been run that way? I don’t think so. There is a lot to be said that people in power make money with shareholders, not off them. I’m not asking for an unreasonable ethos. It was compulsory in Athens. Liturgos, means required behavior. You had to give like hell if you were a leader. They had banishment. When language and traditions impose these… we might need it. We should restrict people in a more old fashioned way.
I remember what I was going to say. Privileges. If you are an investment bank and had to be rescued, there should be limits on leverage and the complications of your business. There should be qualitative limits too. By and large banks behaved well when it worked this way. When I was young, Bank of America – would not have done things they do now. Derivative trading, no good clearance, no rules, excess and craziness feeding on itself. The plain vanilla products got priced down to no profits. They wanted to do complicated stuff. Not sure if it cleared, or other side would be good for it. It didn’t bother anyone since they wanted the profits. The hidden trouble in derivative books is awesomely large. Greenspan overdosed on Ayn Rand ethos. He never got it out of his system. As long as axe murders were a natural outcome, then they were okay. I don’t think it is necessary – and think you can regulate ax murders away. People talk about marvels of system and risk transfer – but some of our troubles COME from having so much risk transfer.
After South Sea Bubble, Britain outlawed public corporations – only private ones allowed. And they led the world for 100 yrs. A modest amount of liquidity will serve the situation. Too much liquidity will hurt human nature. I would never be tenured if I said that. But I’m right and they are wrong. We don’t need worst excesses. We do not need smartest people in science and math in computer driven strategies. This is not a plus for wider civilization. Derivative trading books – is one big clump of excess not having had its denouement.
I am now going to turn to a more interesting subject, the Berkshire Hathaway phenomenon. What are the lessons? On investment side, people are realizing that old fashioned idea of trying to get more value than you are paying for. I think that idea is gaining, and I think a plus for rationality. It doesn’t make it any easier. By the nature of things, it will be difficult to make easy money.
How is it organized? I don’t think in history of world has anything Berkshire’s size organized in so decentralized a fashion. Net amount of bureaucracy is tiny, costs are low, autonomy in subsidiaries is vast, no common culture shuffling people around. How far can this go? This system has gone farther than any other system. Low cost, not a lot of envy effects – where everyone compares everything. People in subsidiaries have a feeling – whereby there is less fealty to headquarters. If you want an imperial headquarters which exacts a big overhead charge on the provinces – they will resent it. Net number of intra-subsidiary transfers is tiny. It has worked well. It can go a lot farther. No one else has been here before.
There are defects to the conglomerate system, where you have a separate quota system driven by headquarters driving provinces to meet central numbers. It causes a lot of expenses at headquarters. GE is good at running a conglomerate system. Berkshire has avoided the minuses. It can go farther. It has a system of running a financial system with low leverage and extreme willingness to let assets run out – that is quite rare. Most financial institutions talk our talk but don’t walk our walk. People can’t stand watching a place shrink. If you take General Re, they needed a derivative book like I needed a case of syphilis. It made headquarters more interesting. When we reached for money it wasn’t there. Out derivative book produced $400m of losses, and we were more conservative than most places.
[break to fix the sound system]
We have moved to a hard mike, so please return to your seats. Microphone system has an educational value. What they should not be allowed to do – is anything that is too complicated. The hard mike system [vs the wired], lo and behold, is working as it always did. Systems need duplicative systems, back up system one, and back up system two. Complicated systems – the high priests usually don’t understand it either. The system just goes out of control. Now we have government guaranteeing credit and then letting investment banks do what they want -- it is a very foolish system. They ought to have behavioral standards. They feel entitled, and that is not what they should feel with privilege of Federal Reserve backing. At Berkshire, we are ridiculously conservative. Even our reserves have reserves. We don’t have to renew our credit every Monday morning. We behave in way that we never need to renew our credit, and we still don’t need the money.
There have been comments on derivative trades we have done. If other people shouldn’t be doing it, why are we? Other people pay us money because people know we don’t have clearance risk, we are not at whim of other parties. It is a very different kind of a trade. The only reason we can make those trades is because there aren’t many out there who others would trust to make those trades. If you ask me, would I give up all of the opportunities of derivative trading to go back to a simpler cleaner world like engineering of yore--I would do it in a heartbeat. But what we have seen in mortgage market is only an aperitif to what we would see, in a system with bad rules and incentives. Especially with the appetites of males – women wouldn’t get us into this mess. In a soccer game, if there were no rules, people would destroy the body of the person on the other side. That is what referee is for. So we need referees to tell boyish adults not to hurt others. I don’t make this stuff up. Mark Twain said that truth is stranger than fiction because fiction has to make sense.
Some people call you people cultists, but most here are people who want to learn. It is a very good thing to be in this world. I think we are accidently creating something which is a learning institution, which may work that way for a long time. I don’t think Berkshire will perish when Warren dies. I had lunch with two Berkshire executives, and my heavenly days, those two guys are likely to make that business one of best in the world. How could there be a business like that buried in a place like Berkshire? There are very good things in this place. With reputation, comes duty. We should try to earn it. And run it in a way that people who succeed us do the same thing. That is what we are trying to do. Warren will never spend any of the money. He has never given a way a dime he needed. He deserves no credit as a philanthropist. I think we are part of something quite interesting and worth following. We get calls from people who trust us, and who don’t trust anyone else. We don’t get many calls like that, but how many of you get any?
I have rambled on. Academic response to Berkshire has been pathetic. It is soft science with enviable formulas. So you had to program a computer to buy only highly volatile stocks in order to make 7% per annum more? But if true, computers would do it. I don’t know why people pay attention to those ideas. Down boy, they say, you just don’t understand modern finance. And these are grown up people. One man, to whom they gave the Nobel, he kept saying Berkshire just lucky. A six sigma event – he wasn’t going to change his theory on the facts available. Business is simple, the details are hard. You need mementoes in place to help you in daily fight.
The only duty of corporate executive is to widen the moat. We must make it wider. Every day is to widen the moat. We gave you a competitive advantage, and you must leave us the moat. There are times when it is too tough. But duty should be to widen the moat. I can see instance after instance where that isn’t what people do in business. One must keep their eye on ball of widening the moat, to be a steward of the competitive advantage that came to you. A General in England said, ‘Get you the sons your fathers got, and God will save the Queen.’ At Hewlett Packard, your responsibility is to train and deliver a subordinate who can succeed you. It is not all that complicated – all that mumbo jumbo. We make bricks in Texas which use the same process as in Mesopotamia. You need just a few bits of ethos, and particularly engineering ethos. Think through the system, and get a margin of safety. Like this backup microphone.
Q1: Thank you Charlie. Financial risk transfers – 500trillion notional value. Sort of like Lilly Toms – things will get worse before they get worse. How does this all unwind?
When the Chinese A-shares went utterly crazy, you could predict this has to collapse. When mortgage excesses got crazy on slicing and dicing by scummy hucksters, it was similar. Derivatives trading books however are not similar. It has no automatic collapse surely to come. Some day it will be a mess, but I don’t know when. The mess that would have been if Bear Stearns went under would have been awesome. In CDS, assume $100mil bond issue, and they allow issuance of $100b notional contracts. You have huge incentive for company to go broke. You are not allowed to buy insurance on other people, unrelated parties. There is no reason in America to have vast bets on $100m bond issue to which no one is party. It creates needless complexity and very perverse incentives. They say “it’s a free market”. The correct adjective is insane.
Q2: Mark from Auz. Last year I was concerned about solvency in banks. I had stocks sent to me in scrip form. Is it now safe to let large corporations hold our stock or safer to keep at home?
Good question. I think risks are low in a cash account at reputable firms. Even in a margin account I think risks are low. It is inconvenient to keep them at home. They all end up in depositaries anyway. Everyone relying on electronic blips. I think fairly safe.
Q3: NY. The amount of derivatives out there today 30tril, 3x GDP. Do you think volumes will present danger in future, have you ever spoken to someone who writes derivatives?
It is complicated. They show large profits. It is peculiar thing – allowed to morph to huge size. Interest rate swaps – overstated. So imperfectly regulated it has a danger to the rest of us.
Q4: CA. Named our son after Warren. We are in market for a house in CA. Wanted your views on house prices.
Housing prices are going down in most places in CA. If you want house in Pasadena, if offer price 1.8m better to start bid at 1.85m. So not going down everywhere. Generally speaking the time to buy a house is when you need one. If you make money on it, it is just a byproduct of you doing your family duty.
Q4: NY. Have you ever asked quality programs at subsidiaries to improve margins?
We try to buy companies so permeated by good ethos that they don’t need checking from headquarters. We are trying to live in a seamless web of deserved trust. It has worked for us, and it is the ideal way to live. If your marriage partner has sixty page contract, you shouldn’t enter. You want to get a seamless web of trust. If life is hard, you may need a command control system. But we try to avoid it.
Q5: NJ. Railroad regulation?
CM: They are regulated. Earned so little money for years, that I expect rules will be better in future. They have increased capacity in a great way. It has been costly. I would not anticipate regulatory burdens to be high because the railroads have behaved well.
Q6: NY. Rationality? No one is 100% rational. How do you reconcile rationality with irrationality required for successful human relationships?
CM: There are some relationships you couldn’t have if you were rational. If someone asked you to join heroin smoking party, you wouldn’t qualify if you were rational. I think rationality is of immense benefit. It is a deep moral duty, you must hold it in trust and must hone it. People who are no good at it, they have to go to a different guru. I was born into a different skin.
Q7: WA. Inflation?
CM: If you have competitive advantage, and make 10% of sales, and sales go up 10% due to inflation, you will tend to make a little more money. Whether we will earn less or more, my answer is probably earn a little more.
Q8: UT. General Re. Brandon resignation.
We want to stay away from that subject. But we will stand behind Joe Brandon. He did a magnificent job. We stand behind that observation. I would trust him personally. [applause]
Q9: TX. Howdy. US force feeding 2bil per day. $2b a day to other countries, is it sustainable?
I would not be running twin deficits if I was running this country. I would have policies that didn’t push things as far as they have been pushed.
Q10: Dan Rizowsky. Discuss opinions and which model to reach a resolution?
We come to agreement once in a blue moon. Very seldom does he do something I wouldn’t do. Once in a while will we change each others’ view. We’re like an old married couple, humph humph and a nod and it is decided – no conversation necessary.
Q11: Harold from LA. Comments on Alan Greenspan and Ayn Rand and finance professor who can’t believe the success of Berkshire. Has there been a time like today when facts on the ground count so little for people in position of power?
You hang around with fellow ideologues. You should avoid this. Many people are totally confident they know the answer. When you have this confidence you need to get over it.
Q12: James Armstrong from Pittsburgh. You have said that Moody’s and HBS have the best pricing power of anyone in the world. What causes Moody’s moat to shrink?
All the rating agencies with 20/20 hindsight have performed poorly. When you perform poorly you impair your franchise. They weren’t quite fundamental enough. Exact example of the kind of thing I was speaking about. In an attempt to make more, they made their position a little worse. This is obvious isn’t it?
Q13: Scott from LA. With portfolio of $2m, vs. that of Berkshire, how would your mandate be different? Small vs mid, us vs intl, etc?
If I was managing smaller money I’d be looking in smaller places, I’d look for mispricing. But I don’t want to change places with you. [laughter]
Q14: Matt from San Jose. California is single A rating. Only other one is worse is Louisiana.
Both parties have been gerrymandering the legislature. It’s hard to get elected unless you’re a left or right wing nut. It’s a perfectly natural result in an insane system. We are not voluntarily going to change the system. I was the largest donor to the last attempt to change this system. We went down in flames. Stay tuned.
Q15: Sam from Santa Monica. What are your thoughts on the war on terror and the war in Iraq?
A: You’re going pretty far afield. Terror is a hell of a problem. People are vastly overconfident in the solution. They are probably making an error.
Q16: Phil, shareholder. What would you do if you were Fed. Suggestions on short and long term solutions to credit crunch?
Changing the system so the system is more responsible. We had margin requirements for decades and the fed forced this. Now with the combination of options and derivatives margin requirements have vanished. Federal Reserve has no power to deleverage. I think the system is seriously wrong.
Q17: Casey from Pasadena. Strong return on intangible assets is what WB likes. What else do you look for?
We buy Kraft these days because we have so much money. We are accepting way lower returns now than we were ten years ago. It is natural consequence of the world getting more competitive.
Q18: What do you think of the treasury market with negative real yields?
It would be depressing if that was my best opportunity.
Q19: Forest from Ft. Worth Texas. Do you look at railroads from a replacement value standpoint?
Do you know what it would cost to replace Burlington Northern today? We are not going to build another transcontinental. And those assets are valuable, have utility. Now they want to raise diesel prices on trucks. Wish I was smart enough to identify this few years earlier. Avoiding the most extreme follies of man makes you better.
Q20: CA. Why has commercial property not fallen as much as residential?
Cap rates came way down and asset values went way up. Financing transactions are getting away from euphoric conditions. A lot of the real estate fortunes have been made with extraordinary leverage. Commercial real estate is not a good business for us but ok for the entrepreneurial types. We shouldn’t be doing it.
Q21: Matt from NYC. How does Berkshire thru its subsidiaries manage an annual budgeting process?
We don’t have one. Obsessing over budgets creates bad incentives. Just eliminate unnecessary costs. Budget committees tend to do just the opposite.
Q22: John, shareholder. Any recent books you recommend?
I’m a bug for history and science. Yes by Cialdini is good. Most of the psychology professors can’t handle this real life material. It’s not a perfect book and not as good as Influence. As Warren says, experience is what happens when you’re looking for something else.
Q23: Peter, Yonkers NY. Which is better, insurance based float or money management float?
A: In terms of pure utilitarian perspective, you can make way more money in money mgmt than insurance business. There are few businesses as good as money management. Average returns in insurance property and casualty have been pretty pathetic. Once you have enough money you stop accepting compensation and just manage money -- it is more manly. At least 95% of the insurance businesses in the world are worse than ours.
Q24: Ashok from LA. Checklist?
I don’t have a simple checklist. You have to work at it a long long time. I still do dumb things after years of hard work. The more big ideas you have the easier. We exclude a whole lot of things because they are in the too tough pile. If you exclude, you do better. Then you must have field where rationality will be rewarded. Some of political ideas – it is very hard to know how they will work out over next few centuries. We are not trying to involve ourselves. We look for things that can be done. But I have no little short list. People who sell strong abs on TV at night might have one. I have no rule for a strong brain.
Q25: Whitney Tilson. NY. You reported earnings, but not a single shareholder asked about it. I was hoping for a comment on Berkshire earnings, and on mark to market derivative losses.
It was a very remarkable occurrence. Like the Sherlock Holmes story – about the remarkable happening with the dog’s behavior. Sherlock Holmes asks about the behavior of the dog in the night. “The dog didn’t make a sound.” “Yes, that was remarkable.” That perhaps is teaching a lesson. Those people trust us. They trust Warren, and rightly so. You saw an interesting example of deserved trust working in real world and in Omaha. By the way, we love that position. The accountants don’t know what they are doing but I don’t criticize them.
Q26: LA. In 25 yrs, where would you see oil production? What year do you see the peak?
This is very flattering, but I don’t think question nor my answer will do much for my reputation. We don’t know year, and the reason Warren picked up on my answer last weekend so strongly is that it is a radically different world where oil production is down 25 yrs from now, with radical adaptations necessary. Hubbert pretty accurately predicted peak. If it hasn’t peaked, it soon will, and it will go down. At $120 / barrel, there are obvious strains in the production system.
Q27: LA. I went to private school where you donated science building. For many minorities, there are low graduation rates. What can government do to help? What can we do?
Very serious problem, anguish causing. CA had once the best public education system in USA. It is a very sad thing. The private system is very competitive. Warren has suggested that if no one was allowed to use private schools, citizens would make sure public system was good. Not sure Warren is right on this. Personally I am better at lifting top up than the bottom up. Why shouldn’t I stick to game where I’m better suited? If you want to know how to raise top higher, I think I could help you a lot. If you want to raise lowest, I don’t know how to do it.
Q28: Boston. Swiss Re transaction. Could you add some color? Long tail insurance?
It will be long tail. It won’t be a bonanza. It ought to be reasonable, we like Swiss Re.
Q29: I’m curious, you are student of history. Does today remind you of any time in past, and why?
I punched premium channel in hotel in Tokyo, and out came exercise in pornography. I would argue Soddom and Gomorah is still around. I think Athens of Pericles is still around today. Our bullies are similar to past eras.
Q30: LA. How will meltdown affect Brazil and China. Will you invest there?
We have [economic] system which is interdependent. [A slowdown here] would have repercussions elsewhere. Will Brazil have troubles? No. Brazil is favorably located now. If I could get equivalent business prospects I would prefer USA. That iron mine that Brazil owns, you only need small knowledge to know that it is one of best in world. Agriculture – they are in a very strong position. We are not invested there at the moment. We have a small position in Brazilian Real.
Q31: CA. Health insurance?
The health insurance industry gets bad press it doesn’t deserve. When medical care fails, they say that characterizes it. But they also prevent a lot of interventions too. But Hollywood assumes everything is bad about health care. I don’t know what will happen. I think single payer could happen, and might not be too far in future. In fact it probably would happen, maybe 50% likely if Democrats win both houses.
Q32: LA. Absurd leverage in banking system. Large mess. Only response is that government has taken toxic portion and thrown it onto their books.
Not at all clear what will happen. If government intelligently spent $500bil dollars, it wouldn’t be that bad. But now they do it unintelligently. I am not shocked that we all have to pony up $500b. We did it in savings and loan crisis, $150bil.
Q33: CA. Hyperinflation. Real estate and gold?
I don’t have a good opinion on that subject. We have not been good at taking advantage of inflation. Net inflation at Costco was zero for ten years. Even Costco is starting to feel it. Not desirable. The previous situation was too good to continue. If it can’t go on forever, it will eventually stop.
Q34: Germany. Many managers typically would be carried away by all the success. Is it genes or is it still to come?
Very flattering. Success tends to make most people pretty pompous. Someone once suggested in a public setting, ‘Don’t you think financial success is making Munger pompous?’ An old friend of mine stood up and responded, “No, that is unfair criticism, I knew him when he was young and poor and he was still pompous.”
Q35: Beverly Hills. Berkshire has history of acquiring operating companies. Wesco has been less active. Will you get more active?
Berkshire will be better at stuff than we are. We have not bought our last operating business at Wesco, so, stay tuned.
Q36: Auz. Wells Fargo, how did you get comfortable with their derivative positions?
They will not be exempt, but we believe they will have less than their share of troubles. I think they have a better culture.
Q37: CA. Common stock returns going forward? Should we go overseas? So much less transparency… hard to satisfy conservativeness.
P&G and Coca-Cola is in developing world. We have exposure there. For a great many investors, the best way to do it may be to own Coca-cola. We’ve thought about these things. We do not lack participation in the rest of the world. And we may get more.
Q38: LA. If you were younger, what asset management type would you join?
If doing it again, I’d find someone I really liked being associated with, and I’d serve little time in a pompous place doing a lousy job. But most of jobs are in lousy places. My Harvard law professor used to say – ‘tell me what your problem is and I’ll try to make it more difficult.’
Q39: Germany. Insurance accounting: Cost or market, or lower of cost or market? Was this good move for accountants of insurance coompanies 30 yrs ago?
Very tough question. Generally speaking, lower of cost or market (standard for inventories) – but various financial types wanted to get away from this. There is a risk of self fulfilling prophecies, like an autocatalytic reaction in chemistry. Conservative insurance companies marking common stocks to market is not a bad thing. If we had lower of cost or market in derivative books, they would have worked better. All intelligent people find it so. You are to be complimented for being bothered by it.
Q40: CA. Average investor should invest in index funds.
All intelligent investing is value investing. Calling something a value fund doesn’t absolve it. You can call yourself a ballet dancer if you dance like me, but it is not a good thing. I wouldn’t recommend people broadly invest with any value fund. I would avoid funds that have 100% turnover per year. It is a ridiculous way for an ordinary index fund to behave. It is imperfect, but best outcome for most know-nothings, in order to avoid being misled by fools and liars.
Q41: USD Currency. How many months would it take for exporters benefit?
I don’t think USD weakness will fix trade deficit.
Q42: MN. Insurance and healthcare: How can we go about having best medical care at lowest cost? Also, could we get your book in schools?
A lot of people think existing system is all bad. People tire of dealing with dumb insurance companies. There may be some reality. Changes have been hard. If you look at hospital I am Chairman, we used to knife the kidney. Now we use lithoscripsy, with a 100% cure rate. I would argue our specialist doctor was one of greatest doctors Los Angeles ever had. I think there are good things in system as well as bad. It isn’t clear how it will work out.
I do have one clear opinion. There is way too much intervention when dying. It is a national disgrace. They are way better at handling it in Europe than US. You can take pride in Europe at dealing realistically. We blow more money on stupid cases near death where no one is helped by the intensity of the interventions.
I have trouble getting my family to read my book.
Q43: US. Are we losing our competitive edge? Education failing, infrastructure falling down. Should corporations move abroad?
Some movement offshore for tax reasons is happening, and it hasn’t ruined the country. It is the natural response to incentives. Berkshire could save a lot of money, but we just haven’t done it. We have some companies in lower tax zones. But we pay enormous income taxes. There is a huge taxation claim between you and your money. We pay taxes that are astronomical. I hope they become more astronomical. There is some development to shift around to save taxes.
Should be concerned if it gets big, but it isn’t really big at the moment. Pharma co’s make drugs in Puerto rico, etc etc.
Q44: CA. Insurance linked securities. Can you discuss insurance linked securities? Are they a threat to quality of underwriting?
Of course. Like slicing and dicing insurance risk – it wouldn’t improve matters.
Q45: What has changed since you first started investing?
I owe a great deal to Mr Buffett. It took a while to convince me. Warren and I together got very good at reinsurance transactions and portfolio transfers. We’ve learned together at it. Berkshire would have been a mess if it had ever stopped learning. Only reason we’ve been able to keep a shred of decency in our record is that we have been hell bent to keep learning.
Q46: There is no shortage of well regarded financial experts about debt – equal to great depression?
Pushing credit hard makes me nervous. I know how countries got ahead, and it wasn’t by pushing consumer credit to its extreme. I am not wild about the developments. But a great system will handle a fair amount of abuse. Some of the [credit] expansion was good. Do I like multiple credit cards being juggled? Do I look like kind of person who thinks that is good idea? It turns someone into a serf. You get customers just screwed together enough to pay you but who don’t realize cost of 36% interest... I don’t admire the guys who are good at acquiring the serfs.
Q47: Sweden. Why do you have so few followers?
From my point of view, we have too many damn followers. I don’t think we have shortage of followers. Of course great bulk of people do things differently because people running the systems have incentives to do it differently. For a security to be mispriced, someone else must be a damn fool. It may be bad for world, but not bad for Berkshire.
Q48: Germany. What do you think of energy drink business and how to can you avoid a bad marriage?
I abuse caffeine, and I like soft drinks. I’ve never even tried an energy drink. There seems to be a growing market for it. Marriage: Ben Franklin gave best advice, keep your eyes wide open before marriage and half shut thereafter. [applause]
Q49: TX. You said at the Berkshire meeting that if there is inflation, Iscar would make a lot more money.
Iscar is selling to very professional customers who know a lot. They can just raise prices like some consumer goods. If I gave impression they would make a lot of money, I didn’t make myself clear. Iscar is so good at delivering good products, it is hard for me to imagine them not selling more to customers who are making more money. They don’t have automatic pricing power. But a price increase is a price increase.
Q50: In 2005 both Berkshire and Bill Gates bought NZD. What do you think now?
I don’t have an opinion about NZ. Some things Warren does I just ignore. [laughter, pause] If I had something intelligent to say, I would say it.
Q51: Why the reluctance to own real estate?
Total real estate holdings are close to zero in the total enterprise. The Chairman has quirks. Old real estate purchases, at times we did borrow out equity in old real estate in order to reinvest it in Coca-cola and other things. We have huge surplus of cash now. But believe me we know all the tricks. We may behave differently in future.
Q52: Where would you sell an operating business?
We tend not to sell operating businesses. That is a lifestyle choice. We have bought well. We have a few which would be better if we sold them. But net we do better if we don’t do gin rummy management, churning our portfolio. We want reputation as not being churners and flippers. Competitive advantage is being not a churner. Warren says, ‘you should take high road since so much less crowded.’
Q: Amex Visa Mastercard. Can you compare these companies?
American express has better customers, and we like that position, a lot.
Good friends – you are through another of our idiosyncratic meetings.
[standing applause]
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Labels: Charlie Munger, Wesco
Monday, May 5, 2008
2008 Berkshire Hathaway Shareholder Meeting: Detailed Notes
Berkshire Hathaway Annual Meeting, Omaha NE 2008
May 3, 2008
Typewritten notes courtesy of Peter Boodell
(As is standard, no recording equipment was used to reproduce these notes. As a result, these notes are recollections only – not quotes, and should not be relied upon. –PB)
A short introductory skit – Susan Lucci from All My Children walks on stage:
CM: Where could he be?
Susan Lucci: Detained at the TV studio. Hi Charlie, I’m Susan Lucci. He’s going to be a big star.
CM: You have some important qualities that Warren lacks.
SL: There are some changes we need to make. We need to change our dividend policy. We are so cheap to our shareholders.
CM: Sounds good to me.
SL: And I want guidance on earnings, weekly. And we need to pay our directors more than $900/yr. [directors stand up and applaud]
[WB walks in]
WB: What’s that talk about dividends? My show is Berkshire Hathaway – All My Children can’t do without you, and I can’t do without Berkshire.
SL: The deal is off?
WB: You’ve brought me back to my senses. Pick out anything you would like at Borsheim’s, and charge it to Charlie.
WB: We are going to follow usual procedure. We are going to answer questions between now and then, based on who gets lined up at microphone first. Our best estimate is 31k people are here to today.
We have Charlie Munger - he can hear and I can see - we work together for that reason. Hold your applause until the end. Howard Buffett, Bill Gates, Don Keogh, Tom Murphy, Walter Scott, Don Olson. The best directors in America.
We’ll take a break at noon.
Q1: Rajesh Vora, Bombay India. I salute your 100% honesty. What key states to correct crowd mindset?
CM: He wants to know how to become less like a lemming.
WB: Since you repeated the question, I’ll let you give first answer.
CM: He wants to invest less like a lemming.
WB: I started investing when I was 11. I believe in reading everything in sight. I wandered for 8 yrs with technical analysis. I read Intelligent Investor, chapters 8 and 20 I recommend, and if you absorb it you won’t be a lemming. I read it early in 1950, and I think as good a book now as then. You can’t get a bad result if you follow it. There is another book out there, Food You Will Enjoy about the Buffett family grocery store. Neither of us were any good at groceries. You don’t want to pay attention to my Grandfather’s advice on stocks. It has three big lessons, a) stock is a part of a business b) market serves you doesn’t instruct, and c) margin of safety. Berkshire holders are better than most at understanding that they own a part of a business.
Q2: George from Cologne Germany. How is operational integration of Cologne Re?
WB: 95% subsidiary of General Re, of which we own 100%. Oldest reinsurance company in world. It does a wonderful job. We have a process in place such that we will soon own 100% of Cologne. It runs fine as it is. They have run own portfolio, but I will take responsibility for Cologne’s investment portfolio. We will consolidate 100% rather than 95%.
Q3: Sam from Fort Lee. Recession, stock market up in April. What next?
WB: I could expand on that question, but I couldn’t answer it. Charlie and I haven’t the faintest idea where it goes next week, next month or next year. We are not in that business. It isn’t our game. We see 1,000s of companies priced every day. We ignore 99% of what we see. Every now and then, we find an attractive price for a business. When we buy it, we would be happy if market was closed for a few years. Wouldn’t get a price quote daily on a farm. We look at expected yield, cost of taxes. If you buy a farm, you would look at cost of fertilizers, what a farm produces relative to purchase price, price per acre, production per acre, etc.. We make judgments.
CM: Nothing to add.
WB: He’s been practicing for weeks.
Q4: Chandra from Seattle. I am bad at hiring good managers. How do you assess capabilities.
WB: You have to understand that we cheat. If you give me 100 mba’s (I am meeting over 30 schools this year), I no more could take the 100 and rank them - it would be impossible. We buy businesses with great management in place. We have seen their record. They come with business. Our job is not to select great managers, our job is to retain them. A majority are wealthy. They don’t have a monetary reason to work in many cases. We have nineteen people at headquarters, and 250k around world. Our job is to make sure they have same enthusiasm. We have to see passion in eyes and believe the passion will remain, but we can create an environment to keep them happy. At these annual meetings, we tell them what a great job they did and make them feel appreciated. We don’t have contracts – it doesn’t work. Our managers are appreciated. I can’t be of help if you are looking at group of MBAs. They know at this point in life how to fool you, what answers to give you. I would look for person with passion for job, doing more than their share, good communicators. At baseball you have to hang up cleats at 40, but our guys go on and on and on. Mrs B worked till 103, then died the next year. That’s a good lesson for our managers. [laughter]
CM: Story of Howard Amundsen, a young man asked him how do you get ahead? He replied, ‘I always keep a few million dollars lying around just in case a good opportunity shows up’.
Q5: Would you use stock options to enter a position in a public co?
WB: If you want to buy or sell a stock, you should buy or sell a stock. We sold puts on Coca-cola once, but usually it is best to just buy stock. Using option technique is an idea where you get to buy a stock cheap. 4 out of 5 times you get it right and one time you may miss the opportunity to buy. We virtually have never used options to enter or exit a position. We have sold long term equity put options described in press report. We don’t get involved in fancy techniques.
CM: If I remember right, a public authority was wondering if they should set up an option exchange market. Warren was alone in the opinion (against it). You wrote a letter saying it wouldn’t do any good to throw out margin rules in this fashion. It doesn’t serve the country. I always thought Warren was totally right. Turning financial markets into gambling markets to enrich the croupiers doesn’t make sense.
WB: A University of Chicago Graduate student asked me once, what are we being taught that is wrong? In business school the amount of time spent teaching option pricing is total nonsense. You only need 2 courses, how to value a business and how to think about stock market fluctuations. The thing is that instructors know the formulas and you don’t, so they have something to fill the time. It has nothing to do with investment success – what matters is buying businesses at the right price. If you were teaching Biblical studies and you could read the Bible forward, backward and in four different languages, you would find it hard to tell everyone that it comes down to the Ten Commandments. The priests want to spend a lot of time preaching. You must have attitude where you aren’t influenced by market. You need a mindset, and you need to have the attitude to divorce yourself from letting the market influence you.
Q6: Germany. You are both generous. Joys of giving, pitfalls of donating money?
WB: I’ve never given up anything that made a difference to me. There are people that drop in the collection plate an amount that makes a difference in their lives. I’ve never given a penny that way. I’ve lived a long time which gives you a huge advantage in accumulating money. I’m giving away excess, not necessity. What I am doing is useful, but it isn’t on a par with people who give real money. Doris gives away money and time which is a real cost – gives help beyond the money. She is retail, I am wholesale. You should give to things that you personally have interest in. I won’t prioritize your giving.
CM: Regarding pitfalls, I would predict that if you have an extreme political ideology, you are very likely to make a lot of dumb charitable gifts.
WB: If you hang around Charlie enough, you get the sunnyside of life.
Q7: Bombay. Ethical dilemma? Fruit of loom have competitors with sweatshops?
WB: We let managers run businesses, and their standards over the years have been extraordinary. I am very happy turning over keys of financial and business performance. I write them a letter every two years, and I ask them to send a letter with successor. I also tell them we have all the money we need. We never want to trade reputation for money. Not only do they behave to conform with the law, but act as if there was going to be a story in local paper in morning written by intelligent investigative reporter. There are no budgets, we have no incentives to cause people to do anything or push people to play games.
CM: We have no rule against foreign plants. We don’t favor foreign plants, we just do what makes sense. The US was doing one billion of shoes per year, 30yrs ago. We tried to compete, great brand and workmanship. We found out it wouldn’t work against shoes produced in china. There are one billion shoes now in USA but all produced outside of US. Some of those factories don’t have same norms. We won’t tell world how to run business. We have standards, but not all same as USA.
Q8: Financial foghorn. Iscar and tungsten. Will it affect profitability of Iscar? Why locating plant in China?
WB: Reason Iscar plant built in China was to serve China, growing. Nice to be near raw material, but geographic plant decision has nothing to do with changes in price of product. If you are creating higher value add like Iscar, there may be 3-6mnth adjustment to raw material prices. But there won’t be substitutes for tungsten as raw material for cutting tools in near term. Raw materials do get passed through. In carpet business, oil based raw materials are having more trouble passing costs. Over time it will pass through. But we’d be having trouble in that anyway. This candy will reflect sugar and cocoa over time. You can have squeezes here and there, not a big deal. Facility in Dalian – I have very high expectations for Iscar, exceeded in every way, both financial and human relations.
CM: I would say that short answer is that while we don’t like inflation because it is bad for country and civilization, we will probably make more money over time because there is inflation.
Q9: Melbourne Auz. Berkshire has bought a lot of shares in last twelve months in listed companies. Do you expect return to be between 7-10% pa over many years? Well below achievements in past.
WB: Yes. We would be very happy if we could buy pretax returns of 10%, dividends included. We would probably settle for a little less than that. Berkshire returns will be less, no question, in future than in past. We operate now in universe of marketable stocks with caps of 10bil, but really 50bil and up in order to have an impact. This universe is not as profitable. If we find 10bil, a 5% position is 500mil. If it doubles, we make 325m, this is less than 2/10ths of 1%. We have found things to do time to time to make money. They are nice, but don’t move needle much at Berkshire. Anyone who expects us to replicate past should sell their stock. We’ll get decent returns, but not indecent returns.
CM: You can take Warren’s promises to bank. We are happy making money at lower rate in future, and we suggest you adopt the same attitude. You may have better things to do with your money than buying Berkshire. You will find things that are more intelligent, if you spend the time. We don’t think it is the most attractive investment in world. We like buying good size to very large with good management. Nice formula, it should work well over time.
Q10: Pacific Corp / Klamath River.
WB: First dam built in 1907. We are prohibited from commenting on this. There are strong disagreements.
David Sokol: It was inappropriate for Mr Buffett to respond. These four dams on Klamath river, there are whole series of issues in the federal regulatory relicensing process. It will be ongoing for eight years. It won’t culminate for another six years. There are twenty eight various parties that are party to a discussion about what should or not happen with these assets. Of these twenty eight parties, there are four different directions that this process should go. We will be pleased to find a resolution. It is up to regulatory commission, state legislators, then each regulator in each state. When public policy moves in direction of removal, fish ladders etc. We are working constructively with each of the parties. We have met with each of the parties, and hope we find an acceptable compromise.
Q11: Dilesh, California. How do you maintain your good mental and physical health?
WB: You start with a balanced diet. [laughter] If Charlie and I can’t have a decent attitude, who can? We get to do what we like every day, and we work with people who love to do what they do. We are not forced to do what we don’t want. I get to do what I like everyday. We are very blessed in so many ways. How could you be sour? Charlie is 84 and I am 77. We have slowed down but we pretend we haven’t. There is no reason to look at minuses in life. It would be crazy. We count our blessings. Not much more to it than that.
CM: I wish we were poster boys for benefits of running marathons with slim bodies, but as much as you can tell we don’t pay attention to health advocates and dietary rules. I for one don’t plan to change.
WB: From moment we get up, till we go to sleep, we are associating with wonderful people. We are biased, we live in best country in world. We could have stayed in grandfather’s store and would have been terrible.
CM: You are in a job you would pay to have, and you are supposed to be an exemplar – there is a lot to be said for not paying yourself very well.
WB: On corporate compensations, the idea that you have to pay someone $10 million dollars in pensions just to keep him around… there’s something wrong in that.
CM: Executives should volunteer to get paid less.
Q12: Germany, high school. What should I do with my life?
WB: We prefer questions that are harder. [laughter]
Q12 cont: what would you do if you started over?
WB: You have to find your passion in life. I would choose same job. I enjoy it. It is a terrible mistake to sleep walk through your life. Unless Shirley Maclain is right you won’t have another one. Dad had a business, with books on his shelves and they turned me on. This was before Playboy. If he was a minister I’m not sure I would have been as enthused. If you have obligations, you have to deal with realities. Go to work for organization you admire or an individual you admire. Which also means most MBAs I meet would be self employed. [laughter] I went to work for Ben Graham. I never asked my salary. Get the right spouse. Charlie talks about the man who spent twenty years looking for a perfect woman and found her. Unfortunately she was looking for perfect man. If you are lucky, you will be happy and as a result you will behave better. It makes it easier.
CM: You’ll do better if you have passion for something in which you have aptitude. If Warren had gone into ballet, no one would have heard of him.
WB: Or would have heard of me very differently.
Q13: What advice would you give to the quieter population to raise their visibility and gain recognition they deserve?
WB: I avoided all classes that had public speaking, I got physically ill if I had to speak. I signed up for Dale Carnegie course. Gave them check for $100, then I went home and stopped payment on check. I was in Omaha, took $100 cash to Wally Kean, I took that Carnegie course, and then I went to University of Omaha to start teaching – knowing I had to get in front of people. Ability to communicate in writing and speaking – it is under taught – and enormously important. If you can communicate well, you have an enormous advantage. Force yourself into situations where you have to develop those abilities. At Dale Carnegie – they made us stand on tables. I may have gone too far. You are doing something very worthwhile if you are helping introverted people get outside of themselves.
CM: It is a pleasure to have an educator come who is doing something simple and important rather than foolish and unimportant.
WB: I hope he won’t name names [laughter].
Q14: Klamath River.
WB: Regulator will deal with issues, when government gets involved in eminent domain there are always tradeoffs. Overall you have people with widely different interests. A big interest is cost of electricity. Every commission who makes decision on coal vs gas makes a tradeoff, and tradeoffs are partly economic cost and partly other issues. FERC will listen to everyone. They have to listen to everyone. We will do exactly what they say. We follow the dictates of regulatory bodies. They give us a fair return. From the standpoint of profitability, it is neutral. Society will make the decision.
Sokol: We distributed a study that found an accumulation of bio-algae and microsystin. There are 27 other lakes in Oregon with that type of blue green algae. It is created from lakes that have high abundance of nutrients. Klamath lake is hyper-eutropic – great abundance of algae and nutrients. 4 reservoirs. FERC does take it into account. Some do not call for removal of dam. All the parties will need to come to agreement.
Q15: Henry Patner, from Singapore. From the partnership letters in 1964, strategy called generals relatively undervalued. We have recently begun to implement a technique, we buy something at 12x, when comps sell at 20x. Comps go to 10x. Is this pair trading?
WB: Yes, didn’t know we started so early. Ben Graham did it in 1920. He did pairs trading. He was right 4 out of 5, but the last one would kill him. We shorted market to some degree, and we would borrow stocks from universities. We were early in this. We wouldn’t short a stock because it was unattractive but as a general market short. ) I would borrow from Treasurer of Columbia, “which ones do you want”, “just give me any of them”. It provoked some odd looks. It was not a big deal, we might have made a little money on it in 1960s, but it is not something we do these days.. If you have good ideas on businesses that are undervalued, it is not necessary to short. 130/30 is being marketed today. Many will sell you the idea of day. No great statistical merit.
CM: We made our money by being long wonderful businesses, not in long short.
Q16: Germany, fixed income markets at discounts. Will you take advantage?
WB: We have seen some important dislocations. I’ve brought some figures. Tax exempt money market funds [auction facilities]. $330b of them. Repricing of first grade muni’s every 7 days. LA County Museum of Art. Jan 24th: 3.1%. Jan 31st: 4.1%. Feb 7th: 8%. Feb 14th: 10%. Fell back down to 3% on Feb 21st. Now 4.2%. Somehow rates were much higher on Valentine’s day. Look at bid sheet of Citigroup. Repricing every 7 days. You would find same issue on several different pages. Same broker at same time on different pages quoting different prices. On one page we bid 11%, and someone else bid 6%. You found this in 1974, after LTCM. These are great times to make extra money. Auctions in esoteric securities. We have $4bil in it. We will have made some insignificant money in this for a few months. There may be opportunities that we can’t spot. If you have enough time you can figure out something that are really mispriced. We don’t play with that, just don’t have enough time. If you spend enough time you may find those that Charlie and I can’t find because we just can’t look at that many things.
CM: What is interesting is how brief these opportunities are. Some idiot bought muni’s, bought 20x what he could afford at incredible margin, those things were dumped on margin calls and suddenly got really mispriced. The dislocation was very brief, but very extreme. The moves are fast and short. You must think fast, resolutely. You have to be like man who stands by a stream and fish comes by once a year.
WB: 2002 junk bond market happened.
CM: Very big dislocations happen about twice a century.
WB: That means we only have 4, 5 times we can do it
Q17: India, how to grow small business into big business?
WB: Berkshire was a small business at one time. It just takes time, it is nature of compound interest. You can’t build it in one day, or one week. Charlie and I never tried to do a master stroke to convert Berkshire into something four times bigger. We have felt and kept doing what we have understood consistently and have fun doing it then it’ll be something quite large at some point. Nothing magical. It would be nice to multiply money in a few weeks. In a general way we have done same things for years. We will have more businesses in a few years, some will do worse, most will do better. It is an automatic formula for getting ahead, but not galloping. We are happy not doing anything at all. As Gypsy Rose Lee said, I have everything I had before, just two inches lower. We want everything in 2 yrs to be higher.
CM: It’s nature of things that most small businesses will never be big businesses. It is the nature of things that most big businesses fall into mediocrity or worse. Most players have to die. We have only made one new business, and that is the reinsurance business – run by Ajit. We only created from scratch one small business into a big one. We’ve only done it once. We are a one trick pony.
WB: Without Ajit we wouldn’t have done it all.
CM: Best investment we ever made was the fee we paid to executive recruiter to find Ajit Jain.
WB: We went into muni-bond business. He got companies up licensed and running. In Q1’08, our premium was $400m. Our volume was bigger than anyone else, and I wouldn’t be surprised if bigger than rest combined. They did 278 transactions. All done in office with 29 or 30 people. One of interesting things about it, almost all the business was from people who needed the insurance. In every case they had insurance already from others, and they are rated AAA, so we paid if muni AND bond insurer didn’t pay. We wrote for 2.25%, original guy charged 1%. This tells you something about AAA in bond insurance in 2008. Ajit has done a remarkable job. We wrote a couple primaries for Detroit sewers, and people have found these bonds trading at better price than other bond insurers. I congratulate Ajit for it.
Q18: If you can’t talk with management, and can’t read annual report, and didn’t know price. But only looked at financial statements, what metric would you look at?
WB: Investing is laying out money now to get more money later on. Let’s leave market price out. Thinking about bushels per acre – you are looking to asset itself. Do I understand enough about business so that financials will be able to tell me meaningful things that will help me to foresee the statements in the future? I have bought stocks on the way you describe. They were in businesses I understood, and if I could buy at 40% of X, I’d be okay with margin of safety. If you don’t tell me nature of business, financial statements won’t tell me much. We’ve bought securities – and most we’ve never met management. We use our general understanding of business and look to specifics from financial statements.
CM: One metric catches people. We prefer businesses that drown in cash. An example of a different business is construction equipment. You work hard all year and there is your profit sitting in the yard. We avoid businesses like that.
WB: Apartments. We could value it if you know where apartment is, and know the monthly checks. I have bought a lot of things off the financials. There is a lot I wouldn’t buy even if best management in world, as it doesn’t make much difference in a bad business.
Q19: Klamath River [again].
WB: Net benefits vs. losses must be weighed. There are lots of competing ideas and desires in a large society. It is up to government to sort it out. People are coming to different conclusions about trade offs, and generally those are at state level. The Oregon Public Utility Commission I am sure is aware of issue. They have to consider best way to generate electricity for citizens of Oregon.
Sokol: We want to clarify that we are not polluting water. We recognize various issues. We have a 50 year FERC license. A societal answer hopefully will be reached.
CM: I note how refreshing it is to find people addressing a pollution problem that has nothing to do with burning carbon.
Q20: Philadelphia, I’m 12 yrs. There are a lot of things they don’t teach you in school, what things should I be looking into?
WB: I’d read a daily newspaper. You want to learn about world around you. Bill Gates quit at letter P in World Book Encyclopedia. Just sop it up, and find what is most interesting to you. More you learn, the more you want to learn. It is fun.
CM: My suggestion is that the young person has already figured out how to succeed in life.
Q21: Germany. Wertheimer. Chocolate industry. I can not buy See’s Candies in Bonn Germany. See’s candies vs. Lindt. Sees’ 20% profit. Growth okay. Lindt does 14%, but now global. Which is better, high profits with low growth, or high growth with lower profits?
WB: It doesn’t make difference. We want a company with durable advantage, which we understand, can trust management, at a good price. We’ve looked at every confectionary business. We can sometimes take action. If you have a good private business, the best thing to do is to keep it. No reason to sell it. You don’t need the billion – it’s just a farm. We never urge people to sell good businesses, and we don’t urge them to sell. They can keep more of the attributes they love by selling to Berkshire. We are a larger buyer. Most people shouldn’t sell us their business. We want them to think of us. We want to be on radar screen. We are going to get more on radar screen in Europe. There is a price we would buy stock in Lindt, but it is unlikely to sell there. Many CEOs want to sell to me, but there are thousands of businesses in the world. We should buy most attractive amongst ones we understand and like. Stocks give you bargains, but individual owners won’t. But we will do it at a fair price. We aren’t going to look for a given confectionary company.
CM: We don’t do anything when phrase regardless of price enters the equation. I watched a man who sold a business to known crook just for a higher price, but who you knew would ruin the business. It’s better to sell companies you created to someone who would be a good steward at a lower price.
Q22: How do you hedge euro?
WB: We are happy to invest in businesses overseas as I don’t think currencies will depreciate in a big way. We could offset, but overall the US will follow policies that will make USD weaker. I’d bet weaker over next 10 years, so feel no need to hedge earnings generated overseas. If I landed from Mars today, with a billion Mars dollars, and was thinking about where to put money… What would I like to exchange? I wouldn’t put 1bil Mars dollars into USD. I don’t mind earnings overseas. We own 200mil shrs of Coca-cola. That is $600m of earnings to us, and $500m from rest of world. I think a net plus over time. We are not in business of hedging currencies.
CM: Nothing to add.
Q23: With small sums of money, what strategies would you pursue?
WB: If I were working with small sums of money, it would open up thousands of possibilities. We found very mispriced bonds. We found them in Korea a few years ago. You made big returns but had to be small size. I wouldn’t be in currencies with small amount of money. I had a friend who used to buy tax liens. I’d look in small stocks or specialized bonds. Wouldn’t you say that Charlie?
CM: Sure.
Q24: St Louis. Huge confusion now, what advice do you have? Three candidates are pandering to voters – some not demonstrating profound understanding of economics. Decrease interest rates? Won’t we have gigantic inflation?
WB: Politics are difficult. Famous line about what would you do if elected? ‘I would demand a recount’. Truth is you get lots of pandering in policies proposed. Candidates are pretty smart about economics. Political process is something that doesn’t lend itself to Douglas Lincoln debates on fine points. I think current candidates will be better in office than on stump. We have a country that works well regardless of who is in office. You want to buy stock in a business that is so good because sooner or later an idiot will run it. I think we have three very good candidates. Motivations of people running it are better than their proclamations. You may win badge for courage but won’t win presidency in Iowa if against ethanol.
CM: When Enron shocked nation, our politicians passed Sarbanes-Oxley. We are currently shooting at an elephant with a peashooter. I confidently predict we will have changes in regulation, and they won’t work for everybody. Human nature always has incentives to rationalize and misbehave. We will have this turmoil as far ahead as you can see.
WB: I would gladly pay to have this job. Let’s assume I was campaigning for this job, and if so, my answers might be different. It is a corrupting process, naturally. There is a boom in oil and also in soybeans. Because of increases in food prices, would anyone expect to propose an excess profits tax on farmers? But what about an excess profits tax on Exxon? Situational ethics and policy making depends a lot on voters. Not sure I’d be able to do better, but if I wanted to be President, not sure my behavior wouldn’t be bad too. Any one of the three candidates will do well in White House. But I think they will do what is best for country.
Q25: Succession. Plan for CFO. Update?
WB: We have three CEOs who could step in. Board will pick someone for CEO. For investment officer, Board has four names. As we’ve discussed, any one or all of four would be good or better than me at this job. Any one of four would be here tomorrow if I died tonight. They are all reasonably young, and all well to do. Compensation is not a major factor. Any of four would come. No reason to come now. I worked for Ben Graham. But in end I wanted to make decisions, I prefer to make my own decisions. It is better in this case. When I’m not around to make decisions – Board will decide how many to use. They will be heavily influenced by incoming CEO by how he wants to work with them. There will be no gap. They could easily have better record than my recent record.
CM: We have a rising young man here named Warren Buffett. I think we want to encourage this rising young man to reach his full potential.
WB: On corporate America aging issue, I think we are doing fine. Our average age is eighty, so we are only aging at 1.25% per year – lowest rate of aging in corporate America. If you have 50 year old management team, they age 2% every year, I think you run bigger risk there.
Q26: New York City. American Express and Washington Post – big positions. How do you get confident enough?
WB: If we were running only our own money, 75% of net worth outside Berkshire has never been a significant amount. Several times I have had 75% of my non-Berkshire net worth in a situation. You will see things where it would be a mistake not to act. You won’t see them often, and the press and your friends won’t be talking about them.
CM: Sometimes I have had more than 100% in individual investments.
WB: You just had a good banker.
WB: Look at LTCM – they put 25x their money in things that had to converge – but couldn’t play out the hand. There are people in this room with more than 90% of their worth in Berkshire. I saw things in 2002 in junk bonds. You could have bought Cap Cities in 1974 – selling for 1/3 the property value, with best manager and in a good business. You could have put 100% in Coca-cola when we bought it and that wouldn’t have been a dangerous position.
CM: Students learn corporate finance at business schools. They are taught that the whole secret is diversification. But the exact rule is the opposite. The ‘know-nothing’ investor should practice diversification. Diversify– but it is crazy if you are an expert. If you only put 20% in the opportunity of a lifetime – you are a not being rational. Very seldom do we get to buy as much of any good idea as we would like to.
Q27: Boys town. I represent Parent’s TV Council. Want to keep toxic violence off television. Berkshire is a bad advertiser?
WB: Geico – we spend $700m on advertising. I don’t regard them as offensive. Please contact Tony Nicely, he is here. I can’t think of another company that advertises as much.
Q28: NJ. 45 yrs old, able to manage money of spouse and myself full time. Goes to marrying well. I wanted to ask diversification question. Each of us has a traditional and Roth IRA. Should assets in those accounts be separated, or managed as a single entity?
WB: Sounds like your marriage will last. Think of it as one unit. Don’t worry about location of assets. Just look at whole picture. Don’t treat in separate pots. I don’t think about what entities things are in. With that I’ll turn it to our marital expert Charlie Munger.
CM: Taxable income may be more suitable for tax deferral. Apart from that, all one pot.
Q29: Doug Hicks, Akron Ohio. Oil will run out this century. Considering US policy is to do nothing until last second, will we face World War III? Will oil companies go to zero?
WB: Oil won’t run out - it doesn’t work this way. At some point the daily productive capacity will level off and then start declining gradually. There is the depletion aspect and the decline curves. We are producing 86m barrels per day or so, more than ever produced. We are closer, by my calculations, to almost our productive capacity, than we have ever been. I think our surplus capacity is less, and quite a bit less, than in past. Whatever that peak is, whether 5 or 10 yrs, the world will adjust, and we will think about it. Adjustments will cause demand to taper off. I don’t know how much oil is there, but there are lots of barrels of oil in place. We never recover total potential. We may have better engineering recovery in future. It is nothing like an on and off switch. You may still have enormous political considerations to get access to avail oil since it so important. There is nothing you can do over short period of time to wean world off oil.
CM: If we get another 200 yrs of growth dispersed over the world while population goes up, all oil coal and uranium will run out so you will have to use the sun. I think there will be some pain in this process. I think it is stupid to use up hydrocarbons of world so quickly. Stupid when there are few and limited alternatives. What should we have done? We should have brought all the oil over from Middle East and put it in our ground. Are we doing it now? No. Government policy is behind in rationality. If we have prosperous civilization, we must use the sun.
WB: Charlie, what is your over/under for oil production in 25 yrs?
CM: Oil in twenty five years, down.
WB: If this is true, that is big number. China is doing 10m cars this year, so down in 25ys is significant.
Q30: Please name three policy decisions to better the country.
WB: Charlie will serve first term, so he’ll answer first.
CM: That takes us so far afield. Three perfect solutions to problems of mankind, we are not up to it.
WB: I would do something about tax system. Super rich pay more, middle class pay a little less.
Q31: Arizona. Food shortages, trends in next decade?
CM: I said last year that policy of turning American corn into motor fuel was one of dumbest ideas in future of the world. I fly here with a head of academics – he agreed, it was stunningly stupid. It is probably on its way out.
Q32: Timothy Ferris, Princeton guest lecturer. Imagine you are investing with small sums of money at 30yrs old, with your first $1mil. Your savings can cover expenses for 18 months. You are not a full time investor, no dependents. What advice do you have, please be as specific as possible.
WB: Put it all in a low cost index fund. Vanguard. Reliable, low cost. Not professional, thus an amateur. Unless bought during strong bull market, that investment would outperform bonds over long period of time and I would forget it and go back to work.
CM: The great horde of professionals taking croupier profits out of system, and most of them pretending to be experts. If you don’t have prospects as a professional investor, do an index fund.
WB: No one will give you that advice since it doesn’t make anyone money. You will get a good return. Why should you expect more than that when you don’t bring anything to the party?
Q33: Austin Texas. For children, can you give them advice about keeping up with the Joneses?
WB: Just keep up with the Buffett’s. [laughter] We’ve always been fans of living within your means and income. You’ll have a lot more income later on. They will follow example of their parents. Parents don’t covet other people’s belongings, don’t increase cost of living which is not necessarily increasing quality of living. If you go too tough on children they go crazy later on. There are plenty of people I don’t advise to save. If you already have money in 401k and Social Security with a little left, who is to say you should give up taking your children to Disney world and the associated happiness now for a 30foot boat later vs. 20foot boat later. There are benefits to spending now. It is not always better to save 10% than 5%, but definitely better than spending 105%. You need to live a life that is true to yourself. We don’t encourage extreme frugality. You are not a better or worse person if you live differently from your neighbor.
CM: Best method is to train your child.
Q34: Idaho. Are investment banks too complicated? Risks unknown.
WB: Exceptionally good question. Answer probably yes in most places, though there are a few CEOs I respect a lot. Gen Re had 23k derivative contracts. I could have spent full time on that, and I probably still couldn’t have gotten my head around it all. And we had exposures that I thought were possible and heads of business units didn’t – I don’t want slim, I want none. I am Chief Risk Officer. If something goes wrong, I can not assign to committee. I think big investment banks and big commercial banks are almost too big to manage effectively in way they have elected to run their business. It will work most of time. You may not see the risk. A 1 in 50 year risk - it won’t be in interest of 62 year old executive who is retiring at 65 to worry about it. I worry about everything. Many CEOs say they didn’t know about what was going on. It’s easier to admit he doesn’t know what’s going on than to admit that he knew what was going on and let it go on. I’ve been asked for advice on regulation. Somehow press hasn’t picked up on this too much. OFHEO supervised Fannie and Freddie – activities had public element, and were semi-regulated. For 200 people it was their sole job to examine the books. They were 2 for 2 with 2 of biggest accounting scams in history of world. Person at top must have it in their DNA to see risks. In many ways, there are firms that in terms of risk are too big to manage. If too big to fail, there are interesting policy implications.
CM: It is crazy to allow things to get too big to fail, run with knavery. As an industry, there is a crazy culture of greed and overreaching and overconfidence trading algorithms. It is demented to allow derivative trading such that clearance risks are embedded in system. Assets are all “good until reached for” on balance sheets. We had $400m of that at general re, “good until reached for”. In drug business you must prove it is good. It is a crazy culture, and to some extent an evil culture. Accounting people really failed us. Accounting standards ought to be dealt with like engineering standards.
WB: Salomon was trading with Marc Rich who had fled country. They said they wanted to keep trading with him. Only by total directive could we stop it. I think Fed did right thing with Bear. They would have failed on Sunday night, and walked to a bankruptcy judge. They had 14.5tril of derivative contracts – not as bad as it sounds, but the parties that had those contracts would have been required to undo the contracts to establish the liability from the estate. The $400m at Gen Re we had took 4-5 yrs, at Bear it would have been 4-5hours. It would have been a spectacle. Two of witnesses said at testimony, ‘we understood we couldn’t borrow unsecured, but we didn’t understand we couldn’t borrow secured’. The world does not have to lend you money. If they don’t want to lend you money, an extra 10bps won’t make a difference. It depends on people’s willingness to lend you money which comes down to how other people feel about you. If you are dependent on borrowed money, you have to wake up every day worried about what world thinks of you.
Q35: San Francisco. Petrochina in 2002, you just read annual report. Most professional investors have more resources at hand, wouldn’t you want to do more research? What do you look for in an annual like that? How could you make investment only on report?
WB: I read it in Spring 2002, and I never asked anyone else their opinion. I thought worth 100bil. It was selling for 35bil. What is sense of talking to management? It doesn’t make any difference. At value of 40bil, you would need to refine analysis. We don’t like things you have to carry out to 3 decimal places. If someone weighed somewhere between 300-350 pounds, I wouldn’t need precision -- I would know they were fat. If you can’t make a decision on Petrochina off the figures, you go on to next one. You weren’t going to learn more if you thought their big field was going to decline out slightly faster, etc.
CM: We have lower due diligence expenses than anyone in America. I know of a place that pays over 200mil to its accountants every year, and I know we are safer because we think like engineers – we want margins of reliability. It is a very dicey process.
WB: If you think auditors know more about an acquisition then they should run the business and you should take up auditing. When we get call on Mars-Wrigley – I’m not going to look at labor or leases. Value of Wrigley does not depend on value of lease or environmental problem. There is a whole lot of trivia that doesn’t mean anything. I never made one that would have been avoided due to conventional due diligence. We would have lost deals. On big deals, people rely more and more on process. When people want a deal, they will come to us. They only wanted to deal with Berkshire - no lawyers involved and no directors involved. Got a call, it made sense, and I said yes. No material adverse change clause. Our $6.5bil will be available regardless, even if Ben Bernanke runs off to South America with Paris Hilton. That assurance is worth something. I’ll do it, but I need x,y,z – that is costly.
Q36: Norman Oklahoma (“we’ll forgive that as Nebraskans”) – Do you believe in Jesus Christ?
WB: I am an agnostic.
CM: I don’t want to talk about my relationships.
WB: Being an agnostic I don’t have to have an opinion.
Q37: What safeguards are in place from breaking up Berkshire?
WB: My stock will be sold over 12 yr period after my death. That takes a lot of time. You wouldn’t be dealing with a company that is much larger than we presently have, and large blocks – if someone wanted to try a 600bil takeover (and might be larger if you go out far enough), it will be hard. It can’t happen at all until I die (a lot of votes concentrated until then). I told my lawyer I wanted a ten year distribution period – to make sure estate lasts quite a while, to which my lawyer said that was like telling his teenage son to have a normal sex life. If we do decent compounding we’ll be largest in USA. Will be difficult to break us up.
CM: Warren doesn’t plan to leave early. “That is the oldest looking corpse I ever saw”.
WB: I am unlikely to change my views on that subject.
Q38: Chicago: economic characteristics of Kraft.
WB: Most of food businesses earn good returns on tangible assets. If you own important branded assets in this country, you have good assets, and it is not easy to take on those products. Just imagine Coca-cola. They sell 1.5bil servings every day. It has been in everyone’s mind since 1886 – associated with good value, happiness and refreshment. It is virtually impossible to take it on in huge way. It may not be same Kraft Koolaid. But I’m not sure I want to take on Koolaid. To implant RC Cola in people’s mind globally is very very difficult. A brand is a promise. Coca-cola delivers something to you. Virgin Cola – an unusual promise in a product. I couldn’t figure it out, and whatever it is it didn’t work. Don Keogh would know. Who would buy a can at 2cents a can less than Coca-cola? We feel pretty good about branded products as leaders in the field. There is nothing unusual about Kraft that’s different from Kellogg, some good factors are price. If you don’t pay too much, you will do okay. But you won’t get superrich, as attributes are well recognized.
Q39: Kevin True – Chicago IL. 4 CIOs. Criteria?
WB: Criteria in 2006 annual report. Records are important. Human qualities are important. We think we can make those judgments. We didn’t know if many would be good, so we made an affirmative judgment on four. We need someone who can see risks, especially ones that haven’t happened before. All the banks have models, but they didn’t have faintest idea. Need someone you trust with analytics, but also ability to contemplate new possibilities and risks. That is a rare quality. That inability to envision something not in models can be fatal. Charlie and I spend a lot of time thinking about things that could hit us out of the blue that other people don’t include in their thinking. We miss a lot of opportunities. But we think essential when managing other people’s money. You should read 2006 annual report again.
CM: You can see how risk averse Berkshire is. We try to behave in a way so that no rational person will worry about our credit. We also try to behave in a way that if people don’t like our credit we wouldn’t notice for months. That double layering of protection against risk is like breathing. The alternative culture is you call a man a Chief Risk Officer, but often he is man who makes you feel good while you do dumb things. Like the Delphic oracle, a dumb soothsayer, and how can he do dumb things if he has a PHD and can do all the advanced math! You crave a system such that you torture reality to fit a structure that doesn’t match with extreme situations in reality, you feel confident because you compute the risks, but you haven’t -- you have just clobbered up your own head.
WB: We run Berkshire so that if world working in different way tomorrow we don’t have a problem. We are not dependent on others. It gives up earning higher returns 99% or 99.5% of the time, but in one year – we wouldn’t feel comfortable running business that way – why be exposed to ruin and disgrace and embarrassment? If we can return a decent return on capital what is an extra point? This can not be farmed out. Management thought they were farming it out at some institutions.
Q40: German. How large is universe of companies whose intrinsic value you know? Why did you invest in Southern Korea or China?
WB: Our immediate decision is whether we can figure it out. We are thought to be rude, when really we are just being polite in not wasting someone’s time. We know very early in conversation whether what someone is talking about it actionable. We don’t worry about stuff we miss. We know there are many things we won’t know enough when we finish thinking about it, so we throw it out. We make a decision in five minutes. We know about a lot of industries, and there are some things we don’t understand. We like to expand universe of knowledge. If we can’t make a decision in five minutes, we can’t learn enough in five months. If we get a call, with business for sale – or I am reading a paper or 10k, we will move right then if big difference between price and value.
CM: We can make a lot of decisions about a lot of things very fast and very easily, and we are unusual in that. Reason is that there are such an enormous amount of things we don’t look at. If you don’t do startups, you blot out a lot of complexity out of your life. What we found out is that there are still a lot of things to look at and available even if we filter out all those things.
WB: There are a lot of giveaways in first sentence or two. We waste a lot of time, but we waste it on things we want to waste it on.
Q41: Carlos Slim?
WB: We had lunch 15yrs ago, with a couple of his boys.
CM: You speak to the total knowledge of both of us about Carlos Slim.
Q42: New York City. Coca cola Beijing Olympics, humanitarian values.
WB: I think Olympics should be allowed to continue forever with everyone participating. It is hard to grade a couple hundred couple countries. It is a terrible mistake to try to start grading, more that participate the better, I would not start getting punitive. I think it’s a terrible mistake to ban countries from Olympics. The United States only started allowing women to vote in 1920s and I consider that a huge violation of human rights, but we wouldn’t (want to) be banned from the Olympics the years prior. I think that overtime they are contributing and getting better.
CM: Warren understates my position. Many are distressed by imperfections in China, so I ask - is china more or less imperfect as decades have gone by ? it is moving in right direction. That is a good thing, and it is not good to pick worst thing about a person you don’t like and obsess about it.
WB: You do better with people you are working with if you nudge him/her a bit.
Q43: Scottsdale AZ. Coal industry? Does cost advantage outweigh environmental?
WB: In short term world will use more coal. There is an environmental disadvantage to it. We will slowly figure out ways to do things coal does now that are environmentally more friendly. But it won’t happen fast. If you shut down coal plants, we wouldn’t be able to hold this meeting. At Mid-American we have put in a lot of wind capacity, probably more than anybody. But we are dependent a LOT on coal, and now it is cleaner than it was. It is worldwide problem, with the Chinese building a lot of coal plants. Per capita Americans have done a lot of negative things to this planet so it is hard for us to preach. It will take a leader who can lead on this.
CM: People who are very against coal, so I ask, which would they rather use up first, coal or hydrocarbons? Coal is less desirable as chemical feedstock to feed the world [into fertilizers]. There is an environmental reason for being pro-coal use. Most people don’t think this way, but I do.
WB: Charlie doesn’t take comfort in numbers.
Q44: Stockton CA. Small regional banks - what would you look at before you buy?
WB: It is hard to make a categorical decision about regional banks. So much depends on character the institution. It will be reflection of CEO you have. A bank can mean anything. It can be an institution that is doing all sorts of crazy things. Bank of commonwealth was an example. We owned a bank in Rockford IL run by Dean Aback – he would always run a super-sound bank. You should know culture of management and institution before making decision to buy a bank. We own Wells Fargo and M&T, but it doesn’t mean they are immune. But likely they are immune from institutional stupidity. There was wise man that said there are more banks than bankers. If you think about that a while you will get my point.
CM: The questioner on to something. So many large banks have cast pall over industry. You are prospecting in a likely territory.
WB: If you took 20 largest and 20 smallest banks in Florida, don’t know you could tell difference.
CM: It is a territory that has some promise.
WB: That is a wildly bullish statement from Charlie.
Q45: Chicago: Iran, Syria?
WB: The great problem of mankind is that the genie is out of bottle on nuclear weapons. More and more will know how to do damage. Psychotics will wish ill will. Materials and deliverability is the choke point. People generally associate this risk with terrorists and rogue states. But I regard as big threat to future of mankind. We haven’t made much progress and we should be doing everything to reduce access to materials. We have a proposal to reduce rationale to have big weapons. World has 6.5bil people, and it is very likely that twice the number of people wish ill than when world had 3bil. We used to just pick up a stone and throw it at our neighbor, so massive damage was limited. Since 1945, it has changed everything in world except how men think. Exponential growth, and we haven’t gotten rid of the nuts. We live in a dangerous world. Getting more dangerous as we go along. In Cuba Missile Crisis it was probably 50/50 odds, we were lucky. It won’t go away. You would hope we have an administration which will try to figure out how to minimize the risk. It should be paramount to eliminate deaths on a large scale.
CM: Well, you can talk about death on a large scale. Population of Mexico probably had a population decline of 95% as result of European pathogens. It won’t wipe out the species. I hope that cheers you up.
WB: The cockroaches will survive.
Q46: Florida. Teach at community college in Florida, teaching students to invest in themselves. Financial independence and freedom. Slow and steady wins the race. Law of reciprocity. What else should I be doing?
WB: I’m ready to hire your entire class right now. Most important investment is in themselves. Potential horsepower is rarely achieved. Just imagine you are 16 – going to give you car of your choice. But only car you would get for rest of your life. How would you choose? Of course you will read manual 5 times. How would you treat it? Keep it garaged. Change oil twice as frequently, keep rust to minimum because you know it’ll last a life time. I tell students that you get only one body and one mind. Better treat it same way. Hard to change habits at age 50 or 60. Anything students do to invest in bodies and mind is good, particularly in the mind. We didn’t work too hard on bodies around here. It pays off in an extraordinary way. Best asset is your own self. You can become the person you want to be. When I get classes in university I ask them to buy one classmate to own for rest of life. They pick the person who not with highest IQ, but who are most effective, the ones you want to be around. These people are easy to work with, generous, on time, not claiming credit, helping others. There are things that turn other people on, and turning other people off. Those are good habits to develop.
CM: I have a specific suggestion that I would add to your extensive repertoire. I would teach them to avoid being manipulated by vendors and lenders. Cialdini has new book – it is called Yes, and I recommend it.
Q47: Chicago. Nine years old. I know you like baseball. My favorite team is Chicago Cubs. Would you like to buy Chicago Cubs from Sam Zell, is it a good investment?
WB: It’s been a good investment. Earnings haven’t gone up so much, though cable expanded the stadium. 40k seats in 1939, cable multiplied seats in a huge way and a lot of it went to players but some stuck to owners. When I was your age, I thought I would buy a team. If Cubs sell for $700m, I don’t think I would buy at that price – there is a psychic income to some owners. It is a way to instant celebrity. A certain percentage of people want the route to that life. Many people have loads of money. I’ve had calls from others on Cubs. I think I will leave that to you.
WB: Charlie is a harder sell. I might do something like that.
CM: You have already done it once.
WB: Touche.
Q48: Americans don’t save. Why, what can we do? Municipalities and Fed don’t save, Asians save 40% of income. Why is it that Americans do not save, what can we do to correct our long term problem?
WB: Savings rate has fallen, may be negative. But value of country in real terms increases decade to decade. It seems worth more than 20 yrs ago – something good has happened. Propensity to save seems innate in some places. I should have thanked Andy Hayward for cartoons in the movie. If you own Berkshire you are saving because we retain earnings and therefore you are net saving – and I have been doing it in Berkshire for 43 yrs. I don’t know that the saving rate – based on calculations on consumption and imports – is accurate. We are importing 700bil more of services than we are exporting. We are exporting claims against America. But we are so rich it may not be really apparent. Average standards are likely to improve, but may be disproportionate. Net real terms the value on per capita will very likely increase decade to decade. But it is nothing compared to China or Korea where savings rate is very high. We may not save very much because we don’t need to. We are a very rich country, and we may not need to save as much as other countries trying to reach their potential.
Q49: Germany. May I ask you your reasons for coming to Germany?
WB: We want more family owners of German businesses. We want more owners who when they think of need to monetize, have Berkshire on their radar screen. We aren’t as prominent in Germany as in US. We are looking for good companies and we want them to know us. We should be better known in a month.
CM: Germany is particularly impressive, an advanced civilization especially in engineering and industrials, with German advancement and inventiveness. It is amazing the impact Germans have had on field after field in America. Look at all the machines in factories with German names.
WB: Sounds like Charlie should go to Germany.
Q50: California. What can we learn from past blow-ups?
WB: All a little different, all have similarities. This one had origins in mortgage field and residential real estate. Trouble in one area has a way to spread to another area. In my lifetime, I can’t remember one where this particular residential real estate bubble sent out the shock wave and exposure of so many other bad practices and weaknesses elsewhere like this one. There isn’t any magic to analysis. There are stupid things that won’t be done soon again, and not the same way again. But variations of it will occur again. Humans are what lead to stupidity and behavior. Primal urges, wanting to believe in tooth fairy that pop up from time to time, sometimes in very big scale. I have no great insights on solutions.
CM: It was a particularly foolish mess. We talked about an idiot in the credit delivery grocery business, Webvan. Internet based delivery service for groceries -- that was smarter than what happened in mortgage business. I wish we had those Webvan people back. I have a rule: The politicians are never so bad you don’t live to want them back.
Q51: How do we better measure leverage and accounting of assets, integrity?
WB: It is a very tough thing. I still lean strongly towards fair value accounting – it is hard to use, but should we use cost? I think there are more troubles when you start openly valuing things at prices that don’t matter instead of best estimates even if inaccurate. I would stick with financials reporting assets at fair value. When you get into CDOsquared, the documentation is enormous. If you read a standard residential security – it consists of thousands of mortgages, then different tranches. Then take CDO and take junior tranches on a whole bunch of juniors – put them together and diversified in theory – a big error to start with. That was nuttiness squared. You had to read 15,000 pages to get a CDO, then 750k pages to evaluate one security in a CDOsquared. To let people use 100cents they paid vs. the 10cents it trades at in market is an abomination. Fair value discipline, mild as it may be, may keep managements from doing some stupid things. I lean toward the market value approach. When you get towards complex instruments, I don’t know how you value it. Charlie, back at Salomon I think you found one mismarked by $20m, right?
CM: A lot goes on in bowels of American industry which is not pretty. A lot of people got overdosed on Ayn Rand. They would hold that even if an axe murderer in a free market is a wise development. I think Alan Greenspan did a good job on average, but he overdosed on Ayn Rand that whatever happens in free market is going to be alright. We should prohibit some things. If we had banned the phrase, “this is a financial innovation which will diversify risk”, we would have been far better off.
Q52: Finance and economics – our constitution.
WB: Do you have a question?
Q52 cont: No.
WB: I sort of suspected that.
Q53: Future of mass transit?
WB: Passenger traffic? [Yes.] The American public generally doesn’t like mass transit. Americans’ love affair with car, which translates into an aversion to mass transit, one person to a car seems to be popular method for moving around. We are unlikely to see expansion in mass transit. American public is genetically averse to mass transit. Seems to be human nature that people want to drive even if they have to pay $4 a gallon on gas and double on parking. I wouldn’t be optimistic about something that has long trend in human nature and that it would reverse all of a sudden.
CM: You have a more optimistic view of it than I have.
Q54: Tom Nelson, North Oaks MN. If you were in charge of country, how would you handle climate crisis.
CM: I’m in awkward position of agreeing with Al Gore, we shouldn’t be burning so many hydrocarbons. But his brain doesn’t work the way mine does, and you’ll have to judge for yourself.
WB: We’ll have a vote later.
Q55: To win, first you must not lose. If corporate default rates escalate, will the credit default swap problem materialize as a threat to financial system? You are great pricer of risk. You must consider selling insurance without pricing appropriately. Is there a chance CDS market may eclipse subprime?
WB: CDS notional is about 60trillion, there are lots of double counting, etc, but no doubt it is a lot of money. They are swaps, or insurance against companies going bankrupt. We have written two types of derivatives, and we have insured a swap that pays to someone else in event of default on high yield indices. I think we will make significant money. I think there is no question that corporate default rate will rise. That has been included in price in writing this insurance. Will CDS market lead to chaos? Probably not, but if bear had failed you would have had chaotic conditions. A CDS is a payment by one party to another. When someone loses money on a loan, they’ve lost real money, but there is not a swap of dollars immediately when loan goes bad. In CDS, there is an exchange of cash. Whether counterparties fail -- I don’t think it will happen. We’ve had enormous collateral payments from one firm to another in this recent crisis. Fairfax Financial made $1bil in CDS. This means another guy lost $1bil. They have been most volatile of instruments – and it really hasn’t created a problem in system. If Fed must step in, I don’t think it will be due to CDS. It may cause big losses, but will be matched by big gains by others. There is a problem of an overnight disruption in the system (bear, nuke bomb) – where discontinuity and collateral postings inadequate. At that time, large CDS exposure could exacerbate chaos to considerable degree.
CM: Could we have mess in CDS? Yes, but stupidity not as bad as sweeping bums off skid row to give them houses. There is an issue of insuring against outcome of losing money on $100mil bond issue, when you have $3bil of contracts on $100m bond issue – there are incentives to manipulate the smaller loss to make big collection on the larger position. It used to be illegal to buy life insurance on people you didn’t know, with big payoffs in event of their death. Why did we want enormous bets to be made in unregulated markets? We have a major nutcase bunch of regulators and proprietors in this field.
WB: Charlie 1 point, Invisible Hand 0 points.
Q56: Why do you not believe in dividends when Benjamin Graham believes in it?
WB: I had to show a little individuality. [laughter] I do believe in dividends, including dividends at companies where we own stock. The test on dividends is can you create more than one dollar of value than the one you retain. It would be mistake for See’s to retain money because they have no ability to use the cash they make to generate high return internally. We hope to move the capital to a place worth $1.20. If we do that, taxable or not, they are better off if we retain money. But when the time comes that we don’t think we can use money effectively, we will pay it out. But because we have ability to redistribute money in tax efficient way within company, we have more reason to retain earnings in company. We like companies where we have investments to pay to us money they can’t use effectively.
CM: Costco paid no dividend when they were growing rapidly. As St Augustine said: “God give me chastity, but not yet.”
Q57: Books to read?
WB: We try to have good selection in bookstore downstairs. I am partial to Larry Cunningham’s book.
CM: California did cause coal plants to be built near Grand Canyon. It caused an uproar. I think those things are about to be decommissioned. I’m glad to put climate back to you.
Q58: Texas. Do you forsee Berkshire buying any businesses in india or china in near future?
WB: We would like to. The odds are somewhat against buying anything outside of USA. Mitek has possibilities outside USA. If we get lucky, we’ll buy one or two in next 3 or 4 yrs. Where it is, who knows. We wouldn’t rule it out. We looked at insurance in India and China, but they restrict ownership in any domestic insurance company. Limit is 25% in China, I think 25% in India. We probably don’t want to go in to own 25%, we want to have more ownership to make it worthwhile. You will see day that Berkshire owns businesses in my view in both countries.
CM: Nothing to add.
Q59: Jim James, MN. Will you share your influences on you, your educators?
WB: Biggest educator was father. It is important who you marry. Those are great teachers. Ben Graham. Dave Dodd. I devour books. Charlie likes Ben Franklin. My grandfather at the family grocery store. Most important job you have is to be the teacher to your children. You are the big great thing to them, you don’t get rewind button, you don’t get to do it twice, teach by what you do not what you say. By the time they get formal school they would have learned more from you than school. Provide warmth and food and everything else. It won’t change when they get to graduate school – and you get no rewind button. You teach with what you do, not what you say.
CM: Differing people learn in differing ways. I was put together to learn by reading. If someone is talking to me – it doesn’t work as well. With a book, I can learn what I want at speed that works. It works for my nature. For those people who are like me, welcome, it is a nice fraternity.
WB: Did you learn more from your father? Your father probably had more impact on you before your readings?
CM: Father did have an impact. He always took more than his share of work and risk – that was helpful. Conceptual stuff – I learned from books. Those authors are fathers in a different sense.
WB: If you keep reading books, you’ll learn a lot. If you read 20 books, you can learn a hell of lot. Having right parents is very lucky. If you get the right spouse, that’s just doubled down.
Q60: Chicago. Thanks for respect for common shareholders. Executive pay - what can we do to get country and issue going right way?
WB: Compensation - you can’t do much. There are relatively few people that could do a lot, by withholding votes. Big shots don’t like being embarrassed. You want a good press. Press needs material. I don’t know how you create incentives for big institutions to do that. A lot of checklists institutions use are asinine. Issue du jour, people recommending how they vote – why can’t they make up their minds. Ben Graham bemoaned investors as a bunch of sheep. Press would do rest. But they won’t respond to you. Small shareholder can write persuasive notes. It takes real effective pressure to change behavior when self interest is in favor.
CM: In England, they got taxes up to 90%, so no possibility of earning large income. That was counterproductive. You can get politics of envy that ruins economics. I think people taking compensation have moral duty not to take it. Moral duty to be underpaid. If generals and archibishops can do it, why can’t leaders of large enterprise take less than the last dollar? That said, it is very difficult to implement.
WB: Envy is the silliest, because you feel worse and they feel fine but maybe they feel better. Rule out envy as part of your repertoire. Gluttony has some upside, with maybe some temporary side effects. Lust – of course I’ll let Charlie speak to that.
Q61: Pharma? (How do you valuate the pipeline of drug companies)
WB: Unlike many businesses, when we invest in pharma We don’t know answer on pipeline and it’ll be different pipeline 5 years from now anyway. We don’t know whether Pfizer or Merck etc have better chance, which of those will come out with a blockbuster. But we do feel we have a group of companies bought at a fair price that overall will do well - should offer chances for decent profits. These companies are doing very important things. I could not tell you potential in the pipeline. A group approach makes sense. Not the way we would go at banks. If you buy pharma at reasonable multiple, you will probably do okay 5 – 10 yrs from now.
CM: You now have a monopoly on our joint knowledge of pharmacology.
WB: He gets cranky at end of day. [laughter]
Q62: Wuxi China. Thank you for observations on Olympics. We came here to see how companies should be run. You did a quick trade on Petrochina. What comes to mind when selling? Any suggestions to these Chinese executives?
WB: I met Dr Gao recently from the China Investment Corp for lunch. I was very impressed with him – we had lunch in Omaha. Petrochina was at $35bil… and analysis was same when I thought value was 275b, and not undervalued. At $200-300 billion we thought it was fairly valued so we sold. It went up significantly afterwards because of A-share listing and at one point became the most valuable company in world by market cap. They’ve done terrific job. If it went to significant discount, we would buy again. I’m not so sure we don’t have a lot to learn from China vs. what we have to teach. China has a remarkable society. I traveled 45min outside of Dalian, and saw hundreds of plants developed in recent years. Chinese are starting to realize their potential. There is lots of ability but the system did not realize potential. I think it will continue to get better. I would look for best practices and I would discard rest. If you look at effective individual – why do people want to be around them? You should copy those qualities… I would look for what I admire and emulated, and try not to let things distasteful be copied.
CM: I hope you will go back to China and tell them that you found one individual that really approves the Confucius’ respect for elderly males.
Q63: Cynthia Beamon, California. What is your fondest hope for Berkshire?
WB: I hope for two things. Decent performance, and that the culture is maintained – we are shareholder and manager oriented. We want to be best home in the world for wonderful family businesses. I fully expect that what we have tried to build into Berkshire will live into future far beyond my tenure as CEO. We have great candidates that succeed me and we have board and managers that have all seen what works. We have a very fine and strong culture. I am sure it will be continued – and that we get good results. I hope in 20 yrs that fine businesses will immediately think that if they have to sell the business they would sell it to Berkshire.
CM: I would like to see Berkshire even more be deserved as an exemplar, and that we have even more influence on changes in other places. Things that have happened here would be useful to other companies.
WB: We also want it to have the oldest living managers. [laughter, applause]
Courtesy of :http://valueinvestingresource.blogspot.com/
, which is out this week. 
