2005 年股东大会 · 上午场

Welcome

WARREN BUFFETTMorning. I'm Warren, he's Charlie. We work together. We really don't have any choice because he can hear and I can see. (Laughter) I want to first thank a few people. That cartoon was done by Andy Heyward who's done them now for a number of years. Andy writes them. He goes around the country and gets voices dubbed in. It's a labor of love. We don't pay him a dime. He comes up with the ideas every year. He's just a terrific guy. He's unable to be here today because his daughter is having a Bat Mitzvah. But he's a very, very creative fellow. He did something a few years ago called "Liberty's Kids." And if you have a child or a grandchild that wants to learn American history around the time of the Revolution, it's a magnificent series. I think it's maybe as many as 40 or so half-hour segments and it's appeared on public broadcasting. It will be appearing again. You can get it and video form. And, like I say, it's just a wonderful way to — I've watched a number of segments myself. It's a wonderful way to get American history. The only flaw in it is that the part of Ben Franklin is handled by [former CBS News anchor] Walter Cronkite, and Charlie is thinking of suing. A little bit upsetting when Charlie is available. Incidentally, we have "Poor Charlie's Almanack" next door in the exhibition hall. And it's an absolutely terrific book that Peter Kaufman has put together. And I think it's going to be a seller, a huge seller, long after most books have been forgotten. It's Charlie at his best. And Charlie's at his best most of the time, but it's a real gem. I want to thank Kelly Muchemore, who puts all of this together. I don't give it a thought. Kelly takes charge of this. She works with over 200 people from our various companies that come in and help make this a success. She does it flawlessly. As I mentioned in the annual report, Kelly's getting married in October. So this is just a warmup. I mean, we're expecting a much bigger event than this come October.

Where daughter Suze draws the line

WARREN BUFFETTI want to thank my daughter Suze, who does millions of things for me. She puts together that movie. She does draw the line, occasionally. A few years ago — we have a dinner at [Omaha steakhouse] Gorat's the day after the meeting. And we were in having — the whole family was there — having dinner. The place was packed and there was a big line that had formed outside. Be sure not to go to Gorat's unless you have a reservation tomorrow, because they're sold out. But the big line had formed and it started raining cats and dogs. And the waitress came to me. We were eating. Waitress said, "I got to tell you," she said. "It's raining like crazy outside and there's a long line and [Walt Disney CEO] Michael Eisner is standing out there getting soaked." So I turn to Suze — and Michael and Jane [Eisner] are friends of my mine, good friends — and I said to Suze, "Why don't you go out there and help them out before they get drenched." And she looked at me and said, "I waited in line at Disneyland." (Laughter) That seems to strike a responsive chord.

Day's agenda

WARREN BUFFETTWe've flipped things this year. We're going to have the business session at about 3:15. The plan is to have questions and answers. We have 12 microphones here. We have an overflow room that's filled also, so we got another few thousand people there. We'll break at noon and when we break at noon — and anybody that's been in the overflow room that wants to come in here, they'll be, I'm sure, plenty of seats in the afternoon session. We will start the questioning as soon as I get through with a few preliminary remarks. We'll go to noon. We'll take a break, you'll have lunch. Many people find that it helps the digestion to shop while you eat. And we have thoughtfully arranged a few things next door that you can participate in while you eat your lunch. Even if it doesn't help your digestion, it will help my digestion if you shop during that period.

Buffett on what he won't talk about

WARREN BUFFETTDuring the question period, we can talk about anything that's on your mind. Just, there's 2 1/2 subjects that we can't talk about. We can't talk about last year's Nebraska football season. We'll correct that next year. But that's off limits. We can't talk about what we're buying and selling. I wish we were doing more of it, but we're doing a little, and I'll make reference to something on that a little later. And finally, in connection with the investigation into the insurance industry practices that's taking place, there are broad aspects of it we can talk about. I can't talk about anything that I or other people associated with Berkshire have disclosed to the investigators. And there's a very simple reason for that: to protect the integrity of any investigation like this, they do not, the investigators, do not want one witness talking with other witnesses, because people could tailor their stories or do various things. And so, witnesses are not supposed to talk to each other and, of course, if you talk — we don't do that. And then beyond that, if we were to talk in a public forum, that could be a way of signaling people as to what you've said and then they could adapt accordingly. So investigators, one thing they like to do, is they like to work fast if they can because they don't want people collaborating on stories . And they — and to protect the integrity of the investigation, we won't get into anything that's specific to something that I or people associated with Berkshire may have told the authorities. But there may be some broader questions that that we can talk about.

Preliminary Q1 earnings

WARREN BUFFETTI can give you a little preliminary view of the first quarter with certain caveats attached. These figures — our 10-K — or 10-Q — will be filed in the end of next week. And I caution you that, particularly in insurance underwriting, it's been a better quarter than —considerably better quarter — than I would normally anticipate. One of the reasons for that is that our business actually does have some — the insurance business has some — seasonal aspect. Now, it doesn't have a seasonal aspect, particularly, at GEICO or at National Indemnity primary business. But when you get into writing catastrophe business, and we're a big writer of catastrophe business, the third quarter — the biggest risk we write in big cat area is hurricanes. And those are concentrated — they're actually concentrated in the month of September. In this part of the world, 50 percent of the hurricanes, roughly, occur in September and about maybe 17 and-a-half percent in October and August, and the balance, maybe, in November and July. But there's a concentration in the third quarter. So when we write an earthquake — I mean when we write a hurricane policy, for example — we may be required to bring the earnings in monthly on the premiums. But all of the risk really occurs — or a very great percentage of it — late in the third quarter, and we don't have any risk in the first quarter of hurricanes. So we earn some premium during that quarter that really has no loss exposure. And then we get that in spades come September. Even allowing for that we had an unusually good quarter. And I would still stick by the prediction I made in the annual report where I said that if we don't have any really mega catastrophes, I think we've got a decent chance of our float costing us zero or less this year, which means, in effect, we have 45 billion or so of free money. In the first quarter, our insurance underwriting income — and all of these figures are pretax — our insurance underwriting income came to almost $500 million, which was about 200 million better than a year ago. And GEICO had a very good quarter for growth. We added 245,000 policyholders, which is almost 4 percent, in one quarter to our base. We were helped very much by this huge reception we're getting in New Jersey, because we weren't in there a year ago, so we're getting very good-sized gains there. We're not getting 4 percent in a quarter from around the country, but the boost from New Jersey took us up to that. And GEICO actually wrote at a 13 percent underwriting profit in the first quarter, which is considerably better than we expect over the full year. And we've reduced rates some places. And it's been an extraordinary period for auto insurers, generally. But all of our companies in the insurance business did well in the first quarter. Our investment income was up something over 100 million pretax. Our finance business income was up, maybe, $50 million pretax. MidAmerican was about the same. And all of our other businesses, combined, were up about — close to $50 million pretax, led by Johns Manville, had the biggest increase. That businesses is very strong, currently. So if you take all of our businesses before investment gains, which I want to explain, if you take them all before investment gains, our pretax earnings were up 400 million or a little more. Now, investment gains or losses: we don't give a thought as to the timing of those. We take all investment actions based on what we think makes the most economic sense, and whether it results in a gain or a loss for quarter is just totally meaningless to us. A further complicating factor, slightly complicating factor, is that certain unrealized investment gains or losses go through the income statement, whereas others don't. That's just the way the accounting rules are. Our foreign exchange contracts are valued at market, really, every day, but you see it at quarter end. And those foreign exchange contracts, which total about 21 billion now, a little more than 21 billion, had a mark-to-market loss of a little over 300 million in the first quarter. And they bob up and down. I mean, sometimes they bob as much as 200 million or more in a single day. And those mark-to-market quotations run through our profit and loss statement. Whereas if we own some Coca-Cola stock and it goes up or down, that does not run through our income statement. But with foreign exchange contracts, it does. So there's a $310 million mark- to-market — it shows as realized, it actually isn't — investment loss on that. And overall, the investment losses, including that 310, came to about 120. In other words, there was 190 million, or something like that, in other gains. As I say, that means — at least to us — that means nothing. And to underscore that point, if later in the year the Procter and Gamble-Gillette merger takes place, we are required under accounting rules, when we exchange our Gillette for Procter and Gamble stock, we are required under accounting rules to show that as a realized gain. Now that will show up as, probably, four-and-a-fraction billion dollars. We haven't realized any gain at that time, in my view. I mean, we've just swapped our Gillette stock for Procter and Gamble stock, which we expect to hold for a very long time. So it's no different, in our view, than if we'd kept our Gillette stock. But the accounting rules will require that. So if in the third quarter of this year the P&G-Gillette merger goes through, you will see this very large supposed capital gain recorded in our figures at that time. And I want to assure you that it's meaningless and you should ignore that as having any significance, in terms of Berkshire's performance. So, first quarter has gone by. We've got a good start on operating earnings this year. We won't earn at the rate of the first quarter throughout the year, in my view. I think it would be very unlikely, in terms of operating earnings. But the businesses are performing, generally, very well.

Insurance acquisition coming

WARREN BUFFETTOne other thing I should mention, and then we'll get on to the questions, that we can't announce the name, because it isn't quite complete in terms of the other party, but we will probably announce, very soon, an acquisition that is a little less — somewhat less — than a billion dollars, so it's a huge deal, in reference to Berkshire's size But it is in the insurance field. I mean, we love the insurance business. It's been very good to us. We have some terrific managers in that field. You'll see it in the first quarter figures, but you'll also see how we feel about the business by the fact that this acquisition, which I would say is almost certain to go through, will probably get announced in the next few weeks. We're looking for bigger acquisitions. We would love to buy something that cost us 5 or $10 billion. Our check would clear, I assure you. I think we ended the quarter with about 44 billion of cash, not counting the cash in the finance operations. So, at the moment, we've got more money than brains and hope to do something about that.

Q&A begins

WARREN BUFFETTNow we're going to go around the hall here. We've got 12 microphones and — get oriented here — and we'll turn the spotlight on the microphone that is live. People can line up to get their questions asked. I think we've got two microphones, also, in the overflow room. And like I say, after lunch everybody should come in here because there's enough people that get so enthralled with shopping that they don't return. They'd rather shop than listen to me and Charlie, and we'll have plenty of seats for everybody in this main hall after lunch. And so, with that, let's go to — have I forgotten anything, Charlie?

CHARLIE MUNGERNo.

WARREN BUFFETTOK. (Laughter) That may be the last you hear from him. You never can tell.

What Buffett looks for in managers

WARREN BUFFETTWe'll go to microphone number 1, please.

AUDIENCE MEMBERSimon Denison-Smith from London. You talk a lot about the importance of selecting terrific managers. I'd just like to understand what your three most important criteria are for selecting them, and how quickly you can assess that.

WARREN BUFFETTYeah. I'll give you two different answers. The most important factor, subject to this one caveat I'm going to give in a second, is a passion for their business. We are frequently buying businesses from people who we wish to have continue manage than them and where we are, in effect, monetizing a lifetime of work for them. I mean, they've built this business over the years. They're already rich but they may not be rich in the liquid sense. They may have all their money, or a good bit of it, tied up in the business, so they're monetizing it. They may be doing it for estate reasons or tax reasons or family reasons, whatever. But we really want to buy from somebody who doesn't want to sell. And they certainly don't want to leave the business. So we are looking for people that have a passion that extends beyond their paycheck every week or every month for their business. Because if we hand somebody a hundred million or a billion dollars for their business, they have no financial need to work. They have to want to work. And we can't stand there with a whip. We don't have any contracts at Berkshire. They don't work, as far as I'm concerned. So we hope that they love their business and then we do everything possible to avoid extinguishing, or in any way dampening, that love. I tell students that what we're looking for when we hire somebody, beyond this passion, we're looking for intelligence. We're looking for energy. And we're looking for integrity. And we tell them, if they don't have the last, the first two will kill you. Because if you hire somebody without integrity, you really want them to be dumb and lazy, don't you? I mean, the last thing in the world you want is that they are smart energetic. So we look for those qualities. But, we have generally — when we buy businesses, it's clear to us that those businesses are coming with managers with those qualities in them. Then we need to look into their eyes and say, do they love the money or do they love the business? And if they love — there's nothing wrong with liking the money. But if — what it's really all about is that they built this business so they can sell out and cash their chips and go someplace else, we have a problem, because right now we only have 16 people at headquarters and we don't have anybody to go out and run those businesses. So we — it's necessary that they have this passion and then it's necessary that we do nothing to, in effect, dampen that passion. Charlie?

CHARLIE MUNGERYeah. The interesting thing is how well it's worked over a great many decades and how few people copy it. (Laughter and applause)

Buffett on beer industry and its history

WARREN BUFFETTGo to microphone 2, please.

AUDIENCE MEMBERGood morning, Warren and Charlie. My name is Walter Chang and I'm from Houston, Texas. Can you describe how you made your investment decision to invest in Anheuser-Busch and how you estimated its intrinsic value? How long did it take you to make this decision? And is Budweiser inevitable, like Coca-Cola?

WARREN BUFFETTI'm still drinking Coca-Cola. The meeting might get a little exciting if I we were drinking Bud here. (Laughter) We don't get into much in the way of description of things we might be buying or selling, but the decision takes about two seconds. But I bought 100 shares of Anheuser about — I haven't looked it up — but I would say, maybe, 25 years ago when I bought 100 shares of a whole lot of other things . And I do that so I can get the reports promptly and directly. You can get them to your brokerage firm, but I've found that it's a little more reliable to put the stock in a direct name. So I've been reading the reports for at least 25 years and I observe, just generally, consumer habits, and at a point — currently, the beer industry sales are very flat. Wine and spirits have gained in that general category at the expense of beer. So if you look at the industry figures, they're not going anywhere. Miller's has been rejuvenated to some degree. So Anheuser, which has had a string of earnings gains that have been quite substantial over the years and market share gains, is experiencing, as they've described — and they just had a conference call the other day — is experiencing very flat earnings, having to spend more money to maintain share, in some cases, having promotional pricing. So they are going through a period that is certainly less fun for them than was the case a few years ago. And it's a fairly easy-to-understand product and consumer behavior is fairly easy to understand. It's a very, very — exceptionally strong business. In fact, what's happened in the beer industry over the last 50 years has been fascinating to me and to Charlie because this is a brewing town that we grew up in, and Charlie knew the members of the Storz family, a number of them, well. Storz had over 50 percent of the Omaha market in beer post-World War II and then basically disappeared as the national brands took over. So it's an interesting phenomenon. Beer business is not going to grow significantly in the U.S. Worldwide, beer is popular in a great many places, and Anheuser will have a very strong position in it. But I would not expect the earnings to do much for some time, but that's fine with us. Charlie?

CHARLIE MUNGERYeah. At our scale of operation now, if we're ever going to buy into a terribly well-regarded company, we almost need a little patch of unpleasantness. (Laughter)

WARREN BUFFETTThat's been the best time to buy Berkshire, incidentally, too. I mean, we do — What we're looking for is businesses with a durable competitive advantage. I don't think there's any question that Anheuser has a very, very strong consumer position. Now, as I said, Miller has been rejuvenated to some degree. But the other thing about it is, of course, in beer you do not see the prevalence of private labels or generic products that you see in a great many consumer products that are being — that had strong positions over the years, that are being attacked . That's a small plus. But beer consumption per capita is going no place. And there's nothing that will change that. Interestingly enough, the average person in this climate drinks about 64 ounces of liquid a year. And I think it's roughly 27 percent of that will be carbonated soft drinks. So almost — and, of course, of that Coca-Cola will be about — Coca-Cola products — will be 40-odd percent. So, of the 64 ounces of liquid that Americans are drinking every day, you can figure something like 11 ounces of that, man, woman, and child, will be a Coca-Cola product. Beer, as I remember — I could be wrong on this — but I think beer is about 10 percent of all liquids. So, one out of every 10 ounces that's consumed by Americans of any kind of liquid is, I believe, is beer. Coffee, incidentally, despite what you read about — you know, the popularity of Starbucks, which is very real, of course, — but coffee has just gone down and down and down over the last 30 or 40 years. Charlie, you have any thoughts about your consumption habits? That you can talk about? (Laughter)

CHARLIE MUNGERWell, there are people here that may remember Metz beer. In this country, we had more breweries — there were hundreds — and small places would have two or three brands. And this trend toward concentration into a few giants is, I think, permanent.

WARREN BUFFETTYes. Schlitz was number one, as I remember, after World War II, for a while. I think Anheuser was number four at that time. There's an interesting book, if you're a beer enthusiast, it came out a few years — a few months — ago, maybe a little longer than that, by a Wall Street Journal reporter that sort of toured the country sampling beers. I don't know how it affected his writing. But it's a pretty good book, if you like reading about the history of beer.

Competition from hedge funds

WARREN BUFFETTLet's go to number 3.

AUDIENCE MEMBERGreetings from Bonn, Germany. I'm (inaudible). Thank you for another great year added to your track record of investing. And thank you again for allowing us to be partners at these favorable terms. This year, I want to ask you another question about how you see Berkshire positioned versus others. Last year, I asked you how you see the increased competition for buying companies through the rise of the private equity industry and how that affects Berkshire's ability to buy great businesses at fair prices, and you basically said that there are still enough business owners who would rather sell to Berkshire versus a private equity fund. This year, I would like to hear your views on the hedge fund industry. We see hedge funds going into all investment strategies. We know that you have spoken about the fees of the hedge fund industries, but I would like to hear from you how you see Berkshire positioned. Are returns in strategies like merger arbitrage, like convertible bonds — are returns going down because of the increased competition? And are there other factors where Berkshire can be unique versus the hedge funds?

WARREN BUFFETTWell, that's a great question. It's the $64 question. There's no doubt about it that there is far more money looking at deals now than five years ago, and they're willing to pay out more for the good, but mundane, businesses that we've been successful at buying in the past. And you mentioned the private equity firms and they're bigger than ever. The hedge funds have gotten into the game, to some degree. And if someone is auctioning off a business today — this has changed just very slightly in the last four or five weeks because of some change in the junk bond market, but not in any significant degree — there were people lined up to bid on almost anything. In fact, you have private equity firms selling their businesses to other private equity firms. And there are a lot of companies that are being sold, that are being sold to someone who's buying them to resell in a fairly short period of time. We can't compete in that field and that's, you know, that's a source of distress to us. But that's the way it is. We will — it won't go on forever, in our view. We still occasionally, as this deal I mentioned to you, the party on the other side and we just — we made a deal that did not go through an auction process. And we see that occasionally, but we don't see it anything like we saw it four or five years ago. So, in terms of the near-term outlook for Berkshire, in terms of doing what it's important that we do, do successfully, which is buy businesses and keep adding to this collection, we are not positioned favorably at all for that. And we do find it extraordinary, both Charlie and I have over the decades, just how fast things can change. There have been at least three times, maybe more, where it's looked to me in my own career, where it looked like there was so much money sloshing around that it would be impossible to do intelligent things with money. And I actually terminated a partnership back at the end of 1969 because I felt that that the money was coming out, you know, of the woodwork. There were all kinds of people that wanted to use it and compete, and I just didn't feel we could do intelligent things. Within four years, I saw the greatest opportunities that I've ever seen in my lifetime. And we've had several experiences like that. You know, in 1998, when Long-Term Capital Management got in trouble in the fall of 1998 and other things were happening, you had incredible opportunities available in the investment world. Now, people were just as smart then. They had all these people with 150 IQs running around, and they actually had money. But the world became paralyzed for a short period. And you literally had so-called "on- the-run" Governments, which were the most recent issue, and "off-the-run" Governments, which were issued by the same government, the United States government, payable in dollars. You had a 30-basis point differential between the 30-year and the 29-and-a-half year. Both bonds issued by the U.S. government, you know, one a half-year shorter. Both quite liquid, but the "on-the-run" being more liquid. And a 30-basis point differential in yield means about a three-point difference in price. Well, you wouldn't believe that could happen in the United States of America in 1998, but it did happen. And I think I have a slide here. Mark, if it — if we can put that up — that shows what high-yield bonds —the situation in those, just really less than three years ago. In the fall of — yeah, there it is —I n the fall of 19 — in the fall of 2002, you had all these high IQ people in the financial world. You had lots of money. And I don't know how easy it is to read those figures, but you'll see that a bunch of high-yield bonds — this actually is a table that involves a friend of mine, but we were doing pretty much the same thing. And you can see that he was buying bonds at anywhere from a 25 percent to 60 or 70 percent yield basis, and within 12 or 14 months had sold these same bonds on a 6 percent yield basis. You don't need to do that very many times in a lifetime. But that was two-and-a-half years ago after all these people had graduated with MBAs, and studied modern finance theory, and had money coming out of their ears, and all had a desire to make money, and yet conditions like that could exist. We bought about seven billion of junk bonds during that period, because it was a fairly short period. But things do happen that change the landscape dramatically, I mean really dramatically, in financial markets from time to time. But right now, we are positioned very badly in terms of buying businesses, and it's a big negative. And your Berkshire stock will not do as well under these conditions as it would do if the conditions of five years ago or 20 years ago existed. And I don't have any magic solution for that except just to tell you what the facts are. Charlie?

CHARLIE MUNGERYeah. A lot of the buying by private equity funds in both real estate and stocks, and for companies, is fee-motivated. In other words, the investment manager will rationalize any price paid because he likes the extra fees for managing the extra assets. I have a friend that tried to buy warehouses with a lot of family money and he just stopped. Whatever he bid was always topped by some professional manager, managing other people's money on a fee basis. So this is a very peculiar era where all these asset classes have been driven to very high valuations, by all historical standards. Some investment operations are very ethical in this (inaubible). I think Howard Marks is here today. He sent a lot of money back, and stopped soliciting money from his clients in certain activities where the opportunities went away. That's the right way to behave, but it's not normal.

WARREN BUFFETTYeah, I don't think he'll mind — I didn't know Howard was here today — but those actually are Howard's figures for one of his funds. And like I say, we were doing similar things. We didn't know it at the time but we found out we had some similar positions later on. About five or six years ago, when the terms of these deals were somewhat different, I actually had a fellow call me, whose name most of you would recognize, and he started asking me questions about the reinsurance business because he was in — he said he was thinking about buying a given company, which got sold, and he didn't really know much about the business, but that unless he spent these x dollars, he was going to have to give it back to his investors in a few months because the term of the initial sign up period expired at that point, and any unexpended funds were to be returned. And he was going to get 2 percent a year on those funds regardless of how they did. So he was looking at businesses that he didn't understand with the hope that he can place the money. Charlie and I are at a disadvantage in buying businesses because we have almost all of our net worth in the downside as well as the upside. You know, if we had a 2 percent fee and 20 percent of the profits and a goodbye kiss for the losses, you know, that's a different equation than exists at Berkshire. We run it as if it's 100 percent our money, which it is close to 100 percent of our net worth. And we will own the downside. And we don't get paid for spending the money, we get paid for making money. And it's tough — competing right now is tough and likely to be relatively futile, although we have one or two things that could happen that could involve the expenditure of real money.

CHARLIE MUNGERI don't think any of the businesses that have sold to us over the years, which are run by the kind of people we like being associated with, would have wanted to sell to a hedge fund. So there exists a class of assets out there that doesn't want to deal with hedge funds or private equity funds. Thank God. (Laughter)

WARREN BUFFETTYeah, we've seen no deal anybody else has made the last year that we wish we had made. Now that was not the case 15 or 20 years ago when there used to be plenty of deals made with other people that we would have liked to have made if they'd come to us . But I have seen nothing that — I've seen nothing that if it sold for 10 percent less than the advertised price that we would have had any interest in buying. So we are in a different world right now.

Buffett's early interest in stocks

WARREN BUFFETTNumber 4.

AUDIENCE MEMBERI'm Dudley Shorter (PH) from Council Bluffs, Iowa. When you were younger, what first sparked your interest in investing, and what advice would you give a younger person if they wanted to invest in the stock market? Thank you.

WARREN BUFFETTWell, I'm not exactly — I got interested probably when I was, maybe, seven or thereabouts. I wasted my time before that. (Laughter) It's a little like W.C. Fields. When he inherited some money, somebody asked him what he did with it and he said he spent half of it on whiskey and the rest he wasted. (Laughter) So there I was, dawdling around. But I got — my dad [Howard H. Buffett] was in the business, so I would go down to his office, and I would see these interesting books, and I would read them and I would go down — he was on the fourth floor of what's now known as the Omaha Building at 17th and Farnam, and on the second floor was Harris Supplement Company, and they had a board, and I would go down there. The market was open on Saturdays in those days, so I could — for two hours — so I could go down on Saturday, and I saw all these interesting things going across the tape. And I just read a lot. I probably took every book in the Omaha Public Library, every book they had on investing — or the stock market — basically. I was very interested in the New York Stock Exchange. I thought maybe I'd want to become a specialist when I grew up and maybe I still will. But the — I took all the books out. I read them. And finally, when I was 11, I bought three shares of stock and I didn't know — I was fascinated by the subject. My dad got elected to Congress, so now the library became even bigger, and I took all the books I could out of there on markets. And I used a chart and do all that sort of thing. And then, finally, I read [Benjamin] Graham's book when I was at the University of Nebraska, "The Intelligent Investor," when I was 19, and that just changed my whole framework. But the advice I would give is to read everything in sight. And to start very young. It's a huge advantage in almost any field to start young. If that's where your interest lies, and you start young, and you read a lot, you're going to you're going to do well. I mean there are no secrets in this business that only the priesthood knows. I mean, you know, we do not go into temples and look at tablets that are only available to those who have passed earlier tests or anything. It's all out there in black and white. It's a simple business. It's not — it requires qualities of temperament way more than it requires qualities of intellect. I mean, if you've got more than 125 IQ, you can throw away the rest of the points or give them to your other members of the family or do something because you don't need it in investing. But you do need a certain temperament that enables you to think for yourself. And then you have to develop a framework — and I developed it from reading Ben Graham, I didn't come up with it myself — very simple framework. And then you have to look for opportunities that fit within that framework as you go through life, and you can't do something every day. You know, you can learn every day, but you can't act every day. And I talked about reading the annual reports of Anheuser-Busch for 25 years, but I've read the reports of Coca-Cola and Gillette and all kinds of companies long before we invested in them. And if you enjoy the game, you know, you'll find that like playing bridge or playing baseball or whatever, if you don't enjoy it you probably won't do well on it. But I would advise you to start early. Read everything in sight. Look for the successful framework that's been successful for people, and there's nothing like Graham's, in my view, and you'll have a lot of fun and you'll probably make a lot of money. Charlie?

CHARLIE MUNGERWell, I'm at a little disadvantage here. Warren has made himself into kind of a dean of investors, starting as a boy, and he has a greater respect for the process than I do. I have a good bit of [economist John Maynard] Keynes' attitude that money management is sort of a low calling, compared to being a surgeon or a lot of other things.

CEOs should know more about investing

CHARLIE MUNGERI think the corporate types — the corporate managers — ought to study investing better because they'd be better managers. And I think that everyone who thinks through the investment process learns more about how the world really works. And I think that's very worth having. But I do not like as big a percentage of GDP as we now have going to money management and its attendant frictions. And I don't like the percentage of the nation's brainpower that is now in all of these different forms of highly-compensated money management. I don't think it's a good thing for the country, and I hate the fact that we've contributed to it by our own predilections.

WARREN BUFFETTCharlie is only sitting up here next to me as part of his outreach program, actually. (Laughter) Please don't take any pictures that you could blackmail him with, being associated with me. Charlie made a very good point there about how managers would do better if they understood investments. I find it absolutely fascinating, and I've seen this throughout my life, I've seen it close up. I will have friends who are CEOs of companies and they'll have somebody else handle their money. If you say to them, you know, should you buy Coca-Cola or Gillette or something like that, they'll say that's much too tough. I don't understand that sort of thing. What do I know about investing? And then some investment banker walks in the next day with the idea they buy a $3 billion company, which is just buying a lot of shares of stock in one company, and they'll run through some little two-hour presentation and turn it over to a strategic planning group and think that they are then the ones that should make that decision as to whether to buy multibillion-dollar businesses when they really don't feel they're qualified to make $10,000 decisions with their own money. And it's extraordinary what you see in corporate America and the acquisition activity. It's a little like they say about making sausage and making laws, it's better unobserved. Charlie, you have any further thoughts on that? You've seen a lot of it with me. (Laughs)

CHARLIE MUNGERWell, I do think that the present era has no comparable precedent in the past history of capitalism. I think we have a higher percentage of the attention of our intelligent classes into buying little pieces of paper and getting — trying to get rich doing it, and in promotional activities with big profit sharing fees. I can recall no past era which had a similar concentration of this type of activity. Can you, Warren?

WARREN BUFFETTNo, but I think you would say, probably, too, that we've seen sort of baby versions of this, something subsequently happened, that —

CHARLIE MUNGEROh, yes. If you want to talk about what are the future implications, a lot that I see now kind of reminds me of Sodom and Gomorrah, and —

WARREN BUFFETTWe weren't there, incidentally. I mean — (Laughter)

CHARLIE MUNGERNo, but there's a published account. (Laughter) And I think when you get as much sort of regrettable activity going on and sort of feeding on itself in frenzies of envy and imitation, that — it has happened in the past that there came bad consequences.

PetroChina investment

WARREN BUFFETTOn that cheery note, we'll move to number 5.

AUDIENCE MEMBERGood morning. My name is Molly Fanner (PH). I'm 11-years-old and I'm from Long Island, New York. I have two questions today and I have put them in the form of a poem. Mr. Buffett, Mr. Munger, to get here we had to fly. I came to hear your thoughts if PetroChina was at an all-time high. My second regards a job that I know is just right for me. To be a See's Candy taster, my sisters and I would work for free. (Laughter)

WARREN BUFFETTWell, if you come up front, I'll put you to work.

AUDIENCE MEMBERBorsheims was for my mom. And my father loves his stock. I have a future tasting chocolate. This weekend has really rocked. Thank you very much. And really, what is your view on PetroChina? (Laughter)

WARREN BUFFETTIf you come up at the break, Charlie and I will have taken all the pieces out of here that we like best, and you will get the rest. (Laughter) Charlie, do you have anything to add to that?

CHARLIE MUNGERShe wants to know what you think about PetroChina. (Laughter)

WARREN BUFFETTIt's funny. I saw her out there in the shopping area and I knew that she had PetroChina on her mind. (Laughter) We bought PetroChina a few years ago, again, after reading the annual report. And fortunately it was in English. It was the first stock — Chinese stock — and really the last. I mean, it won't necessarily be the last, but it's the only one that we've owned so far. We put about $400 million into it. At the time, and still, it produces about 3 percent of the world's oil, which is a lot of oil. It produces, probably, 80 percent or so as much as Exxon Mobil will produce. And it's a huge company. Last year it earned $12 billion. Now, if you look at the Fortune 500 list, my guess is you won't find more than about five companies in the United States that earn $12 billion or more. So it's a major company. At the time we bought it, the total market value was 35 billion. So we bought it at about three times what it earned last year. It does not have unusual amounts of leverage. It — in the annual report, they say something which very, very few companies do say, but which I think is actually fairly important. They say they will pay out about 45 percent of the amount they earn. So, if you can buy it at three-times earnings, what turned out to be three times earnings, and you get 45 percent of 33 percent, you know, you're getting a 15 percent yield on your — cash yield — on your investment. It's a very good annual report. Chinese government owns 90 percent of the company. We own 1.3 percent. If we vote with them, the two of us control the business. (Laughter) It's a thought that hasn't occurred to them, but I'll keep pointing it out. (Laughter) But it's, you know, it's a very major business and a very, very attractive — at what was a very attractive price. Unfortunately, the government shares and our shares have the same economic interest but they are classified differently, so that the government's 90 percent are called one thing and the 10 percent with the public are called A-shares. And we have to report in Hong Kong when we own 10 percent of a company — or we did then — 10 percent of a company shares, so unfortunately the 10 percent applied only to the 10 percent of A-shares and so we had to reveal our ownership when we only had 1 percent of the economic interest in the company. So, we would have bought more but the price jumped up, and we are happy to have our 1.3 percent or whatever it is, and we think that they've done a good job in running the business. They've got large gas reserves, which they're starting to develop now. But it's a very major enterprise. Employs almost 500,000 people. And the interesting thing was, a few years ago relatively few people in the investment world probably even thought about the fact that PetroChina was over there and was a much larger business than most of the — well, just about any oil company in the world, except for BP and Exxon Mobil. Charlie, do you have thoughts?

CHARLIE MUNGERYeah. It would be nice if this sort of thing happened all the time, but that hasn't been true in recent years.

WARREN BUFFETTBut we never — I should emphasize — I mean, the annual report of PetroChina, which, like I say, it's easy to read. Understandable. They declare their policies. Anybody could get it. You can read it. We did not — we did not go over and — we never had any contact with the management before we bought the stock. We'd never attended an investor presentation or anything of the sort. I mean, it's right there in black and white, in a report that anybody can get. And we just sit in the office and read those things, and we were able to put 400 million out that's now worth about a billion-two or something like that. It was interesting. At the time — I think I'm right on this — at the time, Yukos, which is the big oil company in Russia, was probably far better known among the investment community in the United States than PetroChina. And I compared the two. At the time, thought to myself, would I rather have the money in Russia or in China? PetroChina, in my view, was far cheaper. And I felt that the economic climate was likely to be better in China, you know. Would I have — if it had been selling at the same multiple as a U.S. domestic company, would I have regarded it as more attractive? No. I mean, there's some disadvantages, always, to being in a culture that you don't perfectly understand, or where tax laws can change, your ownership rules can change. But the discount at which PetroChina was selling, compared to other international oil companies, was, in my view at the time, ridiculous. So, that's why we bought it. And we will have the candy available for you at the break.

Profit margins squeezed by rising commodity prices

WARREN BUFFETTNumber 6.

AUDIENCE MEMBERGood morning, gentlemen. My name is Matt Sauer (PH) and I'm from Durham, North Carolina. Many businesses are reporting rising costs and surcharges on such inputs as fuel, metals, and wood. They are often unable to pass along these costs to their consumers. If commodities stabilize at price levels above those of the past decade, will corporate margins be compromised into the future?

WARREN BUFFETTWell, it's a great question. I would say that that would depend very much on the industry you're talking about. But, in our carpet business [Shaw Industries], for example, we've just been hit time after time, as I mentioned in the annual report, with raw material increases, because there's a big petroleum derivative factor there. And we have lagged in terms of being able to put through those increases to our customers, simply because we want to protect the Nebraska Furniture Marts, or those that have ordered, for a reasonable period of time. And that squeezed margins in carpet. We use lots of natural gas at Johns Manville, use lots of natural gas at Acme Brick, and that's tended to squeeze margins some. I think, over time — I think there has been a lot more inflation in these basic materials. Steel has been off the chart. I think, over time the businesses with strong competitive positions manage to pass through increases in raw material costs, just as they passed through increases in labor costs. But you get these temporary situations where, sometimes, the costs are increasing faster. I don't think — I don't think the American industry — I mean, a higher cost for oil, when we import 10 million barrels a day or more of oil, if we're paying $20-or-so more per barrel than we were a year or two ago, that's $200 million a day, is a tax, but it's more of a tax on the American consumer, probably, than on American business. The American business will probably be able to pass through most of those raw material cost increases. It is worth pointing out that corporate profits, as a percentage of GDP, are right at the all-time high, leaving out a few aberrational periods. And I would — you know, if I had to bet on the direction of corporate profits, as a percentage of GDP, over the next five years, I would bet they would go down somewhat. But that's because they're right at this very high level. Interestingly enough, while corporate profits, as a percentage of GDP, are at this very high level, corporate taxes, as a percentage of total taxes raised in America, are very close to an all-time low. So, American businesses managed to pull off a situation where they're making extremely good profits and paying a very small percentage of the total tax bill, as measured in this country historically. And I'm not sure whether that could, or should, or will continue, but it's a very, very favorable period right now for corporate America. But that's nothing to get bullish about, because you might expect something of a reversion to the mean. Charlie?

CHARLIE MUNGERWell, I can't add to that but I can restate it. It's hard to know just which companies can pass through the increases in costs that come from higher commodity prices. And it's also important to know.

WARREN BUFFETTWe like buying businesses where we feel that there's some untapped pricing power. We haven't been able to do much of that lately. But back in 1972, when we bought See's Candy, I think it was either — was it $1.95 a pound?

CHARLIE MUNGERSomething like that.

WARREN BUFFETTYeah. And they were selling 16 million pounds of candy a year, making four million pretax, with about 25 million purchase price, which I would have very foolishly refused to budge on, and in history have cost us a lot of money. But one of the questions we asked ourselves, and we thought the answer was obvious, was, you know, if we raised the price 10 cents a pound, would sales fall off a cliff? And of course, the answer, in our view at least, was that no, there was some untapped pricing power in the product. And it's not a great business when you have to have a prayer session before you raise your prices a penny. I mean, you were in a tough business then. And I would say you can almost measure the strength of a business over time by the agony they go through in determining whether a price increase can be sustained. And frankly, a good example of that is the newspaper business right now. Because 30 years ago, when the — whatever the local daily would be had an absolute lock on the economics of the community, because it had the megaphone through which merchants had to talk if they were going to get their message across to their audience — at that time, rate increases, both circulation and advertising, were something that were almost a big yawn to most publishers. They did it annually. They did not worry about the fact that Sears or Walmart or Penney's or whomever would pull their advertising. They did not worry that people would drop their subscriptions to the paper. And they went merrily along, increasing prices, and they increased them when newsprint went up and they increased them when newsprint went down, and it worked. And you got these very fat profit margins. And it looked like about as strong a business as you can imagine. Now publishers find themselves in a position where they agonize over rate increases, both in advertising and in circulation, because they're worried about driving away advertisers into other media. And they're worried about people, when they get a 20 cent increase, you know, per month, or whatever it may be, in their circulation prices, deciding, well, I think I'll just drop it. And when they drop it they don't usually take it up again. So, that world has changed. And you could recognize the change in that world, simply, if you could get inside the mind of the publisher, in terms of how they felt about price increases. You can learn a lot about — you learn a lot about the durability of the economics of a business by observing the behavior of — the price behavior. I mean, you're seeing that — talk about the beer business. Beer has moved up in price every year, but there have been some rollbacks in certain areas in the last year, which means that, you know, it's getting a little bit more difficult to increase prices, even though they increase them at rates below inflation. And those are not — that's not a good economic sign. Charlie?

CHARLIE MUNGERI have nothing to add to that.

Tax rate not a factor in Berkshire dividend calculus

WARREN BUFFETTOK, we'll go to number 7.

AUDIENCE MEMBERMy name is Pete Banner (PH) from Boulder, Colorado. First of all, Mr. Buffett, Mr. Munger, we shareholders consider you our heroes. We appreciate and very much value who you are and what you do in the world. So, thank you.

WARREN BUFFETTWell, thank you, Pete. And I will say in return that we think we've got the best group of shareholders in the world. And to some extent, it's evidenced by the fact we have the lowest turnover, and, I think, the most knowledgeable group, incidentally, too, of shareholders. So, with that our mutual love affair can go on. (Laughter)

AUDIENCE MEMBERThank you very much. Secondly, with taxes as they are today, 15 percent on dividends, how do you feel about declaring a dividend?

WARREN BUFFETTOh, you were setting me up. (Laughter) No, there's no question about the fact that dividends are lightly treated now for taxation purposes. But we have always said, and it's been true, that if there were no tax on dividends, to this point at least, we would have followed an identical dividend policy, because the test with us is whether we think we can retain a dollar, and in turn — and have it worth, in present value terms, more than a dollar. If we can't do that, we should distribute any money that we can't — we can't utilize on that basis. Now, when the cash piles up, like currently — it has currently — you can say it's pretty dumb to hold, you know, billions of dollars at — last year the rates were less than 1 percent after-tax — and, you know, what are you doing for shareholders with that? And I would say that the burden of proof will certainly shift if, within a few years, we can't use a lot more money intelligently than we are now. But, if we were — at the time at which we feel that the present value of the earnings we retain is not greater than a dollar comes, and it could come, and it's more likely to come when you get large like we are, then we should have a — not only a, you know, dividend policy that's X percent of earnings, we should pay out very substantial sums. The test is whether the money can be used effectively within the business. So far, it has been. That doesn’t mean it was yesterday or the day before, but so far, it's produced more than a dollar's worth of market value for every dollar retained. But that will be discussed — our directors meet Monday — that will be discussed then, and you are certainly — if we sit here a couple of years from now and we have not successfully deployed more cash, then I think that the burden of proof has shifted dramatically to us to explain why we would be retaining earnings at that point. Charlie?

CHARLIE MUNGERI've got nothing to add to that, too.

U.S. trade deficit's economic threat

WARREN BUFFETTNumber 8?

AUDIENCE MEMBERMy name is Ola Larson (PH), from Salt Lake City, originally from Sweden. I read your annual report where you mentioned how the current account deficit, or a trade deficit, has to eventually come to an end. And in the report, you were reluctant to give views, a forecast of how this would come down from $2 billion a day. Would you, nevertheless, be willing to share some thought on what — how it might come down, if you have any views on this?

WARREN BUFFETTWell, that really is the $64 question, because, we are, in my view — and Charlie doesn't — he's not as on board on this as I am, so it's important that you listen to him on this, too. The — it does seem to me that a $618 billion trade deficit and a larger current account deficit, rich as we are, strong as this country is, that something will happen that will change that in a major way at some point, and that the longer that it goes before changing, the more likely it is that something fairly significant happens. But most economists — most observers — would still say that some kind of a soft landing is possible. Or they would say it's likely. They never, to my mind, they never quite explain, you know, what the soft landing is. They just say it's, you know, it's likely to be a soft landing but it could be something different but we still think it will be a soft landing. But I don't know what a soft landing is, exactly, in the sense of how the numbers come down quite significantly, and if they don't come down, the current account surplus — or deficit — means that we are transferring more and more wealth abroad and that we will, in addition to our trade deficit, we will, at some point, have a very significant deficit in terms of the net investment position that the rest of the world holds on us. So it becomes a compounding effect. I do recommend — there was an op-ed piece in The Washington Post on April 10 by [former Federal Reserve Chairman] Paul Volcker, and he has expressed himself some on this, and he gets into the question of whether it can be a soft landing or not. But I think he certainly expresses some real apprehension about whether a soft landing will be the likely result. In the kind of world we live in, with so much of the assets of the world, whether they be foreign exchange or whether contracts or whether they be stocks or bonds or junk bonds or whatever, I think as high a percentage is on what I would call a hair trigger now as has ever existed. In other words, I think there are more people that go to bed at night with a position in foreign exchange, or bonds, or a carry trade, or stocks, or whatever, that some event that could happen overnight would cause them to want to change that position in the next 24 hours. I think that's the highest, perhaps in history. Somebody [economist Thomas Friedman] has referred to it as the "electronic herd," that it's out there. I mean people can with — they can give vent to decisions involving billions and billions and billions of dollars, you know, with the press of a key, virtually. And that electric — I think that electronic herd is at an all-time high. I think that some exogenous event — it was almost Long-Term Capital Management in 1998 — but some exogenous event — and we will have them — will cause it — I think it could very well cause some kind of stampede by that herd. You can't get rid — if you're the rest of the world — you can't get rid of dollars. I mean, if you're sitting in Japan, China, or someplace, and you own a lot of U.S. government bonds, if you sell them to somebody in the United States you get U.S. dollars. So you still have U.S. assets. If you sell them to somebody in France, you've now got euros but they've got the [debt.] You can't you can't get rid of those assets. But you can have people trying to head for the door very quickly with them, under certain circumstances. Volcker said, in this thing, he said in the second paragraph, "Yet, under the placid surface there are disturbing trends: huge imbalances, disequilibria, risks — call them what you will. Altogether the circumstances seem to me as dangerous and intractable," and I emphasize intractable, "as any I can remember, and I can remember quite a lot." Well, Paul Volcker can remember quite a lot. And I agree with that. I don't — I have no idea — I have no idea on timing, whatsoever. In economics, it's far easier to tell what will happen than when it will happen. I mean, you can see bubbles develop and things, but you do not know how big the bubble will get. For example, you know, this happened five years ago in the market. So you — predicting timing is — I've just never been successful at it nor do I try to do it. Predicting what will happen, I think, is a much easier sort of thing. And I would say that what is going on, in terms of trade policy, is going to have very important consequences. It was not addressed in the last presidential campaign by either candidate in any meaningful way at all. Now, I'm not sure if, you know, you were standing up in front of the American people, and somebody is giving you three minutes to explain this whole situation, when 90 percent of your audience couldn't define current account, you know, it's not an easy game. But it's an important one. Now, Charlie is less enthusiastic about our foreign exchange position, somewhat, than I am, so I want to yield the floor here for a significant period of time while he gives you the other view.

CHARLIE MUNGERWell, I'm, if anything, a little more repelled than you are by the lack of virtue in the way our nation uses consumer credit and the way we run the public finances. And I have a feeling that eventually a lack of virtue is going to hurt one. Where we differ is that I agree with [18th century Scottish economist] Adam Smith that a great civilization has a lot of ruin in that, meaning it will bear a lot of abuse. And so I think there are dangers in the current situation that make it unwise for anybody to swing for the fences. But I don't think that we have a certainty that the system won't stand a lot more of the kind of abuse it's getting now.

WARREN BUFFETTWhat do you think the end will be?

CHARLIE MUNGERBad. (Laughter)

WARREN BUFFETTI knew I could count on him. (Laughs) No, we are truly, in this country, like an incredibly, I mean incredibly, rich family that owns, we'll say metaphorically, millions of acres of land. They can't see, they can't travel to the outer reaches of their domain. But, nevertheless, they sit on the front porch and wait for the produce to come in from this vast holding, and when they get it all they still want to consume about 6 percent more than everything that's been produced on the farm. And they have the ability to do that by simply selling off a little piece of the farm every day, and every year, that they can't even see. So they don't feel any poorer at the end of the day or the end of the year, because it's still, as far as their eyesight can see, they own everything that God ever created. And they can sell that little piece or they can mortgage it. They can send IOUs to these people that are giving them the extra goods to consume. And we are very, very, very rich family. And we produce a whole lot and we consume a little bit more than we produce. And we trade away a little bit of the farm or put a little bit of a mortgage on every day and the rest of the world is happy to take a little piece of our farm or take a mortgage on it because it's such a terrific asset and we've behaved so well over the years. And so they're willing to work a little harder to send us something so that we can consume a little bit more than we produce. It's been going on a while. It's accelerated a lot in the last few years. And more and more the rest of the world is owning part of us and we're going to have to service that ownership, either through interest if they took it in IOUs, or in some other way. And it can go on a long time. But if it goes on a long time, the world will own a good bit of us and our children will be paying, one way or another, for the fact that we got to consume more than we produced. It could happen — you could have — you've obviously had some less interest in the rest of the world accepting dollars by the fact that the dollar has declined somewhat in value in the last few years. In other words, the investment in us is always going to be equal to the overconsumption. I mean, it's an equation. But if people get a little less excited about one — enthused about one side of the equation — it reflects itself in the pricing mechanism. And the world has demonstrated a diminishing enthusiasm for dollars in the last few years as they get flooded with them. We send $2 billion out every day, whether we like it or not and whether they like it or not. Now, the question is, does that reach some tipping point at some point or does some exogenous event come about that causes people to want to rush for exits? Who knows? I have a hard time thinking of any outcome from this that involves an appreciating dollar, but, as Charlie will point out in just a second, there have been times when we've been surprised. Charlie?

CHARLIE MUNGERYeah, the counter-argument is that, what does it matter if the foreigners own 10 percent more of the United States, if, at that time, the total wealth of the United States is 30 percent higher than it is now. And so, people who have that point of view just roll with it. And some of them think that if we didn't manufacture anything in the United States and just sat here running hedge funds, we would have a wonderful economy because it comports with Republican principles.

WARREN BUFFETTWe could cut each other's hair, too, actually, I mean — But back in the late 18th century, obviously, the idea of taxation without representation caused a certain amount of trouble, and ownership of the rest of the world — by the rest of the world of this country would be seen as a form of taxation, I think, 20 years from now, by the people who resided here. If we — if, instead of fighting the Revolutionary War, we'd simply made a deal with England and said we'll give you three percent or five percent of our national product forever and you let us be free and we'll just mail it — send the royalty over every day — that might have looked like a good alternative to war in, you know, in 1776. But I don't think that subsequent generations would have reacted well. I mean, something would have happened over time. And I have a feeling that the idea of America paying tribute to the rest of the world because of the overconsumption patterns of a previous generation seems to be — I don't think that's a particularly stable scenario. But that's why we have only 21 billion in foreign exchange contracts. Charlie might have a little less, or maybe none, if he were running it entirely, and I might have somewhat more, if I didn't know I'd have him sitting up here next to me next year. (Laughs)

Housing market bubbles and irrationality

WARREN BUFFETTLet's go to number 9.

AUDIENCE MEMBERHello. My name is Johann Freudenberg (PH) from Germany. What do you think would be the consequences of a strong decline of the housing market for sales of carpet retailers and manufacturers? Thank you.

WARREN BUFFETTWell, if there's a strong decline in the housing market, my guess is that whatever we lose in carpet we'll be making up for somewhere else, because it would — a lot of the psychological well-being, as well as the financial well-being, of the American people is tied up with the fact — or comes from the fact that they feel so good about what has happened with their home ownership over the years. And with many people it's been, by far, the best-behaving asset that they've had. So, if there is indeed some kind of a bubble and it's pricked at some point, my guess is that we would feel that in various ways in our operating businesses, but that in terms of what we could do with our capital, the net effect to Berkshire might well be quite positive. We're not big on macro forecasts. I mean, this foreign exchange thing is quite different than what we've done over time and the way we've made money. So, we are — it isn't like we've got some great track record predicting macro factors and have made a lot of money doing that. We've made money by looking at things like PetroChina, or whatever it may be, and just deciding that here is a very good business that's selling at a very cheap price. Certainly at the high end of the real estate market in some areas, I mean, you've seen some extraordinary movement. And I've referred to this before, but 25 years ago or so we saw the same thing in farmland in Nebraska and Iowa and surrounding areas. We had people running from cash — "cash is trash" — and people wouldn't, you know — they were worried about the fact that inflation was out of control in the late '70s, and before [former Federal Reserve Chairman Paul] Volcker did his stuff, people were fleeing from cash. And one of the ways they gave vent to that fear was to rush into farmland. There was a farm about 30 miles north of here that sold for about $2000 an acre in, roughly, 1980. And a few years later, I bought it from the FDIC for $600 an acre. And you can say, how can you go crazy about farmland? It's going to produce about 45 bushels an acre of soybeans, about 120 bushels an acre of corn. And there's no way you could dream about a tripling, or the internet causing, you know, cornmeals to go up or something of the sort. But people went crazy on it. And the consequences were huge, in terms of banks failing, lots of banks failing in this area, banks that had gone through the Great Depression. But the people went — they just want a little crazy. People go crazy in economics, periodically, in all different kinds of ways. And, you know, you had the Resolution Trust Corp. come out of the savings and loan nuttiness that took place in real estate, where they finance everything that was put before them. And, you know, I will not — I don't know where we stand in terms of the residential housing cycle in that it has different behavior characteristics, simply because people live in the houses in many, a great many cases. So it will not behave, necessarily, the same as other markets. But when you get prices increasing at far, far greater rates than construction costs or inflationary factors, sometimes there can be some pretty serious consequences. Charlie?

CHARLIE MUNGERYeah. It's — in a place like Omaha, there's not much of a housing price bubble, is there, Warren?

WARREN BUFFETTNo, there's not been a bubble, but I would say that residential real estate, probably, has increased in price at a rate quite a bit faster than the general inflation rate.

CHARLIE MUNGERYeah, but if you get to Laguna, California or Montecito, California, or the better suburbs of Washington, D.C., you have a real asset price bubble. I have a relative that, to move to a good school district in the suburbs of Virginia, she had to pay four times as much as she can get from selling her nice Omaha house.

WARREN BUFFETTYeah. Well, I sold —

CHARLIE MUNGERSo that's a price bubble.

WARREN BUFFETTI sold a house a few months ago in Laguna for $3 1/2 million. Now it sold the first day, so I probably listed it too cheap. So don't count on me for residential real estate advice. But that house, the physical house, would probably cost a half a million or thereabouts. So, in effect, the land went for $3 million, implicitly, and the land is probably on the area of 2000 square feet, which is a little less than one-twentieth of an acre. Now, you've got streets and all that sort of thing involved. But basically, I think that land sold for about $60 million an acre, which that fellow that you saw in the farm outfit in the movie finds like — sounds like a pretty, pretty fancy price for almost any kind of land. Charlie, you've witnessed it firsthand, though, out there.

CHARLIE MUNGERWell, yeah. There's — one of the Berkshire directors lives adjacent to what I regard as a pretty modest little house, which sold for $27 million recently. Now these are houses that look right at the ocean, and there isn't a great deal of available shoreline in California, and there are a lot of people. But you have some very extreme housing-price bubbles going on. And you would think there might be a real possibility that it could go in the other direction someday.

WARREN BUFFETTAt $27 million, I'd rather stare at my bath tub. (Laughter)

Catastrophe insurance: "everything correlates"

WARREN BUFFETTNumber 10.

AUDIENCE MEMBERDavid Winters, Mountain Lakes, New Jersey. How do you try to manage risk at Gen Re and National Indemnity to be comfortable and maximize returns? Especially, how do you prevent a catastrophic loss or unexpected correlation? Thank you.

WARREN BUFFETTYeah, well, that's a very good question because we are doing things in different parts of our insurance operation where there is correlation. And there's not only correlation among the insurance risks. I mean, just, you know, take a major, really major, earthquake in California, in the wrong place. There have been about 25 6.0s or larger in the last hundred years, but most of them don't occur where a lot of people are. But if you get the wrong one in the wrong place, it would not only hit National Indemnity and General Re, as you mention, but it might very well have a severe effect on See's Candy. It might very well have a severe effect on Wells Fargo. We don't own Freddie [Mac] or Fannie [Mae] now, but we owned Freddie at one time. It could have had a severe effect on Freddie. It can have all kinds of secondary and tertiary effects that you might not think of initially. So, we find when there's trouble, everything correlates. And it's — part of my job is to have at least a general idea of the sort of risk that the various enterprises might be running operationally, and then integrate that into my own notion of the risk that we run, in terms of investments, in terms of all kinds of things. And, you know, that is my job. The most likely mega-cat, at any time, is a hurricane. But we have more exposure to that. On the other hand, if you're talking 25 billion and up, maybe 100 billion and up, insured catastrophes, you know, a quake might be just as likely as some Force 5 hurricane that would come in at the wrong place. But that — my job is to think absolutely in terms of worst case. And to know enough about what's going on, in both investments and operations, to make sure that no matter what happens, you know, I don't lose sleep that night, you know, over what can, you know, whether there's a 9.0 quake someplace or whether there's a Force 5 hurricane that actually goes up the East Coast and enters at places that very seldom does it enter. Long Island, for example: huge amount of exposure. How often is Long Island going to, you know, really have a major hurricane? Not very often. I think there was one back in the '30s, but there were potato fields there in the '30s and now there's all kinds of insured value. Everything will — everything that can happen, will happen. I mean, in terms of our — what we know of history in this country, last three or four-hundred years, and then with the most severe quake, by far, was at New Madrid, Missouri. And who would have guessed, you know, that that quake would happen? And there were two subsequent quakes that were far enough apart so that didn't exactly seem like aftershocks. All three of those were higher than 8 on the Richter scale. Nobody thinks about that, but they've had them in Charleston, South Carolina. They've had, I mean, it's — you will see things, maybe not in your lifetime, but if you take the centuries, some extraordinary things can happen. And it's Berkshire's job to be prepared, absolutely, for the very worst. And, by and large, I would think hurricanes and quakes are the biggest thing now, but a few years ago we did not have nuclear, chemical, and biological risks excluded in policies, and we had huge exposure, subsequently gotten rid of. But we take on large risks. I'll give you a couple of examples. Just the other day — and nobody else will write this stuff, basically, because they would want to reinsure it with somebody else and they're not set up to do it — but one large airport, one large international airport, came to us and we wrote a policy for $500 million, excess of 2 1/2 billion, from any action that was not caused by nuclear, chemical, or biological sources. So, if that airport is taken out in some way, but not by nuclear, chemical, or biological activities, the first 2 1/2 billion, somebody else worries about, and we get the next half-billion. There's a — sublimit is only a billion-six can be counted for business interruption. So you would need — and that airport would have to be out for a couple of years to have a billion-six of business interruption. So you need 900 million of physical damage on top of that. But somebody is willing to buy that policy and there is a real risk. We insured the NCAA Final Four down in St. Louis against being canceled, not postponed, or having the games, those final four games, moved to another city. But if it was canceled totally, and again, not through nuclear, chemical, or biological, we would have paid $75 million. Same thing at the Grammys. I mean, we take on risks that very few people want to write. But in the end, we're willing to lose a lot of money in one day, but we're not willing to do anything that causes us any discomfort, in terms of writing checks the following morning. Incidentally, while I'm on the nuclear — while we're talking about the pleasant subjects — I recommended in the annual report that book, "Nuclear Terrorism." And if you go to lastbestchance.org, you can obtain, or will soon be able to obtain, a tape, free, that the Nuclear Threat Initiative has sponsored, which has a dramatization of something that is now fictional, but it's not fanciful. It's something that could happen, and which the Nuclear Threat Initiative is working to minimize the chances of. And on that program, in addition to this dramatization of what could happen in that field, you have [former Senator] Sam Nunn and Senator [Richard] Lugar with [NBC News anchor] Tom Brokaw, discussing the subject. It's an important subject. It didn't get a lot of attention, again, in this last campaign, although I think both candidates fully recognize the importance. But we would regard ourselves as vulnerable to extinction, as a company, if we did not have nuclear, chemical, and biological risks excluded from virtually all of our policies, although we intentionally take on the risk periodically, but only in an amount that we feel we can handle. We do not write it and give it away for free. And we do not want to write it promiscuously, because there could be events happen that would make it impossible for our checks to clear the next day, and we're not going to get ourselves in that position. Charlie?

CHARLIE MUNGERYeah. We're likely to do better than most other people in dealing with what concerns you. We care more about it, that kind of correlation. We just naturally have minds that think about tidal waves in California, where they've never had one in modern California civilization. Can you imagine what a 60-foot tidal wave would do in California? There's nothing physically impossible in having a 60-foot tidal wave in an earthquake zone, which California is in. But it's never happened in modern history. But it's the kind of thing that we do think about. And you think any other company has as much, as rigorous, nuclear and so on, exclusion as we do?

WARREN BUFFETTWell, nobody's attacked it any more vigorously than we've attacked, I would say. I mean, what you have here is, individually, we probably worry more about the downside than that just about any manager you can find. And collectively, you know, it's Armageddon around here every day. (Laughs) But that's — you know, we care about that. We've never used a lot of borrowed money. Back when I started out, I mean, I had $10,000. But I just didn't want to borrow any significant amount of money. There's no reason to. You know, we're living fine. We were living fine when I had $10,000. And the idea that you risk what you need and is important to you for something that you don't need and it is unimportant, is just craziness. And we try to run Berkshire that way. And you know, I had a 98- year-old aunt, my Aunt Katie [Buffett], that died last year. She had everything she had in Berkshire. And the idea that I should be doing something to try and add a few dollars to my net worth, or a few percentage points to the record, and be risking the fact that she would go back to Social Security, is, you know — I just think that's kind of crazy for a manager. But, you know, maybe if I had a two-and-twenty percent arrangement with my Aunt Katie, I'd be — differently, but I hope not. (Laughs)

Public education reform

WARREN BUFFETTNumber 11.

AUDIENCE MEMBERHello. My name is Martin Wiegand from Chevy Chase, Maryland. On behalf of the assembled shareholders, we appreciate you and the Berkshire staff hosting this weekend and would like to thank you for building this community of shareholders.

WARREN BUFFETTMartin, thank you. (Applause) I should point out that I dated Martin's aunt, but she only went out with me once. Maybe you could explain that, Martin. (Laughs)

AUDIENCE MEMBERNew board member Bill Gates has been talking about education reform in America, and columnist George Will quoted you in an article about Patrick Byrne's efforts to reform education in America. Could you share with us some of your thoughts about these two efforts, or your efforts, to reform education? Thank you.

WARREN BUFFETTWell, interestingly enough, we just dedicated a school here in Omaha yesterday which is named after my Aunt Alice, who taught in the Omaha public schools. And we've — I think we've maintained quite an excellent public school system in Omaha. We also have an outstanding parochial school system here. You know, it takes the interests of parents and, frankly, it takes the interests of the well-to-do in the school system to keep a first-class school system. I've said that, to some extent, a public — a good public school system is a lot like virginity. It can be preserved but not restored. In Omaha, we preserved it, but you preserve it by having the parents interested and involved in the public school system. And Patrick's got an ingenious idea to make sure that more of the money goes to teaching and less to administration and overhead. There's a variety of ideas around about how to correct a system where it's broken. And Charlie, as a big Ben Franklin enthusiast, has always said that an ounce of prevention is worth a pound of cure, and I think we've been spending that ounce of prevention, or providing it, here in Omaha. I think it's a — you know, Charlie will have a lot more to say on this. I admire the fact that people like Patrick and Bill Gates and a lot of other people, John Walton and Teddy Forstmann, all kinds of people — Bob Wilmers, up in Buffalo — are attacking the problem. It's probably the — next to the nuclear, chemical, and biological problem — I mean, it's the number one problem of the country is making sure that the educational system is the best in the world. We've got the resources and we're not providing it, we're not delivering it. So, it's very complicated when you operate through thousands and thousands of school districts and you work with many, many unions, and you've had, to a great extent in many areas, the rich opt out of the system and set up a separate system. You know, I am not as concerned about the public golf courses in Omaha as I might be if I played them every day instead of playing at a country club. And if you have a two-tier school system, one for the rich and one for the poor, it's going to be hard to pass bond issues that benefit the people that don't have the money to send their kids to private schools. I'm a big believer in the public school system, though, in terms of equality of opportunity in this country. (Applause) Charlie's thought about education. He's actually come close to running a school. Cares about it enormously, so I'll turn it over to him.

CHARLIE MUNGERWell I learned something rather interesting about Omaha public schools on my way to this meeting. I stopped to sign some books in a warehouse in South Omaha, and one of the very nice people in the warehouse was married to an eighth grade teacher in the Omaha public schools. And we got to talking about "No Child Left Behind." And he said his wife, this eighth grade teacher, had a very interesting system. For the numerous children who couldn't read, she records "books on tape," speaking slowly in her own voice. And when some children are reading the books, other children are listening to the tapes, and that way the children who listen to the tapes are not left out when they ask questions about what went on in the books Well, this is "No Child Left Behind," in a sense, but it's also a failure, in a sense. And I think it's very hard for a civilization to fix the situation once somebody is in the eighth grade and can't read. So I think there's a lot of failure, even in relatively advantaged places like Omaha. And it's very serious failure. We never should have allowed it to happen.

WARREN BUFFETTYep. My friend Bill Ruane, who is here — I believe he's here — is doing something extraordinary, in terms of a program he has teaching kids to read. In fact, journalists who are here should seek out Bill and learn something about the story of what he's done in the last 10 years, in terms of moving reading abilities, and kids' enthusiasm for reading, which is more important because it's, you know — I talked about our managers and the important thing is that they have a passion for their business. Well, passion for reading can be developed and Bill has shown that in programs that he — I think he first started them in Harlem. He sort of adopted a block up there and went from there. And he would be a very interesting fellow to get some views from on this subject. You know, we've had this great success story in this country and a lot of it is because of people have had something closer to equality of opportunity in the United States than they've had in most parts of the world. And you do not have equality of opportunity when my kids get to go to some school where I can attract outstanding teachers and where they're in the company of other kids that are also motivated and they're getting encouraged at home and all sorts of other things, and somebody else, who is born into a less advantageous family, really doesn't have a chance. They go into something that's close, maybe, to an armed camp where the teachers are just sort of pushing them through. And there's no stimulus from the other kids except to do things that are counter to the interests of society. And that just isn't a situation that really should be allowed to exist in a country where the GDP is almost $40,000 per capita

Bill Gates tops Churchill, Jesus, and Napoleon in survey

WARREN BUFFETTLet's go on to number 12. Oh, incidentally, I have to make one — It was mentioned about Bill Gates being a director and I did — I got a little survey here that came out. Pricewaterhouse and the Financial Times cooperated on the survey. And they asked CEOs around the world to choose — if they could pick anybody to choose from history or today to join their company's board, who would they choose? And I'm happy to report that Bill came in number two. And, actually, number three was Winston Churchill. [Auto executive] Carlos Ghosn came in fourth. Jesus Christ came in fifth. Napoleon Bonaparte was sixth. And I won't give you the rest of the list but —

CHARLIE MUNGERWho was one?

WARREN BUFFETTWell, one was [former General Electric CEO] Jack Welch. I knew you'd ask. (Laughs) But we didn't ask Jack, we asked Bill. So, actually, I thought this quite an interesting list because I think many of the CEOs of the world would prefer people that are dead to be on their board. (Laughter and applause)

VOICEIt's too funny.

Zero-down mortgages fueling housing price bubble

WARREN BUFFETTNow let's see. Where were we? We were going to number 12.

AUDIENCE MEMBERHello, my name is Robert Piton (PH) from Chicago, Illinois. And on that note, maybe a merger of some sorts between Berkshire and Microsoft is in the works.

WARREN BUFFETTI keep hinting but it doesn't do any good. (Laughs)

AUIDENCE MEMBERThe question that I have is, do you think the shift in the banking system during the '90s to finance home purchases with zero percent down impacted the overall savings rate, as home purchases are the largest investment most people make, and the overall rise of home prices driven by these marginal buyers? If so, how would you suggest that we correct the problem.

WARREN BUFFETTYeah. Of course, any time a home is constructed, it represents somebody's savings. I mean, the home buyer may buy it for nothing down, but that means he's borrowing 100 percent of the mortgage through a mortgage that somebody else has saved somewhere, maybe intermediated three or four times or something of the sort. But home construction comes about through savings. Now there's no question that terms have become easier and easier, and I've talked to certain mortgage bankers about this subject, but terms have become easier and easier as prices have increased. Now, that is absolutely counter to, you know, how people think about lending in general. Generally, the more the asset class becomes inflated, the less a prudent banker will lend. But of course, in this country, now you have mortgages intermediated in a way that the person buying the mortgage, in the case of — I'm thinking of Freddie [Mac] and Fannie [Mae] and other forms like that, so we're talking about the lower-priced houses — but the mortgage buyer does not need to care about what kind of mortgage — what kind of a financial transaction the purchase is. All they have to do is look at the guarantee, and they look at that rather than whether somebody's put any money down, or anything of the sort. So I think you've had easy financing facilitating a boom in real estate prices, even at the higher levels. And I think that that that, which has occurred in other asset classes in the past — I mean, that farm bubble I talked about was facilitated by the fact that banks in small towns, who generally had been very conservative in lending, went crazy around 1980 and they lent amounts that the farm itself could never repay. They started saying a farm was an asset appreciation investment, not an income investment. And once you talk about something that's an asset appreciation investment, ignoring the underlying economics of what you're lending on, you're really talking about the bigger-fool game. You're saying, you know, this is a silly price but there'll be a bigger fool that comes along. And that actually can be a profitable game for a while. But it's nothing that bankers should engage in. So I would say that easy lending, obviously, does contribute to, overall in the country, to a lower savings rate. But, in effect, somebody has to save for somebody else to borrow. And what is happening now is the rest of the world is saving. So then in the U.S. — in global terms, I'm talking — but the rest of the world is saving. And they're sending us $2 billion — I mean, we're sending them, in effect, claims for ownership of $2 billion — they're investing $2 billion a day in the United States. But they — a lot of economists will say, well, that's what's really going on. The world loves our assets so much and they have so much confidence in America that the present current account deficit is driven by the fact they want to invest. I don't believe that at all. I think it's just silly, frankly, to make that argument. They are investing because they have to, because of our consumption habits, and not because they want to. And I think the declining dollar is evidence of that. Charlie?

CHARLIE MUNGERI've got nothing to add to that. It's obvious that the easy lending on houses causes more houses to be built and causes housing prices to be higher, probably, in the new field. Eventually, of course, if you construct enough of new anything, you can have a countervailing effect. If you build way too many houses, you'd eventually cause a price decline

WARREN BUFFETTI'll give you a fanciful illustration. Let's just assume that Omaha had a totally constant population. No one was allowed to leave. No one entered. Birth rate equals death rate, all of that sort of thing. So the population was constant, and nobody could build any more houses. We just passed a city ordinance to that effect. But every year, everybody sold their house to their neighbor. So, first year, everybody sold their $100,000 house to their neighbor, and they both switched houses, and that was fine. And then the next year, they agreed we were going to do it at 150,000. And you'd say, well, how could that be? Well, we would all go to Freddie or Fannie and get our mortgages guaranteed for a larger amount, and somebody in New York or Tokyo or someplace would buy the Freddie or Fannie paper. And we'd have an influx of $50,000 per household. We'd all have the same number of houses. We'd all be living one house to a family. And we'd have marked up our houses, and we now have a bigger mortgage, but we'd have $50,000 more of income that year, just to service a little higher mortgage. And we'd do the same thing the following year for 200,000, and so on. Now, that would be very transparent, and people might catch on to the fact there was something funny going on in Omaha. But you can have an accidental aggregation of behavior that somewhat leads to the same effect. I mean, if you keep marking up something, and in the process, the payment for the marked up price comes from someone else who feels they are bearing no risk because they've got the government guarantee in between, the money can just flood in and everybody feels very happy for a long time. And we don't have anything like the fanciful thing I've set forth, in terms of Omaha. But we have certain aspects of that, I think, going on in the economy. Charlie, would you — I'm throwing this one at you. Would you agree or not?

CHARLIE MUNGERYeah, I do agree with that. You have varied Ponzi effects in various parts of any modern economy. And they're very important and they're very little studied in economics.

"Not enthused" about gold

WARREN BUFFETTLet's try number 13. I think, maybe, that's in the other room and we'll see whether we get a response and if not we'll —

AUDIENCE MEMBERGood morning, Mr. Buffett and Mr. Munger My name is Martin O'Leary (PH) and I'm from Austin, Texas. Mr. Buffett, given your past essays concerning the U.S. dollar and foreign exchange forward contract holdings that you have, and many countries' economic policies that have a tendency to debase their currencies, do you think that gold can be considered a viable investment alternative to paper currencies?

WARREN BUFFETTYeah, we're not enthused about gold. People, historically, have felt that was the first refuge from a currency that was going to be — decline in value. But, you know, so is a barrel of oil. So is an acre of land. So is a piece of Coca-Cola. So is See's Candy. See's candy — if the dollar goes down 50 percent, we will be selling See's candy for double the present price. We'll be getting the same real price for See's candy. People will work the same number of minutes or hours per week in order to buy a pound or two-pound box of the candy. So we would much prefer a — some asset that is going to be useful whether the currency is worth what it is today, or 10 percent of what it is today, or whether people are using seashells in order to transact business. Because people will go on eating and they'll go on drinking and doing various things. And their preferences will translate, in real dollars, into more or less the same economics for us. And we would not trade the ownership of those kind of assets for us for a hunk of yellow metal, which has very little real utility except for people who are looking to flee from the dollar and, in our view, really haven't thought through the consequences of what fleeing would — where they should flee. Charlie?

CHARLIE MUNGERYeah. If you have the opportunities of Berkshire Hathaway, averaged out, gold is a dumb investment.

WARREN BUFFETTMy dad [Howard G. Buffett] was a huge gold enthusiast. So I sat around the dinner table — my two sisters are here, too. They will testify to it. We sat around listening to the virtues of gold, and that was in, we'll say, 1940. And gold, at that time, was $35 an ounce. And we would've had some storage and insurance costs. And, you know, here it is, 65 years later. World wars, nuclear bombs, all kinds of things. And the compound rate from $35 to a little over $400, less those expenses, is not something that causes me to salivate.

The danger of earnings expectations

WARREN BUFFETTNumber 14. Do we have a second microphone in the overflow room? Oh, there's only one in there. OK, then we'll go back to number one.

AUDIENCE MEMBERAndrew Noble (PH) from England. Apart from the catastrophic insurance events or Armageddon scenarios that you've been talking about earlier, in relation to the operations of Berkshire Hathaway, what are your greatest fears?

WARREN BUFFETTWell, the greatest, I would say — we don't worry about the economics of the businesses we have. We've got a very diverse group. By and large, they're very good businesses. By and large, they're run by some of the best managers in the country. But we worry about something going wrong. I mean, you know, you heard about the Salomon [Brothers] thing in the movie. And, I mean, we've got 180,000 people out there, and I'll guarantee you something is going wrong someplace, as we talk. That's just the nature of it. But, what you hope is that it's relatively unimportant or that we catch it. And — but that's, you know, that is something that we know will happen. We try to have a culture that minimizes that. And I think we do have a culture that minimizes that. We — it's very important, in our view, to have the right incentives. And many places, we think, have incentives that aren't so good. I mean, when I get on an airplane, and we own the company, like NetJets, the last thing in the world I want to tell the pilot is that I'm running late and I hope we can get to New York a little faster. I mean, that is dumb, to incent a pilot, who may be worried that, you know, somehow you affect his job or something, to get in a hurry about the takeoff or the checklist or whatever it may be. And companies do that time after time in their compensation plans or things that they incent people, in our view at least, some of the wrong things. That doesn't mean nothing wrong will happen under any circumstances. But you should not have a system that causes people to, for example, worry about quarterly earnings. None of our — our managers do not submit budgets into Omaha. I have no idea what we're going to earn next quarter. And I have no implicit body language out there, or anything of the sort, to our managers that I'm hoping to earn X dollars per share in the quarter. Because in the insurance business particularly, you can report any numbers, basically, that you want to, if you write long-tail business for a short period of time. And, you know, we've got 45 billion of loss reserves. Well, who knows whether the right figure is 45 billion or 46 or 44? And if the desire is to report some given number in a given quarter, instead of saying 45 billion, you say 44-and-three-quarters billion, or something of the sort. So we have no incentives, in terms of how people are paid, or in terms of the fact they just don't want to let me down. Let's assume at the start of the year I asked everybody to submit budgets and then I went on Wall Street and preached a bunch of numbers. Even if their compensation didn't depend on it, the managers would feel, you know, we don't want to let Warren down on this. So, you know, we'll take an optimistic view of reserves, and that's easy to do, at the end of the quarter and we won't let him down and then he won't look like a jerk in front of Wall Street. So we try to avoid that sort of thing. But even then, that is what we worry about. We don't worry about this place making money. I mean, we'll make money. And if we don't, it's my fault. That's not that's not the problem. The problem right now, in addition to the one we just talked about, the problem is deploying capital, and that's my job, too. And, you know, I haven't done a very good job of that recently, but with a little luck, you know, we will — and a different kind of market situation — we will get a chance to do that. Charlie?

CHARLIE MUNGERYeah. Well, if you stop to think about it, the history of much of which we don't like in modern corporate capitalism comes from an unreasonable expectation, communicated from headquarters, that earnings have to go up with no volatility and great regularity — corporate earnings, I mean. That kind of an expectation from headquarters is not just the kissing cousin of evil. It's the blood brother of evil. And we just don't need that blood brother in our headquarters.

WARREN BUFFETTBusinesses do not meet expectations quarter after quarter and year after year. It just isn't in the nature of running businesses. And, in our view, people that predict precisely what the future will be are either kidding investors, or they're kidding themselves, or they're kidding both. Charlie and I have been around the culture, sometimes on the board, where the ego of the CEO became very involved in meeting predictions which were impossible, really, over time. And everybody in the organization knew, because they were very public about it, what these predictions were and they knew that their CEO was going to look bad if they weren't met. And that can lead to a lot of bad things. You get enough bad things, anyway, I mean. But setting up a system that either exerts financial or psychological pressure on the people around you to do things that they probably really don't even want to do, in order to avoid disappointing you, I mean, I just think that that's — it's a terrible mistake. And, you know, we'll try to avoid it.

We look for managers with great track records

SPEAKER(Gap in video recording resumes in middle of question)

AUDIENCE MEMBER— quality is largely innate. So if these characteristics are inherent and you were to attempt to consistently identify future great managers or entrepreneurs before there's a track record, how would you go about doing it? And in particular, could there be a way to know that — before someone's made a lot of money, before they built the business that they love and feel passionate about, that they will develop those types of qualities later in life?

WARREN BUFFETTThat's a terrific question. And we have dodged it, largely, over the years by actually buying businesses from people where we've seen the record. In other words, I'm not sure I can go — in fact, I'm quite sure I can't go — to an MBA class of 50 and sit down and talk with each one, examine their grades, examine their extracurricular activities, and whatever, talk to their parents, I'm not sure I could rank those 50 very well in terms of their potential for future business success. And, of course, some of it would depend on what areas they entered into in business. So, I think it's tough. I think it's tough to go out to the practice tee, where people are not actually hitting balls but just taking practice swings, and say which one is, you know, is a 2 handicap and which one's a 15 handicap, and which ones, you know, can make it on the tour I think I can tell a little bit, maybe, but not — but it's very hard to calibrate. And I don't think we've had much success, but we also haven't tried very much, to identify people before they've had a record, to try and identify the ones that are superstars. Instead, we've taken the easy way, and we go — and if somebody comes to us with a business that's done phenomenally for 10 or 15 or 20 years, or maybe for 50 years, and we've seen how — what their batting average is — we've actually seen they batted .350, or whatever it may be, in the major leagues. And we just make the assumption that we won't screw it up by hiring them. And we also make the assumption that they'll live to be 100 or 120 or something and we buy the business. And that's far easier — it is far easier to tell the great baseball batters after you've seen a couple seasons of their batting than it is to go to a college — in college baseball teams or high school baseball teams — and pick out the superstars. The one interesting thing, and I wish I could remember where I saw this study and it may not even be a valid study, but I do remember seeing something many, many years ago where they tried to correlate business success with various variables. And they took grades in school and whether they got MBAs and all that sort of thing, and they found that the best correlation was with the age at which they started their own business first. The people that got very interested in starting a lemonade stands, or whatever, tended to have better — it tended to correlate better with business success than other variables. We have found ourselves — we've got a lot of MBAs running businesses for us, but they ran them for a long time before we hired them or before we made the deal. And we've got others that never set foot in a business school. And I do think there's a lot to wiring. I think there's also a lot to working with the wiring you have and developing it over time. I don't think that it's all innate, and I don't think you can't improve. I know you can improve on what you're given at birth, but I do think an awful lot of it is wiring, more so than I would have thought 30 or 40 years ago. I've certainly seen it in business. I can — there are people, no formal business train — Charlie never went to business school, I mean, but he thought about it. I mean, I never heard him — Charlie say anything dumb about business yet, except when he disagrees with me. (Laughs) The truth is I've never heard him say anything dumb about business, period. And there are other people. I've never heard [GEICO CEO] Tony Nicely say anything dumb about business, ever. They just — they're wired so that they — that the, you know — it doesn't flicker. I mean, they get the answers. It doesn't mean they can — you know, they'd be a great ballroom dancer or a great baseball player, you know, or a great politician, but they are wired for business. Charlie?

CHARLIE MUNGERYeah. Part of it is intelligence and part of it is temperament. I don't know if Bill Ginn is in the audience, but by the time I was 14 years of age, I knew Bill Ginn would be rich. He was a classmate of mine in high school, and a very intelligent man, and he wanted to be rich. And he was sensible in the way he handled life. I think sensible people with the right temperament and the right intelligence, if they live long enough in our system, will get rich. But temperament is, I think to some extent, inherited, too. Don't you?

WARREN BUFFETTYeah. His daughter, incidentally, is a partner with my daughter in a knit shop, which I hope you patronize while you're — (Laughs) We've united the Ginn and the Buffett family. (Laughs) Charlie, when did you first think business was something of interest to you?

CHARLIE MUNGERVery early. (Laughter) I loved games of chance and I love trying to learn how to win at them.

WARREN BUFFETTYeah. It's interesting for me, you know, simply to think about the question of whether the Final Four of the NCAA will be will be canceled, as opposed to postponed or transferred in locale, and decide if we're going to pay out $75 million the next day if it is canceled, and how much we want to receive in today to take care of that. And that probably wouldn't interest — all kinds of people that wouldn't be interesting to. And since my dad wouldn't let me become a bookmaker, I went into investments. (Laughter)

Cologne Re stake

WARREN BUFFETTNumber 3.

AUDIENCE MEMBERGood morning. Jens (PH) from Germany. After buying almost all of Cologne Re, how happy are you about the progress, and what are the plans for the remaining minority shareholders?

WARREN BUFFETTYeah. General Re, at the time we bought it in 1998, owned something in the 80s of Cologne Re, a large German company that they bought this 80-odd percent in, a few years earlier. It's actually slightly more complicated than that because there was an arrangement where a certain purchase was deferred, but as a practical matter they owned in the 80s. Right now, Gen Re owns about 91 percent of Cologne Re. That's a subject that, obviously, it's not pressing with us, because we've owned it for seven years without taking our interest up, except periodically through small purchases. And there's no particular reason to — why 100 would be better than 91 percent. But if the price is attractive and shares are offered to us, we will always contemplate buying it. But it's not key to any strategy.

Munger defends AIG

WARREN BUFFETTNumber 4.

AUDIENCE MEMBERI'm Christian Tukenberger (PH) from Switzerland, Europe. What do you think of the two insurance — reinsurance, AIG and Converium, from Switzerland? Thank you.

WARREN BUFFETTWell, I'm going to give you a chance at a second question because I don't really think I should comment on AIG. There's, you know, they have said that they're going to have their 10-K. They hope to have it by, I guess, today. I haven't received any late word whether it's been filed but they have — there'll be more disclosure on the situation at AIG, and I really don't know anything about what will be in that statement, and I'll just — I'll wait to read it. I'll read it with interest. But I — I have no particular insights on that. Converium has had troubles in the United States, has been announced, but they also raised additional money. But again, I don't really have any specific commentary on those two companies. Charlie?

CHARLIE MUNGERWell, I'll be bold enough to make one comment about AIG. (Laughter) I think whatever comes along, people are going to find that a lot that was very right was done over the years by AIG. There's a lot of ability in that place.

WARREN BUFFETTOh yeah. Extraordinary. I mean, Hank Greenberg was — he was the number one man in insurance. I mean, he developed an extraordinary company, in his lifetime. It wasn't that much when it was handed to him. And he became the most important factor, I would say, by some margin, in the property-casualty business. But in terms of evaluating where it stands now and what will be revealed when the 10-K comes out, I just have no idea.

Fannie Mae, Freddie Mac, and the home mortgage mess

WARREN BUFFETTNumber 5.

AUDIENCE MEMBERGood morning. My name's Mike Nolan. I'm here from Montclair, New Jersey with my 18-year-old son Brian, who's experiencing his first Berkshire annual meeting. My question, and you touched on it a little bit in a couple of earlier questions, deals with the current regulatory environment in Washington, which appears to be growing much more negative on Fannie Mae, Freddie Mac, Farmer Mac, and so forth. What might the implications for the U.S. consumer specifically, and the U.S. economy generally, be if the GSEs are effectively bridled or significantly restricted from their past charters? Could this prick what you earlier referred, and some private economists are calling, a real estate bubble and what will be the fallout?

WARREN BUFFETTYeah. The GSEs, in effect, expanded their original charter and reason for being. The thought, originally, was that they would guarantee mortgages and they had this very limited, I think, two-and-a-quarter billion dollar line of credit from the Treasury. But they were they were brought in, to an extent, to do what FHA and VA had done for mortgages in their arena, was to give people confidence in borrowing money — or in lending money — far away from their own geographical location. I mean, when the local — when I borrowed money on my house in 19 — bought it 1958 — I mean, I went down to see Mr. Brownlee (PH) at the Occidental Building and Loan, and he, you know, he knew something about me, and he knew something about my parents, and he knew where the house was and all of that. But as the mortgage market became more institutionalized and it became more — the source of funds became geographically far more distant from the user of the funds, in order to have a market in which — which would be efficient, the GSEs were a very logical development. And the GSEs came in, Freddie and Fannie, and the idea was that for a fee, which used to average about 25 basis points, they would guarantee these mortgages so somebody living 3000 miles away could buy them through securities and not worry about the individual property. And then, the portfolio operations developed over the following years and, of course, they enabled the GSEs to earn high rates of return on capital, because, in effect, the GSEs were looked at as government guaranteed so that people would lend them money without worrying about the degree of leverage employed. And, in effect, the GSEs became huge — they hugely developed what might be called the carry trade, using the government's credit, in effect, and the spread between what they paid on their money and what they got on mortgages. So that became the dominant source of their earnings. They got very carried away with delivering promised rates of growth. I remember reading in the Freddie Mac report some years ago, where they talked about delivering in the mid-teens or low-teens or something like that. And I thought to myself, you know, that this is madness, because you can't do that when you're running a big carry trade operation. Interest rate — the slope of the curve will develop. There's no way to lend money for 30 years to somebody who can pay you off 30 seconds later, to actually match assets and liabilities in a way that's risk-free. The only way you could do it would be to issue a 30-year bond of your own, which you could call 30 seconds later, and people don't buy those bonds. So, as a practical matter, you could not perfectly handle the risk of significant interest rate changes. But the GSEs got caught up with delivering increasing earnings all the time to Wall Street. So they first enlarged their portfolios and later, as we've seen, they got involved in some accounting shenanigans, which really sort of boggle the mind when you think of two of the most important institutions in the country, with all kinds of financial experts on the board and top-named auditors and everything, and turning out that billions and billions and billions of dollars were misreported. It shows you what can happen in a system. Now Congress is reacting, administration is reacting, [Federal Reserve Chairman] Alan Greenspan is reacting, in terms of saying that, you know, what have we created? What is this — the situation where these two companies have a trillion-and-a half or more of mortgages they own, and people really think the federal government is on the hook, and the federal government does — wants to say it isn't on the hook. But the truth is, it is on the hook. And institutions worldwide own the credit — own the securities — based on this implied promise. And it was all being done just because, basically, these companies wanted earnings per share to go up. Now, they say they did it to maintain an orderly market, and all that stuff, in the mortgages. But they were really set up to guarantee mortgage credit. And there's going to be reaction in Congress. It will be a huge fight. Both of those institutions have been heavy supporters of various legislators over the years. They've got lots of clout. Not as much clout as they had a year ago, but they've got lots of clout in Congress. And on the other hand, people have lost faith, to some degree, in what they've done. And they've also seen that the consequences of the government issuing a blank check to two institutions that are trying to produce annual gains in earnings per share of 15 percent, and doing it by accounting means when they ran out of the ability to do it by other means. So it's something that Congress should be giving a lot of attention to. They can't cut them off, in my view and, I think, most people's view. They can't say get rid of your portfolios or anything like that. So my guess is that some kind of a curtailment comes in, some kind of tougher accounting requirements come in, sometimes it may be tougher capital ratios. And that over a long period of time, the government tries to figure out something that sort of eases them out of this position, where they were basically backing two entities that, at times, acted like the two biggest hedge funds in history. Charlie?

CHARLIE MUNGERYeah. Well, he was asking, partly, is what happens if the government reins these two institutions in and forces a big reduction in asset base.

WARREN BUFFETTI don't think they'll — I don't think the government is going to do something worse, they sell off hundreds of billions of dollars of mortgages, at all. But if they curtail it — let's just say they say that from now on you got to operate in a runoff mode for a few years. There are plenty of people out there to buy mortgages. They're already buying the securities of Fannie Mae and Freddie that are financing the mortgages. So it isn't like Fannie and Freddie, independently, were coming up with the funds to finance these mortgages. They got them from somebody else and that somebody else can leave Freddie and Fannie out of the picture and buy the mortgages through some other form. It would not be the end of the world, at all, if Freddie and Fannie no longer had new portfolio purchases. I don't think it would change things in any significant way, in terms of the cost of homeownership or anything else. How about you, Charlie?

CHARLIE MUNGERWell, I agree. I don't think it would have enormous macro effects if future growth were curtailed. I do think a lot of the troubles that came, came from a large use of derivative books, and from Fannie and Freddie both believing a lot of silver-tongue salesmanship from derivative traders. And, as many of you know, I think there is much wrong with derivative accounting and derivative trading operations in the United States, and I don't think the full penalties have yet been paid.

WARREN BUFFETTWhen you can have a $5 billion mismark in one direction at one of these — and bear in mind these are among the most scrutinized companies in the world, and with outstanding people on their boards, in terms of financial expertise — if you can have a $5 billion mismark in one direction, while at the same time the other one has a 9 billion mismark in the other direction, you know, I would say we've come a long way from Jimmy Stewart and "It's a Wonderful Life." (Laughs)

CHARLIE MUNGERYeah.

UK reporting requirements are a deterrent

WARREN BUFFETTNumber 6.

AUDIENCE MEMBERHi, this is Peter Webb from London, U.K. The question I wanted to ask you: I've been an investor for many years and done very well following a similar sort of style to yourself. So thank you for that. The big question I have is —

WARREN BUFFETTWould you want to quantify that? You can always send us a check. (Laughs)

AUDIENCE MEMBERBut if there's a deal to be had, maybe we can speak afterwards.

WARREN BUFFETTOK. (Laughs)

AUIDENCE MEMBERThe question that I have for yourself and Charlie is, over the time I've bought many different companies in the U.K. and Europe, and I've seen many American value funds buying the same companies, but I see very little activity from Berkshire and its subsidiaries. And I didn't know whether that was a reflection on your views on U.K., Europe, and the world. Whether you just see a lack of investment opportunity? Is it outside your sphere of competence? Or is there some other reason that I see less activity from you in Europe?

WARREN BUFFETTYeah, it's a good question. We own, of course, as you know, 80 percent or so of MidAmerican Energy, which has a very large business in the U.K., but that's an operating business. As you know, in the U.K. there's a rule that requires reporting when you own three percent of a company's stock. And actually, there's some conditions under which the ownership will be reported even sooner than that three percent. There's a provision that — I think if there is an inquiry or anything, that it has to be responded to. So, if you take a company with a market cap of, you know, £5 billion, if we bought £150 million of it, we would have to report, and that tends to mess up subsequent purchases. So, we bought stock — we own stock in Diageo, which was Guinness at the time. We've owned stock in some other U.K. companies. But we've thought twice before going over three percent, because of the reporting requirements, and then we'd have to report if we were selling, and all of that. So that's a deterrent, but it's not an overwhelming deterrent. And if we, you know, if we get a chance to buy a significant piece of something that we think is cheap, particularly if we could buy it in one purchase. But there's a lot of special rules that kick in, over in the U.K., that do not in the United States. Incidentally, there was something in the Journal the other day that said that we had to report if we bought over five percent of a company within 10 business days in the U.S. That is not true. That was a mistake in the report. But it is the case in the U.K. that at 3 percent, reporting is triggered. But there — we would feel very comfortable with lots of U.K. businesses. And, you know, they'd have — it'd be the same criteria we applied over here: a durable competitive advantage, and a management that we like and trust, and a reasonable price. And we have seen some of those. There was an insurance company in the U.K., a year or so back, that I would very much have liked to have bought, but we couldn't come to terms on price. But we have no bias whatsoever against buying businesses in the U.K. And as I say, we've — at Yorkshire and Northern Electric, you know, we have a business that, shows in our report, made close to $300 million after-tax. And actually, considering my views on currency, you know, I would have — I'd give a slight edge to buying something where the earnings would be in sterling in the future, rather than in dollars. Charlie?

CHARLIE MUNGERWell, I regard it as kind of amusing that we ended up preferring the currencies of Europe when it's so much more socialized than the United States is. That's a queer occurrence.

WARREN BUFFETTYou actually prefer them or not, Charlie? (Laughs)

CHARLIE MUNGERWell, certainly in recent — over a considerable period of recent months — we've actually preferred the currencies of socialized Europe to our own currency. I just regard that as an odd occurrence for both of us. That wouldn't have happened.

WARREN BUFFETTNo. Up till three years ago, if I came back from Europe and I had a euro in my pocket I couldn't wait to run to the bank or someplace. I was afraid it would depreciate before I could get rid of it. But I changed my views a few years ago. We hope to buy businesses, and stocks, other places in the world. And Charlie mentions the difference in political climate. One thing: you read about slow growth in Europe and Japan and all those, and it's true. But usually — but the growth figures that you see are usually not on a per capita basis. And since the population of Europe has been, generally, very little changed, whereas the population of the United States grows one or one- and-a-half percent a year, if you look at growth figures in the United States and somebody says three- and-a-fraction percent, that's not on a per capita basis. I mean, you've got to — you have to deflate that by the growth in population. Whereas, if you read about the growth in Europe, generally, you're dealing with a population base that hasn't changed. So the differences in growth rate on a per capita basis are not as wide as the headlines would suggest.

Legal liability for someone else's accounting?

WARREN BUFFETTNumber 7.

AUDIENCE MEMBERGentlemen, my name's Mike McCloskey. I'm from Toronto, Canada. My question is: what obligation does a financial intermediary, or a party to a transaction, have to ensure that the other party to the transaction properly accounts for it.

WARREN BUFFETTWell, that question may come up in a very real sense. (Laughs) But, you know, we have lots of reinsurance transactions, obviously. Banks have lots of transactions with people. Certainly, if you knowingly are doing something that causes a company that are participating in it, you know, you may have very serious obligations on that. But on the other hand, if you're — I mean, we reinsure hundreds of companies. They have legal departments. They have auditors. And there could be somebody out there today — well, they could be doing anything with their accounting. It probably wouldn't be limited to the contract they had with us. It might well be other things. But it really gets down to whether there's knowing participation, I would say. Isn't that right, Charlie?

CHARLIE MUNGERWell, as you say, it's a subject rife with ambiguities and different issues. You have had some bartender liability, if you serve a drink to somebody that's already inebriated, why, some people say the bartender is liable. On the other hand, radio stations are allowed, in America, to sell advertising time to people that use it for perfectly obvious fraud, and nobody ever sues the radio station. It's very hard to predict what things are going to get legally shifted around so a supplier gets liability for its customer's behavior.

Invest in yourself and ignore asset allocation

WARREN BUFFETTNumber 8.

AUDIENCE MEMBERMy name is (UNINTEL). I live in Sacramento, California. My question is related to the issue of U.S. trade deficit again and its implications on the future value of the dollar. Do you think an individual or a business owner here in U.S. should be concerned about the purchasing power of his future dollar earnings or savings, and diversify his or her investments in non-dollar-based securities?

WARREN BUFFETTI think it's very tough for individuals to either select individual stocks, select individual times to enter the market, select currencies. I mean, I just think that's a game that they tend to get interested in at the wrong time. There's some adverse selection, in terms of when people who do not follow stocks carefully get interested in stocks. I think that, you know, the best investment you can have, for most people, is in your own abilities. I mean, when I talk to students, you know, I would pay a student — in many cases, I would be glad to, you know, pay them $100,000, cash up front, for 10 percent of all their future earnings. So, I'm willing to pay 100,000 for 10 percent of them, I'm valuing the whole person at a million dollars, just capital value standing there in front of me. And those — anything you do to develop your own abilities is probably going to be — or your own business — is probably going to be more productive for you than starting to think about individually making commitments into foreign exchange. If you have a good business in this country earning money in dollars, you'll do ok. I mean, you may live in a world 20 years from now where a couple percent of the GDP is going to service the debts and the ownership that we've created now by running these deficits. But you'll do fine in America. So, I wouldn't worry about that much. Charlie?

CHARLIE MUNGERWell, if you look at Berkshire, you will find that it really doesn't do much of conventional asset allocation to categories. We are looking for opportunities and we don't much care what category they're in, and we certainly don't want to have our search for opportunities governed by some predetermined artificial bunch of categories. In this sense, we're totally out of step with modern investment management, but we think they're wrong.

WARREN BUFFETTYeah. And incidentally, we have 80 percent of our money, or more — well over 80 percent — tied to this country and to the dollar. So it's not like, you know, we've left the country or anything of the sort.

CHARLIE MUNGERWhen have you done a big asset allocation strategy?

WARREN BUFFETTNever.

CHARLIE MUNGERYeah.

WARREN BUFFETTYeah. We end up with peculiar asset mixes. I mean, if the junk bond thing had gone on a little longer, instead of having 7 billion in there, we might have had 30 billion in. But we were doing that simply based on the fact that it was screaming at us. And we do the same thing with equities. I mean, back — for many years, we had more than the net worth of Berkshire in equity positions. But they were cheap.

CHARLIE MUNGERAnd I want you to remember one of my favorite sayings as you do this asset allocation. "If a thing's not worth doing at all, it's not worth doing well." (Laughter)

WARREN BUFFETTYou can see why Ben Franklin turned the mantle over to Charlie. (Laughter)

Lunch break

WARREN BUFFETTWe're going to take a break now, so you can all go out there and enjoy yourself in the adjoining room, and have lunch, and we'll be back here at 12:45. And those in the other room might come back to this area because I think we'll have enough seats for everybody after lunch.