2009 Berkshire Hathaway Annual Meeting (Full Version)

51m read

·Nov 11, 2024

[Applause] Good morning. I'm Warren, the hyperkinetic fellow. Here is Charlie, and uh, we're going to go in just a minute to a, uh, question and answer section—a question session, uh, that will be a little different than last year. We have a panel. I can't see very well here, uh, over to the right of journalists who will ask questions and alternate with the people, uh, in the audience. And we'll go back and forth a little. Checklist here that we'll use as we go back and forth—here we are—and we should have a pen here someplace to check things off.

But first, even though we'll have the formal meeting later on, I would like to introduce our directors, and if they would stand as I announce them and then remain standing until the end. And if you'll just hold your applause until the end or even later if you wish, we'll recognize them. We'll have a meeting later on to elect them, but if you'll stand up—like I say, you can't see very well here with the lights—but there's me and Charlie. We start off, and then Howard Buffett, Susan Decker, Bill Gates, Sandy Gottesman, Charlotte Guyman, Don Keogh, Tom Murphy, Ron Olson, and Walter Scott. Those are the directors of Berkshire Hathaway. [Applause]

Now, we only have one slide which actually is more than we would usually have. And it does tell you something about what happened last year, and it also acts as a commercial for our Nervous Nelly Mattress with the famous Knight Depository feature. Last year, and we got that up on the slide, last year we wrote a ticket on December 19th, and we sold five million of treasury bills. I hope you can see that; we've got the December 19th circled up there. Those treasury bills came due or were to come due on April 29th of this year, so they were going to come due over four months later.

And the remarkable thing is—and this tells you something about what an extraordinary year it was—is that we sold those five million of treasury bills, which we're going to pay off at five million on April 29th of 2009. In December of 2008, we sold them for five thousand five million and ninety dollars and seven cents. In other words, if the person who bought those from us and paid us five million and ninety dollars instead had bought the Nervous Nelly mattress and had put their money under the mattress, they would have been ninety dollars better off at the end of the year—at the end of four months—than by buying treasury bills.

If the U.S. Treasury had just sold five trillion of these, they could have made an easy 90 million dollars, and Tim Geithner could have put the money under a Nervous Nelly mattress, and we all would have been better off. Negative yields on U.S. Treasury bills are really an extraordinary thing: you got less on less for your money from the U.S. Treasury than you got from sticking it under a mattress. I'm not sure you'll see that again in your lifetime, but it's been a very extraordinary year.

We have with us the journalists. We have Carol Loomis of Fortune, we have Becky Quick of CNBC, and we have Andrew Ross Sorkin of the New York Times. They have received questions from shareholders all over the country. Andrew told me that he received a couple hundred just this morning, and they have selected what they think are—all Berkshire Hathaway-related questions.

We were having a problem in recent annual meetings with Berkshire into the realm of what people's children had done in school recently and that sort of thing, and so we wanted to bring it back a little bit to Berkshire. So they have selected among the best of the Berkshire-related questions that they've received.

And we will go from—we will start with Carol Loomis, and we will go then to the audience. We have 13 sections, 12 in this room, one in an overflow room, and we selected the people in each of the audience sections by a raffle system half an hour—of an hour ago—and we'll go back and forth, and with that, we'll start it off with Carol.

Um, good morning. Um, I come first because, uh, Loomis outranks the others alphabetically, but this gives me a chance to just have a few sentences to tell you about the questions that we received. Uh, we conferred this morning. Andrew definitely got more than either Becky or me. We got almost 5,000 questions, which I think even will surprise Warren because I don't think he knew that it'd run that high.

And the main thing I wanted to say is that, um, an awfully lot of them were very good, and we had a real problem, uh, trying to get them down to the number that we're probably going to be able to ask. We don't even know what that is for sure. But we want to apologize to anybody who, uh, sent us a Berkshire-related question because we did have to cut out some because they weren't that, and, um, and whose question we didn't get asked. And maybe in another year, it will work.

So my first question, um, uh, Warren and Charlotte, Warren particularly, you have referred to derivatives, famously as weapons—financial weapons of mass destruction. In the 1964 movie Dr. Strangelove, Major T.G. Kong, nicknamed King Kong and played by Slim Pickens, rides a weapon of mass destruction out of the bomb bay of his B-52. As a long-term Berkshire shareholder, I'm feeling a little like Slim today.

I understand that despite the dramatic decline in the stock market, there is a good probability we could make money on our derivatives, taking into account the return on our premiums. But given the amount of accounting equity and statutory capital—and I would argue market value—that these derivatives have destroyed at least temporarily, do you think these large derivative positions are appropriate for a highly-rated insurance company? And if so, do you think you will be adding to these positions?

Yeah, I would say this: The questioner, to some extent, answers his own question that I don't know whether he anticipates as strongly as I do that net these positions will make money. But over, over, you know, our job is to make money over time at Berkshire Hathaway. It does not impinge on capital. We have arranged them so that the collateral posting requirements, which are one of the big dangers in the derivatives field, that we have very, very minimal exposure to that. Even on March 31st, at a time when the market was down very substantially from when we entered into these transactions, we had posted collateral of a little less than one percent of our total marketable securities.

So they pose no—they pose problems to the world generally, and that's why I referred to them on a macro basis in the 2002 report as being financial weapons of mass destruction. But I also said in that report that we use them in our own business regularly when we think they're mispriced. And we think our shareholders are intelligent enough that if we explain the transactions as we try to do in the annual report and explain why we think we will make money—there's no guarantee we'll make money, but our expectancy is that we will make money.

We think as long as we explain them that the financial consequences to our shareholders far outweigh any accounting consequences. We explained in earlier reports that because of a mark-to-market, that these things can swing billions of dollars as an accounting liability. But for example, in our equity put options, we have received four point nine billion dollars, roughly, and we hold that money; originally the terms of these were 15 to 20 years, so we have the use of four point nine billion for 15 to 20 years. And then markets have to be lower at that time than they were at the time of inception.

So I personally think that the odds are extremely good that on the equity put options we will make money. I think on the high yield index credit default swaps we've written, I think that we will probably lose money before figuring the value of the money we've held. Now, I told you a year ago I thought we would make money on those but we have run into far more bankruptcies in the last year than as normal. We've, in effect, had a financial hurricane. We insure against natural hurricanes and we insure against the financial hurricane, and we have been in a bit of a financial hurricane.

So I would expect those contracts before investment income would show a loss and perhaps after investment income. The bigger contracts are the equity put contracts, and I think the odds are very high that we make money on those. Now, it would be nice if we were writing them at current prices, but we probably couldn't write them without getting into collateral posting requirements now. So we have a very favorable position on those. In fact, in the last week, we modified two equity put contracts, one that had a strike price of 15 14 that has been reduced to 994 on the S&P 500.

Now, we shortened it up eight years but it still has about 10 years to run. So merely for reducing the term of 18 years to about 10 years, we still have the use of the money for 10 years. We reduced the strike price from 1514 to 994. So I think those are going to be very advantageous contracts. I think our shareholders are intelligent enough to, uh, if they're explained properly, to realize how advantageous they are and we can—we'll continue to hold them and we'll continue to explain them. And they have no impact on our financial flexibility.

And we are far more than an insurance company. I mean we have earnings coming in from many areas, we have lots of cash sitting at the parent company, we have lots of cash in the subsidiaries, we have no significant debt maturities of any kind, so we're ideally suited to hold this sort of instrument. Uh, and Charlie, what would you say?

Well, I would agree with the questioner that there is some limit to the amount of those things we should do, but I think we stayed well short of the limit.

Okay, we'll go to zone one. Hi, my name's Scott Slaby, I'm from Denver, Colorado. Um, first off, I'd like to thank Mr. Buffett and Mr. Munger for having us out here today. I appreciate you bringing us out here, so thank you very much and, uh, answer our questions. I'm a former teacher or I'm a teacher—I shouldn't say former—being a former teacher yourself. Um, I see a problem with financial literacy with our future generations, and I'm curious what you think future generations should know, and if there's anything that needs to be in school curriculums to teach younger people financial literacy as we move forward?

Yeah, I think there's a problem with financial literacy with our current generation, but then the I—there's a, uh, Andy Hayward, who has helped us with the, uh, cartoon, has a, will have a—he sold his company last year, but he has a new company, and he will have a program coming out that works on, uh, that question and that I play a very small part in.

ABC has a program coming up with a number of, uh, well-known, uh, personalities in it that will deal with the question of financial literacy, and it, it's, uh, you know, it is a tough, uh, a tough sell in a world of, of credit cards and a world that depends on, on calculators rather than people sitting down and doing actual arithmetic and all of that too, uh, to teach people. But in the end, I think we make progress over time. I mean, I hope our annual reports contribute to that sort of thing, but you're going to have people doing very foolish things with money. I remember on my honeymoon, I was 21 and my wife was 19, and we drove west to Las Vegas in 1952.

And we stopped at the Flamingo, and, uh, people were better dressed in the casinos then and there were a bunch of Omaha fellows that actually owned part of the Flamingo at that time, terribly nice to us. But I looked around at that casino and I saw all kinds of well-dressed people who had traveled thousands of miles to do something very dumb.

And I thought, this is a country where you're going to get very rich if people are going to get on a plane in New York and fly a couple thousand miles to stand there and do things with a mathematical expectation that's negative on every action they take. That is, it's a world of opportunity. So I, uh, you know, I—I recommend that you and, you know, you work with your students. I started teaching at the university of Omaha, you know, when I was 21, and you work with your students to make them literate, and, uh, they will have a terrific advantage.

Charlie?

Well, a world where legalized gambling is now conducted by a great many states in the form of lotteries where people are encouraged to bet against the odds and a world where we have a vast overuse of high-cost credit card debt needs a lot more financial literacy, I would argue. Literacy— I think we've been going in the wrong direction.

So I don't think you can teach people high finance, and can't use a credit card intelligently.

Yeah, if you're—I talk to students about that. If you're willing to pay 18 or 21 on a credit card, and the credit card companies need it incidentally currently because you have losses running close to ten percent, so it's expensive they may need that, but there's no way that you're going to financially come out borrowing money at those kind of rates. And I wouldn't know how to do it.

And, you know, it's too bad. On the other hand, it's probably good for our business. I mean, that one of—you know, we are looking for things that are mispriced. And, and, uh, the more people think that borrowing money on credit cards is intelligent, and they probably will not think that doing equity long-term equity put contracts is intelligent, and we'll go our way and they'll go their way.

Becky, first of all, we've been asked to pass on a message that the attendance today is 35,000.

Good! If they all just spend appropriately, it'll be a big day.

This question comes from James Lewis from Logan, Ohio, who said it was okay to use his name and city. He says one of the substantial investments of Berkshire is Wells Fargo. The chairman of Wells Fargo supposedly indicated that he did not want to take TARP funds from the federal government. He furthermore recently said that some of the programs of the federal government to reinvigorate the banks were asinine. Mr. Munger, do you agree with the chairman of Wells Fargo? And please explain why you do or do not agree? And Mr. Buffett, do you agree with Mr. Munger?

Yes. When a government is reacting to the biggest financial crisis in 70 years, which threatens important values in the whole world, and the decisions are being made hurriedly and under pressure and with good faith, I think it's unreasonable to expect perfect agreement with all of one's own ideas.

I think the government is entitled to be judged more leniently when it's doing the best they can under trouble. Of course, there's going to be some reactions that are foolish, and I happen to share one of the troubles of some of the Wells Fargo executives in that I'm pretty blunt.

I happen to think that the accounting principle that says your earnings go up as your credit is destroyed because if you had any money left, you could buy your own debt back at a discount, I happen to think that's insane accounting, and I think the people who voted it into effect ought to be removed from the board. So a man who talks like that has to have some sympathy with the people at Wells Fargo; he usually gets to hang him by their thumbs, but he held back this morning.

The government in mid-September last year really did—they were facing a situation that was as close to a total meltdown throughout the financial system as I think you can imagine. You had a couple hundred billion dollars move out of money market funds in a couple of days. You had the commercial paper market freeze up, which meant that companies all over the country that had nothing to do with the financial world basically would have trouble meeting payrolls.

We really were looking into the abyss at that time, and a lot of action was taken very promptly, and overall I commend the actions that were taken. So as Charlie says, to expect perfection out of people that are working 20-hour days and are getting hit from all sides by new information, bad information, that one weekend with Lehman going, AIG going, Merrell would have gone, in my view, unless the BFA had bought it.

I mean it was when you're getting punched from all sides and you have to make policy and you have to think about congressional reaction and the American people's reaction, you know you're not going to do everything perfectly, but I think overall they did a very, very good job.

I'm sympathetic. That remark was made by Dick Kobachovich, who came in second last year to Charlie in the Plain Speaking Contest around the world. And it's true that Dick Kobachovich was called on a Sunday at little afternoon as I understand it and told to be in Washington the next day at one or two o'clock without being told what it was about, and there were 11 bankers there and some officials, and they were told that they were going to take TARP money, and they were going to take loans from the government and preferred stock, and that they only had an hour or two to sign it, and they didn't get to consult with boards.

But that's the nature of an emergency. You know, it—I think you will have some decisions that later can be looked back at and somebody will say, “I could have done it a little bit better.” But by and large, the authorities in my view did a very good job, and all banks aren't alike by a long shot, and in our opinion Wells Fargo is—among the large banks particularly—it's a fabulous bank and has some advantages that the other banks don't have.

But in a time like that, you're not dealing in nuances. Incidentally, I would recommend to all of you that you go to the Internet and read Jamie Dimon's letter to his shareholders. Jamie Dimon of JPMorgan Chase—it's a fabulous letter. It talks about a point that Charlie made there, but it—Jamie did a great job of writing about what caused this and what might be done in the future. It's as good a shareholders letter I've ever seen; so by all means look it up. It's long, but it's worth reading.

Okay, we'll go to area two.

Yeah, thank you, Mr. Buffett and Mr. Munger. My name is Rick Franklin. I'm from Saint Louis, Missouri. I'd like to follow up on the microphone one’s question on financial literacy and my own question from two years ago on your discount rate. But before I do that, I hope you'll indulge me. [Transcriber note: unclear audio] If you could come to section 222, I found your husband. You can come to my microphone too if that's easier. You get a little of everything here.

So my question is free cash flow. Sell-side analysts like to do a 10-year discounted cash flow analysis with the terminal value. Even some of the books written about your style, The Warren Buffett Way and Buffetology imply that you go through that exercise. But I know you're famous for not using computers or calculators. I'm wondering if those type of exercises fall into the too hard file and if you basically do a simple free cash flow, normalized free cash flow over a discount rate. And if you care to augment the answer with your numerical analysis of Coke, I’d appreciate that.

[Laughter] Well, the answer is that investing, all investing, is laying out cash now to get more cash back at a later date. Now, the question is how much do you get back? How sure are you of getting it? When do you get it? It goes back to Aesop's fables; you know a bird in the hand is worth two in the bush. Now, that was said by Aesop in 600 BC now, and he was a very smart man. He didn't know it was 600 BC, but I mean he couldn't know everything.

But that's what's being taught in the finance—you get a PhD now and you do it more complicated and you don't say a burden of hands worth two in the bush because you can't really impress the lady with that sort of thing. But the real question is how many birds are in the bush? You know, you're laying out a bird today, a dollar, and then how many birds are in the bush? How sure are you in the bush? How many birds are in other bushes? What's the discount rate?

In other words, if interest rates are 20, you've got to get those two birds faster than if interest rates are 5, and so on. That's what we do. I mean we are looking at putting out cash now to get back more cash later on. You mentioned that I don't use a computer or calculator; if you need to use a computer or calculator to make the calculation, you shouldn't buy it. I mean, it should be so obvious that you don't have to carry it out to the tenths of a percent or hundredths of a percent; it should scream at you.

So if you really need a calculator to figure out that the discount rate is 9.6 instead of 9.8, forget about the whole exercise; just go on to something that shouts at you. And essentially we look at every business that way, but you're right, we do not sit down with spreadsheets and do all that sort of thing. We just see something that obviously is better than anything else around that we understand, and then we act. And, uh, Charlie, you want to add to that?

Well, I'd go further; I'd say some of the worst business decisions I've ever seen are those that have done with a lot of formal projections and discounts. Back when shale oil company did that when they bought the Bellridge oil company. And they had all these engineers make all these elaborate figures. And the trouble with that is you get to believe the figures.

And it seems that the higher mathematics with more false precision should help you, but it doesn't. The effects averaged out are negative when you try and formalize it to the degree you're talking about. They do that in business schools because, well, they’ve got to do something.

There's a lot of truth to that. I mean if you stand up in front of a class and you say a bird in the hand is worth two in the bush, you know, you're not going to get tenure. So it's very important if you're in the priesthood to look at least like you know a whole lot more than the people you're preaching to. And if you come down and just—if you're a priest and you just hand down the Ten Commandments and you say this is it and we'll all go home, you know, it just isn't the way to progress in the world.

So the false precision that goes into saying this is a two standard deviation event or this is a three standard deviation event, and therefore we can afford to take this much risk, and all that—it’s totally crazy. I mean you saw it with Long-Term Capital Management in 1998. You've seen it time and time and time again. And it only happens to people with high IQs. You know those of you who have 120 IQs are all safe, but if you have a very high IQ and you've learned all this stuff, you know you feel you have to use it.

And the markets are not that way. The markets of mid-September last year when people who ran huge institutions were wondering how they were going to get funding the next week, you know, that doesn't appear on a—you can't calculate the standard deviation that that arises at—it’s going to arise much more often than people think in markets that are made by people that get scared and get greedy, and they don't observe the laws of flipping coins in terms of the distribution of results.

And it's a terrible mistake to think that mathematics will take you a long place in investing. You have to understand certain aspects of mathematics, but you don't have to understand higher mathematics, and higher mathematics may actually be dangerous, and it will lead you down pathways better left untrod.

Okay, Andrew?

One of those 200 questions from this morning or whatever. This one's not from this morning, but it relates to Moody's, and we probably received about 300 questions at least on this topic. This question, which is representative of many, comes from Aaron Goldsmizer, and the question is the following: "Given the role of rating agencies in the current economic crisis, their conflict of interest, their reliance on, quote, flawed history-based models, as you describe in this year's letter to shareholders, and the likelihood that a loss of credibility and/or regulatory reforms could force drastic changes in their business models or earnings streams, why do you retain such a large holding in Moody's? And more important, why didn't you use your stake to try to do something to prevent conflicts of interest and reliance on these flawed history-based models?"

Yeah, I don't think the conflict of interest question was the biggest by anywhere close to the major cause of the shortcomings of the rating agencies in foreseeing what would happen with CDOs and CMBSs and all sorts of instruments like that.

Basically, five years ago, virtually everybody in the country had this model in their mind, formal or otherwise, that house prices could not fall significantly. They were wrong. Congress was wrong. Bankers were wrong. People who bought the instruments were wrong. Lenders, the borrowers were wrong. But people thought that if they were going to buy a house next year, they better buy it this year because it was going to be selling for more money the following year.

And people who lent the money said it doesn't make any difference if they're lying on their application or they don't have the income because houses go up. And if we have to foreclose, we won't lose that much money. And besides, they can probably refinance next year and pay. So there was an almost total belief, and there was always a few people to disagree, but there was almost a total belief throughout the country that house prices would certainly not fall significantly and that they would probably keep rising.

And the people that the rating agencies, one way or another, built that into their system. I don't really think it was primarily the payment system that created the problem. I think they just didn't understand the various possibilities of what could happen in a market or in a bubble, really, where people leveraged up enormously on the biggest asset that most Americans possess, their house.

And so you had a 20 trillion dollar asset class in a 50 trillion dollar total assets of American families of 50 trillion that got leveraged up very high, and then once it started melting down, it had self-reinforcing aspects on the downside.

So I said that they made a major mistake in terms of analyzing the instruments, but they made a mistake that a great, great, great many people made. And that probably if they had taken a different view of residential mortgages four or five years ago, they would have been answering to congressional committees who would be saying how can you be so Un-Americanist, deny all these people the right to buy houses simply because you won't rate these securities higher?

So I—they made a huge mistake, but the American people made a huge mistake. Congress made a huge mistake. Congress presided over the two largest mortgage companies and they were their creatures, and they were supervised by them, and they’re both then in conservatorship now. So I don't think they were unique in their inability to spot what was coming.

In terms of us influencing their behavior, I don't think I've ever made a call to Moody's, but it's also true that I haven't made it to—or maybe made one or two to other companies in which we're involved. I mean we don’t tell, you know, the Burlington Northern what safety procedures to put in. We don’t tell American Express who to cut off on credit cards and, you know, who they should lend to and who they shouldn’t.

We are—when we own stock, you know, we are not there to try and change people. Our luck in changing them is very low anyway. In fact, Charlie and I have been on boards of directors where we're the largest shareholders, and we've had very little luck in changing behavior.

So we think that if you buy stock in a company, you know, you better not count on the fact that you're going to change their course of action. And in terms of selling the stock, um, the odds are that the rating agency business is probably still a good business. It is subject to attack, uh, and who knows where that leads and who knows what Congress does about it, but it’s a business with very few people in it.

It's a business that affects a large segment of the economy. I mean the capital markets are huge. I think there will probably be rating agencies in the future, and I think that it's a business that doesn't require capital, so it has the fundamentals of a pretty good business.

It won't be doing the volume in the next probably for a long time in certain areas of the capital markets, but capital markets are going to grow over time. We have said in this meeting in the past many times that Charlie and I don't pay any attention to ratings. I mean we don't believe in outsourcing investment decisions.

So if we buy a bond, the rating is immaterial to us except to the extent that if we think that it's rated more poorly than it should, it may help us buy it at an attractive price, but we do not think that the people at Moody's or Standard Poor's or Fitch or any place else should be telling us the credit rating of a company.

We figure that out for ourselves, and—and sometimes we disagree with the market in a major way, and we made some money that way.

Charlie?

Yeah, I think the rating agencies being good at doing mathematical calculations eagerly sought stupid assumptions that enabled them to do clever mathematics. It's—it’s an example of being too smart for your own good. There's an old saying, "To a man with a hammer, every problem looks pretty much like a nail," and that's what happened in the rating agencies.

The interesting thing about a lot of those AAA's is the people that created them ended up owning a lot of them, so they believed their own bologna themselves. Every—it was—the belief was enormous. So you've had these people stirring up the Kool-Aid, and then they drank it themselves. And they, um, you know, they paid a big penalty for it, but I don't think it was—I think it was stupidity, and the fact that everybody else was doing it.

I sent out a letter to our managers only every couple of years, but the one—[Music]—the one reason you can't give at Berkshire, as far as I'm concerned for any action is that everybody else is doing it. You know, and it just—if that's the best you can come up with, you know, something's wrong.

And so, but that happens in security markets all the time. And of course, it's when Charlie and I were at Solomon or someplace like that, it's very difficult to tell a huge organization that you shouldn't be doing something that the well-regarded competitors are doing, and particularly when there's a lot of money in it.

So it's very hard to stop these things once you get sort of a sort of an industry acceptance of behavior. And, you know, we were very unsuccessful, Charlie and I at Solomon, in saying, "Well, we just don't want to do this sort of thing." We couldn't even get them initially when we got in there at first.

They were doing business with Marc Rich, and we said, "Let's stop doing business with Marc Rich." You know, that's like saying in the '30s, "Let's stop doing business with Al Capone," or something. And they said, "But it's good business. If he doesn't do it with us, he'll do it with somebody else." And they felt that way, and I think we won that one, but it wasn't easy.

Do you remember that, Charlie?

I certainly do.

Okay, we'll go to area three.

Okay, psalm 3, are we on? I'm Laurie Gould from Berkeley, California. Where do you see the residential real estate market headed, nationally, particularly in California, over the next year or two?

Well, we don't know what real estate is going to do. We didn't know what it was going to do a few years ago. We thought it was getting kind of dangerous in certain ways, but it's very, it's very hard to tell.

I would say this from what we're seeing—and I do see a lot of data—there's—and California, incidentally, it's a very big—I mean there are many markets within California. Stockton is going to be different than San Francisco and so on. But in the last few months, you've seen a real pickup in activity, although at much lower prices.

But you've seen, I think you've seen something in the medium to lower price houses, and medium means a different thing in California doesn't Nebraska, but you've seen it maybe 750,000 and under houses, you've seen a real pickup in activity—many more bidders. You haven't seen—you haven't seen a bounce back in price.

Prices are down significantly and vary by the area, but it looks as if you had a foreclosure moratorium for a while, and so you get into distortions because of that. But what it looks like looking at our real estate brokerage data, and we have the largest real estate brokerage firm in Southern California in Orange County, Los Angeles County, San Diego County, and Prudential of California, that's owned by Mid-America.

I—we see something close, I would say, to stability at these much reduced prices in the medium to lower group. If you've got a $5 million house or a $3 million house, uh, that still looks like a very erratic—it's a market in which there still isn't a lot of activity.

But in the lower levels, there's plenty of activity now. Houses are moving. Interest rates, of course, are down. So it's much easier to make the payments. The mortgages being put on the books every day in California are much better than, you know, the mix that you had a few years earlier.

So it's improving, and I don't know what it'll do next month or three months from now. And then the housing situation is pretty much this way—you can look at it this way. We create about 1,300,000 or so households a year. It bounces around some, but it tends to, in a recession, it tends to be fewer because people postpone matrimony and so on to some extent.

But if there's a million 300,000 households created in a year and you create two million housing starts annually, you were going to run into trouble. And that's what we did. We just created more houses than the demand was—the fundamental demand was going to absorb.

So we created an excess of houses. How much excess is there now? Perhaps a million and a half units. We were building 2 million units a year. That's down to 500,000 units a year now. If you create 500,000 units a year and you have a million 300,000 households created, you are going to absorb the excess supply.

It will be very uneven around the country. South Florida is going to be tough for a long, long time. So it isn't like you can move a house from one place to another if there's demand in one place and not another. But we are eating up an excess inventory now and we're probably eating it up at the rate of seven or eight hundred thousand units a year.

And if we have a million and a half excess, that takes a couple of years. There's no getting away from it. You have three choices: You could blow up a million and a half houses, you know, and if they do that, I hope they blow up yours and not mine. But that's it.

We can get rid of it. We could try to create more households. We could have 14-year-olds start getting married and having kids, or we can produce less than the natural demand increase, and that's what we're doing now. And we're going to eat up the inventory, and you can't do it in a day, and you can't do it in a week, but you—but it will get done—and when it gets done, then you will have a stabilization in prices, and then you will create the demand for more housing starts, and then you can go back up to a million and a quarter, and then our installation business and our carpet business and our brick business will all get better.

Exactly when that happens, nobody knows, but it will happen.

Charlie?

Well, I think in a place like Omaha, which never had a really crazy boom in terms of housing prices, with interest rates so low, if you've got good credit, that if I were a young person wanting a house in Omaha, I would buy it tomorrow.

We own the largest real estate brokerage firm in Omaha, so Charlie will be called if he qualifies. We will give him a mortgage application. It is true; there are 4.5 million houses that will change hands. There are about 80 million houses in the country. 25 million of those do not have a mortgage. About a third of the houses in the country do not have a mortgage.

You've got about 55 million or less that have a mortgage, and five or six million of those are in trouble one way or another. But we're selling 4.5 million houses every day, and by and large they're going into stronger hands. The mortgages are more affordable; the down payments are higher. The situation is getting corrected, but it wasn't created in a day or a week or a month.

It's not going to get solved in a day or week or a month. We are on the road to a solution.

Okay, Carol?

Perhaps I should have said one other thing at the beginning. Those of you who read the annual report carefully know that Charlie and Warren were to be given no clue as to what any of the three of us were going to ask. So don't think that they have gotten a little list. They have seen nothing.

This question I got many versions of—this question—this one happens to come from Jonathan Brandt of New York City. It concerns the four investment managers you have said are in the wings as possible successors to you. Can you please tell us, without naming names but preferably in both quantitative and qualitative terms, how each of the four did in 2008 with the money they are managing? They were managing for their clients.

You said you hoped to pick people who would be able to anticipate things that had never occurred before. While the world has seen credit crises before, there were a lot of things that happened in 2008, especially in the last few months of the year, that few were predicting and that you yourself have described as almost unprecedented! How would you rate the way that these managers did in managing against these low probability risks? Are all four still on the list?

Well, the answer is all four are still on the list. And let me just make one point first too because it got misreported a little bit. We have three candidates for the CEO position, and this is always a major subject discussion at our director's meetings. All of them are internal candidates. You should—I should say that that’s been said before, but it got misreported here once or twice and it got confused, I think, because of the four possibilities for the investment job.

And you could have all four come to workforce—in that case, we won't have three CEOs or two CEOs, but we might have multiple investment managers after I'm not around, or we might just have one—that would be up to the board at that time. They are both inside and outside the organization and we don't preclude anything in terms of where they come from.

So we could have a whole big list from outside the organization. That will not be true about the CEO position. The person that follows me will come from within Berkshire Hathaway. The four, I don't have precise figures from them. I’ve got a fair amount of information on someone. I would say they did no better than match the S&P last year, which was minus 37 after adding back dividends.

So I would say that in terms of 2008 by itself, you would not say that they covered themselves with glory, but I didn't cover myself with glory either, so I'm very tolerant of that in 2008. They, uh, Charlie, you know some of the records pretty well, wouldn't you?

That's true. Yeah, what's interesting to me is that practically every investment manager that I know of in America and regard as intelligent and disciplined and with an unusual record of past success, they all got creamed last year—the group.

I don't hear a lot of laughter about that. I think you're hitting a nerve out there, Charlie. They—the four have a better-than-average record over time. If you'd asked me at the start of the year, if you said there’s going to be a minus 37 percent year, will this group do better than average? I would have said yes, but I think I would have been wrong.

And like I said, I didn't—I haven't gotten all the returns from everyone, but I would say I would be wrong. I would say their record over 10 years has been in each case has been anywhere from modestly to significantly better than average, and I'd be willing to bet that would be the case over the next 10 years. But certainly last year, you know, a lot of things—there were a lot of things that didn't work. And our group was not exempt from them.

I have not changed the list. Um, that doesn't mean that we're always looking at it with the idea of finding more people to add to it. And as opposed to the CEO job, you know, if I drop dead tonight, the board needs to put somebody in as a CEO tomorrow morning, and they'll—and they will do so and they know who it is and they feel very good about it—uh, not too good, I hope—but on the investment officers, one or more, and it could easily be more, they don't need to do something the next day or the next week.

I mean the portfolio isn't everything—it doesn't stop because of that. So they can—that can be a somewhat more leisurely decision. They'll have and it will be made in an important way in consultation and agreement with the new CEO, so that is something that you shouldn't expect the next day to hear an announcement on the investment managers, but you should expect us here, you know, within a month or something like that.

I don't think we would want a manager who thought he could just go to cash based on macroeconomic notions and then hop back in when it was no longer advantageous to be in cash, since we can't do that ourselves.

Yeah, we think it's impossible if we can't do it ourselves, yeah, right.

So we're not looking for a typo who went to cash totally. No, that would—in fact, we would leave out anybody that did that. We would exclude them.

Yeah, they're not dumb enough for us.

Okay, let's go to zone four. Hi, Warren, that's a little loud. Sorry. Hi, my name's Sarah, and I'm from Omaha, Nebraska. I'd like to know if you could explain your strategies, namely value investing, in regards to cultivating the next generation of investors. How will you teach this young group?

Well, I had 49, mostly universities, a few colleges that came to Omaha this year. We do them in clumps of six, and then the last one we had an added university, so we had eight sessions, full-day sessions—and they asked me what—sometimes they asked me what I'd do if I was running a business school teaching investments.

I tell them I’d only have two courses. One would be how to value a business, and the second would be how to think about markets. And there wouldn't be anything about modern portfolio theory or beta or efficient markets or anything like that. We'd get rid of that in the first ten minutes.

But if you know how to value a business—and you don't have to know how to value all businesses on the New York Stock Exchange; I don't know—there's four or five thousand probably businesses and a whole lot more on NASDAQ. You don't have to be right on four thousand or five thousand; you don't have to be right on 400; you don't have to be right on 40. You just have to stay within the circle of competence—the things you can understand and look for things that are selling for less than their worth of the ones you can value.

And you can start out with a fairly small circle of competence and learn more about businesses as you go along, but you'll learn that there are a whole bunch of them that simply don't lend themselves to valuations, and you forget about those. And I think accounting helps you in that. You need to understand accounting to know the language of business, but accounting also has enormous limitations, and you have to learn enough to know what accounting is meaningful and when you have to ignore certain aspects of accounting.

You have to understand when competitive advantages are durable and when they're fleeting. I mean, you have to learn the difference between a hula hoop company, you know, and Coca-Cola. But that isn't too hard to do, and then you have to know how to think about market fluctuations and really learn that the market is there to serve you rather than instruct you, and to a great extent, that is not a matter of IQ.

If you have—if you're in the investment business and you have an IQ of 150, sell 30 points to somebody else because you don't need it. I mean, you need to be reasonably intelligent, but you do not need to be a genius at all. In fact, it can hurt.

So, but you do have to have sort of an emotional stability, and you have to have sort of an inner peace about your decisions, uh, because it is a game where you get subjected to minute-by-minute stimuli where people are offering opinions all the time. You have to be able to think for yourself, and I don't know whether— I don't know how much of that's innate and how much can be taught, but if you have that quality, uh, you'll do very well in investing if you spend some time at it learning something about valuing businesses.

It's not a complicated game. As I've said many times, it's simple but not easy. It is not a complicated game. You don't have to understand higher math. You don't—you don't have to understand law. There's all kinds of things that you don't have to be good at. There's all kinds of jobs in this world that are much tougher. But you do have to have sort of an emotional stability that will take you through almost anything, and then you'll make good investment decisions over time.

Charlie?

Yeah, you do have the basic problem that exactly half of the future investors of the world are going to be in the bottom 50 percent. In other words, you're always going to have more scale at the top than you have at the bottom, and you're never going to be able to homogenize the investment exercise expertise of the world.

There is so much that's false and nutty in modern investment practice and in modern investment banking and in modern academia in the business schools, even the economics departments that if you just reduce the nonsense, I think you should reasonably hope for beyond a certain basic level of skill. Wouldn't you say your emotional makeup is more important than the super high degree of skill?

Absolutely. And if you think your talent—if you think your IQ is 160 and it's 150, you're a disaster. You know, much better a guy with 130 that's operating well within himself.

I get to see the students that come by. I love the fellow from the University of Chicago. One of the students said, “The first question that was asked to me is what are we learning that's most wrong?” I mean, that’s the kind of—I wish they'd asked that sort of thing of the panel here; how do you handle that in one session? But it was holy writ 25 years ago, efficient market theory. You know, that I never understood how you could even teach it.

I mean, if you walked in in the first five minutes, you said to the students, “Everything is priced properly.” I mean, how do you kill the rest of the hour? But they did it, and they got PhDs for doing it. Well, you know, and the more Greek symbols they could work into their writings, the more they were revered. It's astounding to me.

And it may have even given me a jaundiced view of academia generally, as the degree to which ideas that are nutty take hold and get propagated. And then I read a quote the other day that may have partially explained it. Max Planck was talking— the famous physicist, Max Planck, was talking about the resistance of the human mind, even the bright human mind, to new ideas and particularly the ones that had been developed carefully over many years and were blessed by others of stature and so on. And he said, “Science advances one funeral at a time.”

And I think there's a lot of truth to that. Certainly been true in the world of finance.

Okay, Andrew?

Okay, uh, we have a succession question, however, this one has a twist. Uh, coming from Ben Noll. You famously said, quote, “You should invest in businesses that a fool can run because someday a fool will.” Given your reinsurance company's capacity and inclination for big financial bets, can you provide us more reassurance about the risk once Ajit is gone? Do you have a succession plan for him?

Ben says the Titanic-like ending at AIG once Greenberg was gone has me spooked.

Yeah, I would say that it would be impossible to replace Ajit, and we wouldn't try, and therefore we wouldn't—we wouldn't give the latitude in terms of size of risk or that sort of thing that we give to Ajit. No, we’ve got a—we've got a unique talent in my view there, and I think in Charlie's. And so when you get somebody like that, you give enormous authority to them after you firmly establish in your mind that that's who you're dealing with.

But that doesn't mean that the authority goes with the position; the authority goes with the individual. And we would not give—your pen away in insurance as they say is extraordinarily dangerous, and we have in this town we have Mutual of Omaha which in the 1980s had been built up carefully over probably 75 years by that time and become the largest health and accident association in the world, I believe.

And they got the idea that they should be writing property casualty reinsurance, so they gave a pen to somebody within the place and probably nobody even heard the guy's name, you know, and then just signing a few contracts, they lost half their net worth in a very short period of time, and they were worried that they might have lost more than that.

So you can do enormous damage in the insurance business with a pen, and you better have to be very careful about who you give your pen to, and we've given our pen to Ajit in a way that we wouldn't give it to anybody else.

Now, it just so happens that I enjoy hearing about the kind of things he does, so we talk daily. But we don't talk daily because he needs my approval on anything; we talk daily because I find it very interesting when he says, “How much should we charge to ensure Mike Tyson's life for a couple of years?” I mean that's the kind of thing I can get kind of interested in.

I asked him whether there was an exclusion in case he got shot by a woman that felt unhappy about her treatment or something, but it makes a difference in the price. But I enjoy that sort of thing, but I'm not needed. And Ajit is needed, and we won't find a substitute for him.

And, you know, there are some things that just have to be faced that way.

Charlie?

Yeah, what that quotation indicates is sometimes stated differently. You say if it won't stand a little mismanagement, it's not much of a business. Of course you prefer a business that will prosper pretty well even if it's not managed very well, but that doesn't mean you don't like even better when you get such a business that's managed magnificently, and both factors are quite important.

We're not looking for mismanagement, but we like the capacity to stand it if we stumble into it. But we're not looking for it, yeah. We will not do things that we think are—we will not assign tasks to people that we think are beyond their capabilities, and it just so happens that the Jeet has enormous capability, so he gets assigned some very unusual things, but you don't see that prevailing throughout our insurance operation.

And our managers don't expect to operate that way—that's a one-off situation with Ajit, and he's in good health, and, you know, we send him all the Cherry Coke or fudge that he wants.

Okay area six.

I recommend this Fiji tonight; it's terrific.

I'm having a good time.

Good morning, I'm Steve Fulton from Louisville, Kentucky. I gave up box tickets to the Kentucky Derby this afternoon to come out and ask you this question. Thank you for this opportunity.

My question relates to how you view or what your view is of the market's valuation of Berkshire shares. You commonly comment that Berkshire has two primary components of value: the investments that they own, the stocks, the bonds, and similar, and the earnings from the non-insurance operating companies that you've got.

And when you compare 2007 to 2008, the investments were down about 13%, and the earnings were down about 4%. But the value that the market was placing on the shares was down about 31%, and I was curious as to your comments on that valuation.

Yeah, well I think you put your finger on something. We do think that the—we think, obviously, the investments are worth what they're carried for or we wouldn't own them. In fact, we think they're worth more money than they're carried for at any given time because we think on balance they're underpriced, so we have no problem with that number.

We define our earning power; we leave out insurance underwriting profit or loss on the theory that insurance is, if it breaks even, will give us float, which we will invest. And on balance, I actually think that insurance probably will produce some underwriting profit, so I think we've even understated a little bit on that in that respect.

But we think the earning power of those businesses was not as good last year as normal. It won't be as good this year as normal, but we think those are pretty good businesses overall. A few of them have got problems, and, uh, but most of them, uh, will do well, and I think a few of them will do sensationally.

So I think it's perfectly reasonable to look at Berkshire as the sum of two parts: a lot of liquid marketable securities or maybe not so liquid, but at least fairly priced or maybe even undervalued securities and a lot of earning power, which we are going to try and increase over time.

And if you look at it that way, you would come to the conclusion that Berkshire was cheaper in relation to its intrinsic value at the end of 2008 than it was at the end of 2007. But you'd also come to the conclusion that was true of most securities. In other words, the whole level of securities and every stock is affected by what every other stock sells for.

I mean if the value of ABC stock goes down, XYZ, absent any other variables, but XYZ is worth less. If you can buy stocks at eight times earnings, good companies, you know, or nine times earnings, you know, it reduces the value of Berkshire, as opposed to when stocks were selling well 18 or 20 times earnings.

I'm pulling those numbers out of the air, but everything is affected by everything else in the financial world. When you say a bird in the hand is worth two in the bush, you're comparing it—you've got to compare that to every other bush that's available.

So you're correct that Berkshire was cheaper in relation to intrinsic value at the end of 2008 than at the end of 2007, at least in my opinion, and that those two variables will count. We'll report them to you regularly, and over time we would hope that both increase, and we particularly hope the operating earnings aspect increases because that's—that's our major focus.

We would like to move money into good operating businesses over time.

And if we do that, it'll be another good day at Berkshire.

Yeah, I would argue that last year was a bad year for a float business. It was naturally going to make the pro owner of the float appear briefly to be at a disadvantage.

But long term, having a large float, which you're getting at a cost of less than zero, is going to be a big advantage. And I wouldn't get too excited about the fact that the stock goes down. I happen to know there was one buyer there who, rather inartistically, bought about 10,000 shares when Berkshire was driven to its absolute peak, and how much significance does that have in the big scheme of things?

Over the long term, what matters are things like this: our casualty insurance business is probably the best big casualty insurance business in the world. Our utility subsidiary—well, if there's a better one, I don't know it. And if I had to bet on one carbide cutting tool business in the world, I'd bet on Iskar against any other comer.

And I could go down the list a long way. I think those things are going to matter greatly over the long term. And if you think that it's easy to get in that kind of a position—the kind of position that Berkshire occupies—you are living in a different world from the one I inhabit.

Okay, we'll go to area two.

Yeah, thank you, Mr. Buffett and Mr. Munger. My name is Rick Franklin. I'm from Saint Louis, Missouri. I'd like to follow up on the microphone one's question on financial literacy and my own question from two years ago on your discount rate. But before I do that, I hope you'll indulge me.

[Transcriber note: unclear audio]. If you could come to section 222, I found your husband. You can come to my microphone too if that's easier. You get a little of everything here.

So my question is free cash flow. Sell-side analysts like to do a 10-year discounted cash flow analysis with the terminal value. Even some of the books written about your style, The Warren Buffett Way and Buffetology, imply that you go through that exercise. But I know you're famous for not using computers or calculators. I'm wondering if those type of exercises fall into the too hard file and if you basically do a simple free cash flow over a discount rate, and if you care to augment the answer with your numerical analysis of Coke, I’d appreciate that.

Okay, Andrew?

One of those 200 questions from this morning or whatever. This one's not from this morning, but it relates to Moody's, and we probably received about 300 questions at least on this topic. This question, which is representative of many, comes from Aaron Goldsmizer, and the question is the following: "Given the role of rating agencies in the current economic crisis, their conflict of interest, their reliance on, quote, flawed history-based models, as you describe in this year's letter to shareholders, and the likelihood that a loss of credibility and/or regulatory reforms could force drastic changes in their business models or earnings streams, why do you retain such a large holding in Moody's? And more importantly, why didn't you use your stake to try to do something to prevent conflicts of interest and reliance on these flawed history-based models?"

So I—they made a huge mistake, but the American people made a huge mistake. Congress made a huge mistake. Congress presided over the two largest mortgage companies, and they were their creatures, and they were supervised by them. And you know, they're both then in conservatorship now. So I don't think they were unique in their inability to spot what was coming.

In terms of us influencing their behavior, I don't think I've ever made a call to Moody's, but it's also true that I haven't made it to—or maybe made one or two to other companies in which we're involved. I mean we don't tell, you know, the Burlington Northern what safety procedures to put in. We don't tell American Express who to cut off on credit cards and who they should lend to and who they shouldn't.

We are, when we own stock, you know, we are not there to try and change people. Our luck in changing them is very low anyway. In fact, Charlie and I have been on boards of directors where we're the largest shareholders, and we've had very little luck in changing behavior.

So we think that if you buy stock in a company, you know, you better not count on the fact that you're going to change their course of action. And in terms of selling the stock, the odds are that the rating agency business is probably still a good business; it is subject to attack, and who knows where that leads, and who knows what Congress does about it, but it's a business with very few people in it.

It's a business that affects a large segment of the economy. I mean, the capital markets are huge. I think there will probably be rating agencies in the future, and I think that it's a business that doesn't require capital, so it has the fundamentals of a pretty good business.

It won't be doing the volume in the next probably for a long time in certain areas of the capital markets, but capital markets are going to grow over time. We have said in this meeting in the past many times that Charlie and I don't pay any attention to ratings. I mean, we don't believe in outsourcing investment decisions.

We figure that out for ourselves, and—and sometimes we disagree with the market in a major way, and we made some money that way.

Charlie?

They were doing business with Mark Rich, and we said, "Let's stop doing business with Mark Rich." You know, that's like saying in the '30s, "Let's stop doing business with Al Capone," or something. And they said, "But it's good business. If he doesn't do it with us, he'll do it with somebody else." And they felt that way, and I think we won that one, but it wasn't easy.

Do you remember that, Charlie?

I certainly do.

Okay, we'll go to area three.

Okay, psalm 3, are we on? I'm Laurie Gould from Berkeley, California. Where do you see the residential real estate market headed, nationally, particularly in California, over the next year or two?

It will be very uneven around the country. South Florida is going to be tough for a long, long time. So it isn't like you can move a house from one place to another if there's demand in one place and not another. But we are eating up an excess inventory now, and we're probably eating it up at the rate of seven or eight hundred thousand units a year.

We can get rid of it. We could try to create more households. We could have 14-year-olds start getting married and having kids, or we can produce less than the natural demand increase, and that's what we're doing now. And we're going to eat up the inventory, and you can't do it in a day or a week, but you—but it will get done—and when it gets done, then you will have a stabilization in prices, and then you will create the demand for more housing starts, and then you can go back up to a million and a quarter, and then our installation business and our carpet business and our brick business will all get better.

Exactly when that happens, nobody knows, but it will happen.

Charlie?

It's not going to get solved in a day or week or month. We are on the road to a solution.

Okay, Carol?

You said you hoped to pick people who would be able to anticipate things that had

2009 Berkshire Hathaway Annual Meeting (Full Version)

More Articles