2007 年股东大会 · 上午场

Jimmy Buffett sings "Berkshire Hathaway-ville"

ANNOUNCERAnd now, please welcome the charming, insightful, witty, rather brilliant, debonair, influential, well-heeled yet down-to-earth, talented, surprisingly modest, handsome, and refined exemplar of unflappable character, Mr. Buffett. (Applause and cheers as musician Jimmy Buffett comes on stage with a guitar)

JIMMY BUFFETTWho were you expecting? My junior partner? (Laughter) For those of you who don't know, I'm the distant cousin, Jimmy Buffett. This would be a good day to rob a bank in Omaha. Everybody's here, you know, so — (Applause) I couldn't be around for the game with LeBron James. I was busy working on my wardrobe for this surprise appearance. This is my first time in the Qwest Center, so I feel very at home in large spaces like this. It's great to be back in Omaha. (Applause) That's the good news. The disturbing news is, as a long-time Berkshire Hathaway stockholder and shareholder, the big question is, you know, those guys are getting up in age, you know, Charlie and Warren. Who are they going to leave it to? Well — (laughter) — I got news for you. We did a genetic test, Warren and I did. You won't see that in your program or in the shareholders report. And somewhere back about 6,000 years ago, in some ancient village in Scandinavia, they were trading Buffett genes, and I got the talent. He got the business. So, later on in life, after Doris [Buffett, Warren's sister] introduced us — I don't know, 30 years ago — I started figuring out, so I better get that business thing going as well. So, since blood is thicker than water, I am your new chairman. So, I hope you like that. (Applause) Don't run out to sell. I'm keeping my mine. (Laughter) So, on the way out here on the plane, I figured — it was an interesting day, if you read The New York Times business section yesterday. There was a lot going on. So, I thought I would — this song has done very well for me, so I thought I would bring this for my first appearance in Omaha at the Qwest Center — I would rewrite a little "Margaritaville" with a little Berkshire — well, actually we're wasting away in Berkshire Hathaway-ville this — today. I've never sung this early in the morning, except on the [NBC] "Today" show, so you're not paying, so don't worry about it, so — (Laughter) Don't worry, I'm a semi-professional. This is OK. I will be looking at these notes. As you can tell, Warren gave me a really big budget for a teleprompter here. (Laughter) All right. So, you can sing along if — but you will not know — you'll know a few of the words to these songs. But then I'll try to do this slowly, and I have my bifocals, so I think we're in good shape here, so — We'll start the morning off with a little hymn. (Singing to the melody of "Margaritaville") Nibblin' on sponge cake, And Omaha beef steak, Watchin' you stockholders buying the rounds. The Qwest Center's rockin', The press is all blockin'. There isn't a doubt Warren's big in this town. Wastin' away in Berkshire Hathaway-a-ville, Searchin' for my lost box of See's. Some people claim that Charlie Munger's to blame, And you know, Rupert Murdoch is peeved. From World Books to sofas, Jet planes, diamonds, and (inaubible), (Inaudible) in euros, Let's not forget euros. (Spoken) Uh oh. I made a mistake here. All right. Hold on. You won't pay for that, OK? Are you going anywhere? We'll start again. From — from — Let me get these bifocals off here. (Singing) From World Books to sofas, (Inaudible) and (inaubible), Jet planes, diamonds, and underwear cover the floor. (Spoken) It was the Fruit of the Loom that got me. (Singing) Tool books (inaudible). Let's don’t forget euro, Make all those — (Spoken) Oh, this is a good line. I got to — (Singing) Make all those hedge funders Want to go and buy stores. Wastin' away again in Berkshire Hathaway-ville, Searchin' for some good companies to buy. Some people claim privatization's to blame, But we know, this holding company's on fire. So, who was the wizard, Who thought up the lizard, To sell car insurance to humans while making some jokes? Projects we'll surmount, But I still want that discount. Can someone show me where they're sitting those rich Geico bulbs? Wastin' away again in Berkshire Hathaway-ville, Searchin' for my lost shaker of salt. And some people claim that Doris Buffett's to blame, But I know this is all Warren's fault. And some people claim that ukulele's to blame, If there's a God, he'll turn that thing into (inaubible). (Applause) (Spoken) All right. So you thought I was kidding about that running the company stuff, didn't you? So — I was. (Laughs) That's a big relief there. So, with a great bit of pride and admiration, please welcome my junior partners, Warren and Charlie. (Applause)

WARREN BUFFETTSeparated at birth. Separated at birth. (Laughs) Thanks, Jimmy.

JIMMY BUFFETTAll right.

WARREN BUFFETTOK. I actually had asked Charlie to do that number — (Laughs)

Opening remarks

WARREN BUFFETTGot a lot of people to thank, starting off with Jimmy. Wonderful. We hid him out — came in last night kind of late and we — to be sure it was a surprise, we stashed him away over at the Hilton, and I just want to say thanks to him. We both got the commercial gene, but unfortunately, he got the singing gene. I got this voice you're hearing. We — the movie, as we mentioned, we get a lot of help from a lot of people. They all do it just for the fun of it. I particularly want to thank Andy Heyward of DIC who did that cartoon. He's done them now for a number of years. They come back here to get my voice recorded and to get Bill's [Gates] voice and Charlie's voice. They do it all themselves just to participate in the movie. Andy and I — I'm working with Andy on a cartoon series that will be out pretty soon, which we're aiming toward younger people to try and work a little financial education into a good time on Saturday morning for kids. And we'll see how that all comes out. But Andy is wonderful to work with. It's been — (Applause)

WARREN BUFFETTMy daughter Suze puts that movie together. It's a lot of work and it's a labor of love. She does a terrific job, and I just want to thank her for — as usual. (Applause) Thank you.

WARREN BUFFETTThen finally I want to particularly thank the grand impresario of this whole affair is Kelly Broz. And Kelly puts this all together, the exhibition hall. I just turn it over to her. I forget about it, and Charlie and I just show up on Saturday morning. And Kelly is having her 50th birthday tomorrow. So, Kelly, would you stand up and take a bow, please. Yeah. (Singing) Happy birthday to you. Happy birthday to you. Happy birthday, dear Kelly. Happy birthday to you. For Kelly. (Applause)

WARREN BUFFETTNow, today we're going to follow the usual format. We have a number of microphones placed around this room and we have overflow rooms. We will go from one station to the other, keep going until about noon or thereabouts, and then we'll break for 30 or 45 minutes for lunch. We'll come back here, and we will then go until about 3 o'clock, continuing the same routine. We don't prescreen the questions or the questioners. It's whoever got in line first for the microphones. At 3 we will take a break for a few minutes. We will reconvene at 3:15 for the official business meeting. We have an item of business — normally we take care of business in about five minutes, re-elect the directors. But today we have an item on the proxy relative to our holdings of PetroChina. We were not required to put that on the ballot. The SEC told us we didn't have to, but we really thought it would be a good idea to do it so that all of you that are interested can hear about our reasoning and the reasoning of the people who disagree with us. We'll give them plenty of time to tell you why they think we're wrong and we'll respond. And I hope anybody that's interested at all on the subject, I hope you stay right until 4 o'clock when we will adjourn, because Charlie and I are then going to greet, perhaps, as many as 600 shareholders who have come from outside of North America. We have a record number. I think we have a hundred or so from Australia, and we have close to that number from South Africa. We have shareholders from all over the world. So we feel if they come all the way to Omaha, Charlie and I would at least like to shake their hands, and we have that from about 4 till 6:00 o'clock, and then we'll be doing some other things this evening. But that is the drill for this meeting. We won't elect the directors until the regular meeting, which commences at 3:15, but I would like to introduce them at this time and we have a few special announcements in that connection.

Berkshire directors introduced

WARREN BUFFETTBut we start off — this is Charlie, this fellow that's been making all the noise over here. (Laughter) He's quite hyperkinetic. But we seem — I think he's on his medicine. (Laughter) Charlie, incidentally, can hear quite well and I can see, so we work together. I have a little — I thought I was doing pretty well when I remembered his name, actually. But our combined ages are 159 for those of you who can't work with big numbers. So Charlie. And then we have — and if you'll stand as I read your name — Howard Buffett. (Applause) Bill Gates. (Applause) Sandy Gottesman. (Applause) Charlotte Guyman. (Applause) A former Omahan, Don Keough. (Applause) Tom Murphy. (Applause) Ron Olson. (Applause) And a lifetime Omahan, Walter Scott. (Applause) Now, in addition, we have with us a director whose family has been involved with Berkshire Hathaway and its predecessor companies for over a hundred years. His father played a very key role in Buffett partnership obtaining control of Berkshire Hathaway in 1965. He was supportive in every possible way, as his father, and now his son. And Kim Chace has been on our board for a great number of years. He's been a — just like his father before him, he's been a wonderful director. He's been a great friend. He will be leaving the board this year, but Kim is here with his family and, Kim and the family, if you would stand up, I'd like the shareholders to recognize you. (Applause)

WARREN BUFFETTAnd then finally we will have a new director get elected, and I've got the votes in my pocket so there's no question about it, and that is Sue Decker. And, Sue, if you will, please stand. (Applause)

Q1 earnings are "good"

WARREN BUFFETTJust one or two items of business the — before we start the questioning. We did report our earnings yesterday after the close, and I can't see the — are they up on the monitor? But it was a good first quarter. We had a good year last year. The insurance earnings are going to go down. There's no question about that. How much they go down depends on Mother Nature and a few other factors. But it's been an extraordinary period for insurance. I mean, nothing bad happened last year, and the same was true in the first quarter. As you might expect, that favorable experience has caused people to lower prices in some areas quite dramatically. And the nature of insurance, if you write a one-year contract, say, six months ago, you were still getting premium at the old rate, if you write at a one-year policy, for another six months. So there's a lag effect when things are getting either better or worse. And the lag effect from this point forward, we will — our insurance rates results will show the effect of lower prices. They will probably show — certainly we have the most benign hurricane season imaginable last year. We have less hurricane exposure that we've written this year but, nevertheless, as natural catastrophes occur we will be paying out lots of money if and when they occur. It couldn't get any better than it was last year from our standpoint. So things in the insurance world, our insurance earnings, underwriting earnings, are bound to decrease. Now, what we really hope over time is more or less to break even on the underwriting of insurance. So when you see a significant profit like last year or underwriting profit this year, just look at that as kind of the good side of what will later be an offset to it in a way of an underwriting loss. But if we break even in insurance on underwriting, we do very, very well because we generate lots of float and we earn money on that float and our float is at an all-time high. So this is really the frosting on the cake when we have an underwriting profit, and it's not to be expected to necessarily — well, it won't occur year after year. Ever since we've been in the insurance business, about half the years we've made money underwriting and half we haven't. I think our mix of business now is such that we'll even maybe do a touch better than that in the future, but we won't do anything like what we did in the last year and in the first quarter this year. There's one unusual item in our balance sheet that you should be aware of. March 31, you'll see our receivables went up by about $7 billion. That was because of the Equitas transaction I described in the annual report. On March 31st, the deal, basically, was closed at the end of the quarter. So we had a receivable of 7 billion, and then a couple of days later we were given 7 billion of cash and securities. So that receivable very quickly turned into liquid assets, cash. And we sold all those securities we got. So we had 7 billion transferred from receivables to cash very early in April. Other than that, most of our noninsurance businesses did fine. The residential construction-related businesses are getting hit, in some cases getting hit very hard, and in some cases getting just — but still reflecting decreases in their business. And my guess is that that continues, perhaps, for quite a while. So you will see lower earnings coming from the companies that are related to residential construction such as Shaw, Johns Manville, ACME Brick, and that group. But overall, compared to the companies they compete with, our managers continue to do an absolutely sensational job. We have the greatest group of managers and, for that matter, we've got the greatest group of stockholders, of any company I know of in the world, and Charlie and I are very grateful. You saw in the movie Charlie and I going over there to give the fellows in Israel a lot of advice on how to run their operation better. And Charlie might want to — you might want to comment on ISCAR.

CHARLIE MUNGERWell, that was a great experience, and ISCAR is a very great company. I have never seen anything as automated as that ISCAR operation. I think they regard it as a disgrace if any human hand has to do anything.

WARREN BUFFETTWe bought it without looking at it, but after we looked at it, we really liked it. (Laughter) For those of you who won't be around for the 3:15 — and I hope everybody that's interested sticks around for that — it will be an interesting discussion. But we do have a preliminary vote. Again, I can't see the vote up there. But, [CFO] Marc [Hamburg], is the vote up there? Unable to hear anything there, but I assume it. The — basically, I can't see it from here, but it's about 2 percent are in favor of the resolution and about 98 percent opposed. And that was true of both the A and the B stock. So there really wasn't any great difference in the way people voted on the proposal. And even if you leave out my personal vote, which was against, it's about a 25-to-one margin that voted in opposition to it. And anybody that wishes to vote in person or to change their vote, be sure and stay for the meeting at 3:15, and I think you'll find the discussion very interesting if you care to stay.

Buffett sees no private equity "bubble" about to burst

WARREN BUFFETTLet's get a map here. Here we are. We will start with area 1, which I think is over here, and there we are and we have a questioner.

AUDIENCE MEMBERGood morning, Mr. Buffett and Mr. Munger. My name is Kevin Truitt (PH) from Chicago, Illinois. Thank you both for, again, hosting this "Woodstock for Capitalists" for your shareholders and fellow capitalists. I have two questions. My first question is for both Mr. Buffett and Mr. Munger.

WARREN BUFFETTI don't like to interrupt you, but we're only letting everybody do one question, so pick whichever one you feel the strongest about getting an answer for, please.

AUDIENCE MEMBEROK. First, given the ocean of equity money that is out there — private equity money — that is out there today chasing deals, and with the quality of the deals continually diminishing as the quantity of good deals continues to go down, and given the fact that these private equity funds are getting their equity portion of the money from pension funds and college endowments and using very high levels of borrowed money from the banks, this has the look, feel, and smell of a bubble that is about to burst and is likely to end badly for many of the deal-makers and the investors. What events, in your opinion, could cause this bubble to burst, and how do you think this is likely to all end?

WARREN BUFFETTWell, as you were reading off that list, we are competing with those people, so I started to cry as you — (laughs) — explained the difficulty we have in finding things to buy. The nature of the private equity activity is such that it really isn't a bubble that bursts. Because if you're running a large private equity fund and you lock up $20 billion for five or longer years and you buy businesses which are not priced daily, as a practical matter, the plug will not — even if you do a poor job, it's going to take many years before the score is put up on the score board, and it takes many years, in most cases, for people to get out of the private equity fund even if they wished to earlier. So it does not — it's not like a lot of leverage can lead to in-marketable securities or something there. And the investors can't leave and the scorecard is lacking for a long time. What will slow down the activity — or what could slow down the activity — is if yields on junk bonds became much higher than yields on high-grade bonds. Right now the spread between yields on junk bonds and high-grade bonds is down to a very low level, and history has shown that periodically that spread widens quite dramatically. That will slow down the deals, but it won't cause the investors to get their money back. There's one other aspect, of course, that — of this frenzied activity, you might say, in private equity is that if you have a $20 billion fund and you're getting a 2 percent fee on it or $400 million a year, which seems like chump change to those that are managing them but sounds like real money in Omaha — if you're getting 400 million a year from that $20 billion fund, you can't start another fund with a straight face until you get that money pretty well invested. It's very hard to go back to your investors and say, well, I've got 18 billion uninvested and I'd like you to give me money for another fund. So there's a great compulsion to invest very quickly because it's the way to get another fund and another bunch of fees coming in. And those are not competitors for businesses that Charlie and I are going to be particularly effective in competing with. I mean, they — we are going to own anything we buy forever. The math has to make sense to us. We're not given to optimistic assumptions, and we don't get paid based on activity. But I think it will be quite some time before — it's likely to be quite some time — before disillusionment sets in and the money quits flowing to these people that are promoting these. And whether they can continue to make deals will depend on whether people will give them lots of financing at what I would regard as quite low rates. Charlie?

CHARLIE MUNGERYeah. It can continue to go on a long time after you're in a state of total revulsion.

WARREN BUFFETTThe voice of optimism has spoken. (Laughter.)

I didn't do enough to "sell" Berkshire internationally

WARREN BUFFETTWe'll go on to 2. And I should have mentioned at the start. We really only take one question per person because there's a lot of people waiting and some people get very talented about rolling four or five into one, but we — we've gotten more talented about unraveling them, so try to keep it to one. Area 2, please.

AUDIENCE MEMBERGreetings to all of you from the Midwest of Europe from the city of Bonn in Germany. My name is Norman Rentrop. I'm a shareholder in Berkshire since 1992, as well as a shareholder in Wesco and Cologne Re. I'm a great admirer of both of you and want to thank you again for sharing your wisdom with us and for continuing to stay humble by managing Berkshire for the benefit of all of us without any big 2 and 20 percent fees, without stock option plans. (Applause)

WARREN BUFFETTBe careful. You're giving Charlie ideas here. (Laughter)

AUDIENCE MEMBERAnd I want to applaud you in setting another great example by donating most of your wealth to charity and for donating — (applause) — and for donating it in a very intelligent and selfless — that it's not your name on the foundation — way. Now, I'm a little disturbed by the remarks from another great investor, from John Templeton, who continues to say that you are narrow-sighted in not investing more overseas. You do focus on the U.S. with relatively little, so far, internationally. You explained that it doesn't really matter whether a company is headquartered in the U.S. or London or Munich or Paris, and that you would pay almost as high an amount for such companies as for similar U.S. companies. You were audacious to invest your petty cash in South Korean stocks. Coca-Cola went totally global many years ago; whereas, Hershey's missed the opportunity to go global, leaving the chocolate globalization to Swiss-based Lindt & Sprungli. Now, what would it take you to go totally global with Berkshire by investing internationally in a big way?

WARREN BUFFETTWell, that's a very good question. And I would say that I know I probably bought my first stock outside the United States at least 50 years ago. It is not that we have not looked in the marketable securities field beyond this country, and we've made some investments there. It really wouldn't make any difference to us if Coca-Cola was based in Amsterdam or Munich or Atlanta as long as they had the business they had. So we're very involved in international business, but the hard fact is that in terms of buying entire businesses, we were simply not on the radar screen to the same extent — close to the same extend —outside the United States as we became in the United States. When we started in the United States, really, nobody knew anything about Berkshire, either, so we had — we had a selling job to do here, but we did not do the selling job — or I did not do the selling job — well abroad. And thanks to Eitan Wertheimer, he found us. And I think has contributed in a very significant way to getting us better known. We have no bias against buying either marketable securities or entire businesses outside the United States. Eitan is even planning a little procedure to get us even better known — get Berkshire even better known — outside the United States, and I'm going to participate in that with him within the next six or eight months. But we can be very validly criticized for not being a better effort to get on that radar screen. I think we're — I think it's improving. We own a number of non-U.S. securities. We own stock in — just stock, marketable securities — we own two that are based in Germany, and we own others — as it's been pointed out — we own, for example, 4 percent of POSCO, which is based in South Korea. That's over a billion-dollar investment at current market. And we have — I can think of a half a dozen or so marketable securities investments outside the United States. We don't have to report those in the 13F — I believe I'm right on this, [CFO] Marc [Hamburg] — so they don't necessarily get picked up the same way as do our domestic investments by reports we make to the SEC. There's a problem — for example, in Germany we have to report our holdings in Germany if our holdings exceed 3 percent. Well, if you're talking about a company with 10 billion in market value, that means at $300 million we have to tell the world what we're buying, and telling the world what we're buying is not the favorite activity of Charlie and myself. So — and it tends to screw up future buying. So that 3 percent threshold, which exists in the UK, exists in Germany, is a real minus to us, in terms of accumulating shares. But I can assure you that the entire world is definitely on our radar screen, and we hope to be on its. Charlie?

CHARLIE MUNGERWell yes. I'd say that John Templeton made a fortune going into Japan very early and having the Japanese stocks go up to 30 or 40 times earnings. And that was a very admirable piece of investment. But, you know, we did all right in the same period. (Applause)

CEO compensation is a "joke"

WARREN BUFFETTLet's go to station 3, please.

AUDIENCE MEMBERHi. (Inaudible). I lived most of my life in India, but now in Hoboken, New Jersey. Warren, first thank you for replying to my letter. I misspelled your name, and where I come from if I did the same thing, the reply would have been, more on, get my name correct before asking a question. So thank you once again. Investment managers nowadays are benefiting a lot more at the expense of the investors and the (inaudible). My question is both to you and Charlie is, what do you think is the best structure/fees that managers should have that will give him an opportunity to maximize the time (inaudible) and money (inaudible) over the next few decades and being fair to the profession — the investors and himself? Thank you.

WARREN BUFFETTBefore I answer that, I think I should tell you a very short story. It's a little embarrassing, but I got worried a few years ago about Charlie's hearing. But I mean, the guy's been my pal for 45 or 50 years. I didn't really want to confront him with this apparent evidence of old age. So I went to a doctor and I said, "You know, I got this good pal. I don't think he's hearing so well. I really don't want to confront him with it, so what do you suggest I do to check this out?" He said, "Well, stand across the room, talk in a normal tone of voice, see what happens." So the next time I was with Charlie, I got across the room and I said, "Charlie, I think we ought to buy General Motors at 30. Do you agree?" Not a flicker. Not a flicker. I went halfway across the room. I said, "Charlie, I think we ought to buy General Motors at 30. Do you agree?" Nothing changes. Get right next to him, put my voice in his ear and said, "Charlie, I think we ought to buy General Motors at 30. Do you agree?" Charlie said, "For the third time, yes." (Laughter) So, Charlie, would you like to address that question? (Laughter)

CHARLIE MUNGERYes. The question addressed the problem of unfairness of executive compensation and the effects of that unfairness on investors. And now that you know the question, you can solve the problem. (Laughter)

WARREN BUFFETTWell, Charlie and I have plenty to say about compensation, and some of it makes our stomach turn. I will say this, though. There are more problems with having the wrong manager than with having the wrong compensation system. I mean, it is enormously important who runs — you name the company — Proctor & Gamble, Coca-Cola, American Express — and any compensation sins are generally of minor importance compared to the sin of having somebody that's mediocre running a huge company. That said, Charlie and I think that compensation has — there's a natural tendency — because of ratcheting, because of the publicity of what other people get, and because of the lack of intensity in the bargaining process. I mean, you read about labor contracts, you know, where impasses go on for weeks and where they negotiate till 3 in the morning and, you know, both sides take their case to the press and everything. I ask you, when have you heard of a comp committee, you know, working until 4 in the morning, declaring an impasse for a week, not being able to make a deal? It just doesn't happen because the CEO cares enormously how he or she is paid, and to the comp committee — and they're doing, perhaps, a little better job now — but it's basically play money. And, of course, as I've pointed out in the past, I've been on 19 boards. They put me on one comp committee and they regretted it subsequently. You know, they are looking for cocker spaniels with their tails wagging to put on comp committees and, you know, they're not looking for Dobermans. And I try to pretend I'm a cocker spaniel just to get on one, but it doesn't work. (Laughter) But it is not — there is not a parity of intensity in the bargaining process. One guy cares enormously and the others don't. And as Charlie has pointed out in the past, what really drives a lot of this ratcheting impact is envy. I saw that on Wall Street. You can talk about greed, but if you paid somebody $2 million, they might be quite happy until they found out the guy next to them made 2 million-one, and then they were miserable. And Charlie has also pointed out that envy, of the seven deadly sins, is probably the dumbest, because if you're envious of somebody, you feel terrible and, you know, the other guy isn't bothered at all. So all you get out of envy is this miserable grinding in your stomach and all that sort of thing. You know, compare that to some of the other sins like gluttony, which we are about to engage in. (Laughter) You know, there's some upside to gluttony. I'm told there's upside to lust, but I'll leave that to Charlie to explain. (Laughter) But envy, where the hell is the upside, you know? But it does produce this ratcheting effect in pay. The comp committee sits down. The human relations person comes in. The human relations person knows what the CEO thinks of them is going to determine their future, and the human relations department recommends some comp consultant. The comp consultant knows that his recommendation to other firms is dependent on what these people say about him. So under those circumstances, you know, can you imagine that it's anything like a fair fight? It's a joke. Charlie?

CHARLIE MUNGERYes. The process is contributed to by a wonderful bunch of people called compensation consultants. And that reminds me of the old story where the mother asked the child why she told the census taker that the man of the house was in prison for embezzlement. And the child said, "I didn't want to admit he was a compensation consultant." (Laughter)

WARREN BUFFETTWe'll get around to the rest of you later on, too. Don't feel smug because we haven't attacked your — I just had a note handed to me. We do have about 27,000 people here. The overflow rooms are full, and we will have a whole bunch in the exhibition hall as well. (Applause)

Corporate jets can be good

WARREN BUFFETTLet's go to number 4.

AUDIENCE MEMBERYes. Good morning. I'm Rob (inaudible). I'm from the UK, and I traveled from Switzerland to be here today. This is a question that Charlie will like. There's a study by David Yermack that companies with private jets underperform their peers by 4 percent. What is the yardstick that you use to judge whether people are good stewards of money — management?

WARREN BUFFETTDid he direct that to you, Charlie?

CHARLIE MUNGERWell, he referred to private jets being a possible indication of executive excess. I want to report that we're solidly in favor of private jets. (Laughter)

WARREN BUFFETTWe even pay for them ourselves. (Laughs) Charlie used to only — he traveled on the bus, and only then when they offered a senior citizen's discount. But in recent years I've shamed him into getting his own NetJets share — I have my own — I have two NetJets shares. Actually, Berkshire is significantly better off in a number of its businesses, and including at the corporate level, because we use corporate jets. I don't know which deals wouldn't have been made, but I do know that — excuse me — I would not have had the same enthusiasm for traveling thousands of miles to go after deal after deal and so on. And I see what it produces at our — a number of our other businesses. So it has been a valuable business tool. It can be misused like anything else. I remember many, many years ago, we owned stock in a public company, and the CEO stopped off in Omaha on the way to see me, and he explained that they use some grocery chain in Idaho or something to be sort of their test case on all new products. And they would go visit it because they also had this lodge out there. I mean, you can abuse any system. But properly used, I would say that corporate jets have been a real asset to Berkshire. I would go back to this comp question just one second, too. I mean, comp is not rocket science. I mean, we have very simple systems that compensate those people whose pictures you saw during the movie. They're terrific people. We compensate them based on things that are under their control and that we care about. And we don't make it complicated, and we don't pay them for things that are happening that they have nothing to do with. I mean, we talked last year about what you do in a commodity business like copper, oil. I mean, if oil goes from $30 to $60 a barrel, there's no reason in the world why oil executives should get paid more for what's going on. They didn't get it to $60 a barrel. If they have low finding costs, which is under their control, and which is important, I would pay like crazy for that, because a person who finds oil and develops reserves at $6 a barrel is worth a lot more than somebody that finds and develops them at $10 a barrel, assuming they're similar quality reserves. That is the job that you hire the person for. But the price of oil, they've got nothing to do with it, and to hand them huge checks because oil goes up or to cut them back because it goes down — if oil went down and somebody had the lowest finding costs that was working for us, we would pay them like crazy. Charlie?

CHARLIE MUNGERYeah. Well, I'd like to go back to that corporate jet thing. If the trappings of power are greatly abused, I think you would find a correlation that some of those companies would be disappointing to investors. And, you know, man has known for a long time that getting too enchanted with the trappings of power is counterproductive. The Roman emperor that's most remembered as presiding over a period of great felicity was Marcus Aurelius, who was totally against the trappings of power even though he had them all — he had all the power. So I think all these things can be abused, and I think the best way to tackle a subject is to provide examples of contrary behavior.

WARREN BUFFETTCharlie, have a (inaudible) —

CHARLIE MUNGERI think I'll go over here.

WARREN BUFFETTThis is our idea of corporate benefits up here, lots of fudge, lots of peanut brittle. I recommend the diet to everyone.

"Extraordinary" things can happen when people panic

WARREN BUFFETTLet's go to number 5.

AUDIENCE MEMBERDavid Winters, Mountain Lakes, New Jersey. Could you please explain what you believe the impact and, hopefully benefit, of a credit contraction would be on Berkshire Hathaway, and maybe higher interest rates as well?

WARREN BUFFETTWell, we do benefit when others suffer. That doesn't mean we enjoy their suffering, but times of chaos in financial markets, the situation that existed in junk bonds in 2002, the situation that existed in equities, you know, back in 1974. So I don't think you'll necessarily see a contraction in credit. That — I think most authorities are very reluctant to really step on the brakes. You know, it's too easy to figure out who did step on the brakes. But you could very well see some exogenous event that starts feeding on itself in markets. In fact, I think it's much more prone to feed on itself in markets than in most periods in the past, if you really got a shock to the system. And that would result in a huge widening of credit spreads, cheaper equity prices, all kinds of things that actually are helpful to Berkshire because we usually have at least some money around to do something at times like that. There will be periods like that. If you go back 30 or 40 years, when credit contracted, it just really wasn't available. Charlie and I went through a couple periods like that. We were trying to buy a bank in Chicago 40 — 40 or so years ago, and the only people that would lend it to us in the world — because banks weren't lending for acquisitions — we found some people over in Kuwait who said they'd lend it to us in dinars. And we thought, you know, it might be fine to borrow it, but when it came time to pay them back the dinars, they would probably be telling us what the dinar was worth, so we passed on that particular deal. But you had real credit contractions then. And, of course, the whole reason — not — I would say the major reason the Federal Reserve was established was the huge contractions in credit that were felt, particularly here in places like the Midwest where they were dependent on correspondent banks in the larger cities, and when those banks had problems, the banks here got shut off. And we really needed a system that would not have that happen except by design. And I would say the Fed, by design, is probably not going to produce any credit crunches. Charlie?

CHARLIE MUNGERWell, the last time we had that credit contraction, we made, what, a quick 3 or $4 billion? And we were acting with vigor. The whole investment world is more and more competitive, and if you talk about a real credit contraction, which gums up the whole civilization, no one would welcome that. And I would predict that if we ever had a really big credit contraction after a period like the one we're in with all this excess, which is causing so much envy and resentment, that we would get legislation that most of us wouldn't like.

WARREN BUFFETTThere's a book by Jonathan Alter that came out about a year ago that talks about the first hundred days after [President Franklin] Roosevelt took over [in 1933], and by the nature of the book it tells about some of the days before that, too. But if you want to get an example of — I mean, this country was close to the brink at that point, and, basically, Roosevelt got anything passed he wanted, just as fast as they could write the bills there, initially. And that was a good thing, you know, with banks closing and people dealing in scrip and that sort of thing. So nobody wants that to come back, and we've learned a lot more about that sort of thing since the Great Depression. I don't think you'll see an orchestrated credit contraction. Now, you had in 1998, in the fall, when Long-Term Capital Management got in trouble, you had a seize up of the credit markets. It wasn't an orchestrated by the Fed-type contraction. You simply had people panicked about even the most — even the safest of instruments and credit spreads doing things that they'd never done before. And that's rather an interesting example, because that was not a hundred years ago. It was less than ten years ago. You had all kinds of people with high IQs in Wall Street. You had all kinds of people with cash available. And you had some really extraordinary things happen in credit markets simply because people panicked and they felt other people were going to panic. And you get these second- and third-degree type reactions in markets. We will see that sort of thing again. It won't be the same but, you know, as Mark Twain said, history doesn't repeat itself but it rhymes. And we will have something that rhymes with 1998.

Munger reminds people "too much of John Adams"

WARREN BUFFETTNumber 6.

AUDIENCE MEMBERHello. My name is Andrew Paullin (PH), a former Michigander now from Woburn, Massachusetts. My question is for Charlie, though Warren, please add your thoughts as well. Charlie, you were quoted in "Poor Charlie's Almanack" as saying, quote, "Ben Franklin was a very good ambassador and whatever was wrong with him from John Adams' point of view probably helped him with the French," end quote. If you are willing, I'm curious to hear your additional thoughts regarding John Adams and his wife, Abigail Adams.

CHARLIE MUNGERWell, of course, they were wonderful people, both of them. And —

WARREN BUFFETTDid you know them personally, Charlie? (Laughter)

CHARLIE MUNGERNo. No. But if you wanted to have a really jolly evening, I would have taken Franklin every time. And the French love Franklin. I think I remind many people too much of John Adams and too little of Ben Franklin. (Laughter)

WARREN BUFFETTHe does pretty well in respect to Ben Franklin, too

Corporate profits can't stay at record highs

WARREN BUFFETTLet's go to number 7.

AUDIENCE MEMBERMy name Takashi Ito (PH) from Japan. In addition to the global excess liquidity, corporate profits are very high compared to the share of labor. Does that make it extra challenging for you to find investment opportunities? Thank you.

WARREN BUFFETTYes, corporate profits in the United States are — except for just a very few years — are record, in terms of GDP. I've been amazed that after being in a range between 4 and 6 percent of GDP, they have jumped upward. And — (coughs) — you would not think this would be sustainable over time. Excuse me just one second. Charlie, want to talk for a second? (Laughter) You've just heard him on the subject. But corporate profits, when they get up to 8 percent plus of GDP, you know, that is very high. And so far it has caused no reaction. One reaction could be higher corporate taxes. You have lots and lots of businesses in this country earning 20 or 25 percent on tangible equity in a world where long-term bond rates are 4 3/4 percent — government bond rates. That's extraordinary. If you'd read an economics book 40 years ago and it talked about that kind of a situation persisting, you wouldn't have found a book like that. I mean, that does not make sense under pure economic theory, but it's been occurring for some period of time and, as a matter of fact, it's gotten more extreme. Corporate profits continue to rise as a percentage of GDP. That means somebody else's share of GDP is going down. And you're quite correct that the labor component of GDP has actually fallen fairly significantly. Whether that becomes a political issue — maybe in the next campaign — whether it becomes something that Congress does something about — Congress has the power to change that ratio very quickly. Corporate tax rates not that long ago were 52 percent and now they're 35 percent and a whole lot of companies get by with paying 20 percent or less. So I would say that, at the moment, corporate America is kind of living in the best of all worlds, and history has shown that those conditions don't persist indefinitely. What brings it to an end, when it happens, I don't know. But I would not expect corporate profits to be eight-and-a-fraction percent of GDP, on average, in the future. Charlie?

CHARLIE MUNGERYeah. Of course, a lot of the profits are not in the manufacturing sector or the retailing sector, either. A lot of them are in this financial sector. And so we've had a huge flow of profit to banks and investment banks and investment management groups of all kinds, including various kinds of private equity. And that has, I think, no precedent. I don't think it's ever been as extreme as it is now. Do you agree with that?

WARREN BUFFETTYeah. And Charlie and I would have said 20 years ago — and we've done things in banking from time to time, including owning a bank. But if you had said to us, in a world of 4 3/4 percent long-term governments, will one major bank after another be earning more than 20 percent on tangible equity, dealing in what is basically a commodity — money — we would have said that that condition just wouldn't persist. Now, part of that is because the banks are geared up more. So if you earn 1 1/2 percent on deposits, you know, and you have — or 1 1/2 percent on assets — and you have assets of 15 times equity, you're going to be earning 22 1/2 percent on equity. And by gearing up more, it does improve the return on equity. But you still would think that would be self-neutralizing. You'd think that after one guy did it, another guy would do it, and then instead of earning 1 1/2 percent on assets, you'd earn, you know, 9/10 of a percent or 1 percent on assets, but it hasn't happened. It's gone on for a long time. And, you know, we are living — I'd have to look at a chart on it, but there may have been a year or two post-World War II, but I don't think that — I would bet there haven't been more than two or three years in the last 75 when corporate profits, as a percentage of GDP, have been this high.

CHARLIE MUNGERSome of this has come from consumer credit, which I think has been pushed to extremes that we've never before seen in the history of this country. Some other countries that pushed consumer credit very hard had enormous collapses. Korea had one, for instance, that caused chaos for, what, two or three years? Maybe longer. So I don't think this is a time to just swing for the fences.

WARREN BUFFETTAnd the chaos in 1997 and 1998 when the IMF stepped in, I mean, it was bad in Korea for a while. It produced some of the most ridiculously low stock prices that I've ever seen in my life. In fact, I mean, you could go back to 1932 in this country and you wouldn't have seen things any cheaper. And in the meantime, the companies rebuilt their balance sheets and their earning power. So things do turn around in financial markets. You will — if you're young enough, you will see everything and then some. I mention in the annual report, in looking for an investment manager to succeed me, that we care enormously about finding somebody who's not cognizant of everything risky that's already happened, but that also can envision things that have not yet been experienced. That's our job in the insurance business, and it's our job in the investment business. And there are a lot of people that just don't seem to — they're not — they're very smart, but they just — they're just not wired to think about troubles that they haven't actually witnessed before. But, you know, that's the problem Noah had. You know, the first 40 days, it was tough sledding for Noah, but he got revenge eventually.

We welcome short-sellers betting against us

WARREN BUFFETTLet's go to number 8.

AUDIENCE MEMBERHello. My name is Brian Bowalk (PH), Fremont, Nebraska. With the growing number of fail-to-deliver trades happening in our stock markets, including investors' cash accounts, Roth IRAs, and other retirement accounts, it seems like the problem is getting worse. With some companies being on the Regulation SHO list for hundreds of days, what can be done to make Wall Street deliver stock that they have sold but never delivered? Thank you.

WARREN BUFFETTYeah. The so-called fail to deliver and naked shorting, I think is the question. I don't know exact — I've never been in a position where I've asked a broker from whom I bought stock to give me the certificate and have them decline it for any period of time. I would think that you might have some action against them. But I've never — I do not see the problem at all with people shorting stocks. I mean, I would welcome people shorting Berkshire Hathaway. I mean, it — if you own stock, and they need to borrow from you, you can get some extra income from your stock. And the one sure buyer of your stock eventually is somebody who shorted it. I mean, that guy is going to buy it someday. And I have no problem with shorts. If there's some kind of a game that's played — and I've read about it — I've never seen it happen to anything that we've owned. Like I say, if anybody wants to naked short Berkshire Hathaway, they can do it until the cows come home, and we'll be happy to. We'll have a special meeting for them. But — and I would say this: the shorts generally have the tougher time of it in this world. I mean, there are more people bowling stocks for phony reasons than there are burying stocks for phony reasons. So I do not see shorts as any great threat to the world. If enough people shorted Berkshire stock, they would have to borrow it and they would pay you to borrow your stock and that's found money. We did that on USG. When USG got hammered after they went into bankruptcy — or maybe just before — one large brokerage firm came to us and they wanted us to lend them millions of shares and they paid us a lot of money. And we happily lent them the stock. We wished they borrowed more. In fact, we insisted that they borrow it for a given length of time just so that we could collect a large premium. And I don't know how many — I'd have to look it up but — I don't know whether it's in the hundred thousands or, maybe, low millions, but we were better off. And they didn't do too well shorting USG at $4 a share either, but it was immaterial to us. So I do not regard — I do not regard shorts as — it's a tough way to make a living. It's very easy to spot phony stocks and promoted stocks, but it's very hard to tell when that will turn around. And somebody that's promoted a stock to five times what it's worth, may very well promote it to ten times what it's worth, and if you're short, that can get very painful. Charlie, do you have any thoughts on shorting?

CHARLIE MUNGERWell, not on shorting. But those delays in delivering sometimes reflect a tremendous slop in the clearance process, and it is not good for a civilization to have huge slop in the clearance processes for its security trades. That would be sort of like having a lot of slop in the management of your atomic power plants. It's not a good idea to have slop that causes a lot of financial exposure that people are ignoring.

WARREN BUFFETTCharlie, reach back into your law practice. If I buy a thousand shares of General Motors, and my broker doesn't deliver it to me, and I ask him to deliver it and he doesn't deliver it to me after a week or two weeks or three weeks, what's the situation?

CHARLIE MUNGERWell, if you're a private customer, you may wait a while. And a lot of the other trades — the clearance systems do cause people to put up collateral and so on. But a lot of — take derivative trading. There's a lot of slop in derivative trading. And the clearance problem would be awful if a lot of people wanted to do something at once.

WARREN BUFFETTBut if I demand delivery after three weeks, can I walk into court and say I want my stock, I've given you the money?

CHARLIE MUNGERI don't think there's any court that can issue you a stock certificate just because you want it. No, the clearance system is failing you. Why, you can scream a lot, and you may have some ultimate remedy, but there's —

WARREN BUFFETTI'll get somebody else to represent me. (Laughter)

"Gambling is a tax on ignorance"

WARREN BUFFETTNumber 9.

AUDIENCE MEMBERHello, hello. My name is Johann Fortenberg (PH) from Hanover, Germany. Do you think gambling companies will have a great future? Thank you.

WARREN BUFFETTWhat kind of company?

CHARLIE MUNGERGambling companies.

WARREN BUFFETTGambling companies. Gambling companies will have a terrific future, if they're legal. You know, which ones or anything, I don't know anything about that. But the desire of people to gamble and to gamble in stocks, incidentally, too. Day trading, I would say, very often was — came very close to gambling as defined —. But people like to gamble, you know. I mean, it's a — if the Super Bowl is on — better yet, if a terribly boring football game is on but you don't have anything to do, and you're sitting there with somebody else, you're probably going to enjoy the game more if you bet a few bucks on it one way or the other. As you know, I mean, we insure hurricanes, so I watch the Weather Channel. But that's a — (Laughter) It can be exciting. (Laughter) But people — the human propensity to gamble is huge. Now, when it was legalized only in — pretty much in Nevada — you had to go to some distance, or break some laws, to do any serious gambling. But as the states learned to — you know, what a great source of revenue it was, they gradually made it easier and easier and easier for people to gamble. And, believe me, the easier it's made, the more people will gamble. I mean, when I was — my children are here, and 40 years ago I bought a slot machine and I put it up on our third floor, and I could give me kids any allowance they wanted as long as it was in dimes. I mean, I had it all back by nightfall. (Laughter) I thought it would be a good lesson for them. Now they weren't going to Las Vegas to do it, but believe me when it was on the third floor, they could find it, you know. And my payout ratio was terrible, too, but that's the kind of father I was. (Laughter) The — but gambling, you know, people are always going to want to do it. And for that reason, I particularly think that access — you know, in terms of friendly gambling or anything like that, I'm not a prude about it, but I do think that to quite an extent, gambling is a tax on ignorance. I mean, if you want to tax the ignorant, people who will do things with the odds against them, you know, you just put it in and guys like me don't have to pay taxes. I really don't — I find that — I find it kind of socially revolting when a government preys on the weaknesses of its citizenry rather than acts to serve them. And, believe me, when a government — (Applause)

WARREN BUFFETTWhen a government makes it easy for people to take their Social Security checks and start pulling handles or participating in lotteries or whatever it may be, it's a pretty cynical act. It works. It's a pretty cynical act. And it relieves taxes on those, you know, who don't fall for those or who don't — who aren't dreaming about having a car instead of actually having a car or dreaming about a color TV instead of having one. So it's not government at its best, and I think other things flow from that over time, too. Charlie?

CHARLIE MUNGERYou know, I would argue that the gambling casinos use clever psychological tricks to cause people to hurt themselves. There is undoubtedly a lot of harmless amusement in the casinos, but there's also a lot of grievous injury that is deliberately caused by the casinos. It's a dirty business, and I don't think you'll find a casino soon in Berkshire Hathaway. (Applause)

How to be a better investor

WARREN BUFFETTNumber 10, please.

AUDIENCE MEMBERGood morning. I'm Thomas Gamay (PH) from San Francisco. I'm 17-years-old and this is my tenth consecutive annual meeting. (Applause)

WARREN BUFFETTYou must be a Ph.D. by now at least.

AUDIENCE MEMBERMr. Buffett and Mr. Munger, I'm curious about what you think is the best way to become a better investor. Should I get an MBA? Get more work experience? Read more Charlie Munger almanacs or merely is it genetic and out of my hands?

WARREN BUFFETTWell, I think you should read everything you can. I can tell you in my own case, I think by the time I was — well, I know by the time I was ten — I'd read every book in the Omaha Public Library that had anything to do with investing, and many of them I'd read twice. So I don't think there's anything like reading, and not just as limited to investing at all. But you've just got to fill up your mind with various competing thoughts and sort them out as to what really makes sense over time. And then once you've done a lot of that, I think you have to jump in the water, because investing on paper and doing — you know, and investing with real money, you know, is like the difference between reading a romance novel and doing something else. (Laughter) There is nothing like actually having a little experience in investing. And you soon find out whether you like it. If you like it, if it turns you on, you know, you're probably going to do well on it. And the earlier you start, the better, in terms of reading. But, you know, I read a book at age 19 that formed my framework for thinking about investments ever since. I mean, what I'm doing today at 76 is running things through the same thought pattern that I got from a book I read when I was 19. And I read all the other books, too, but if you — and you have to read a lot of them to know which ones really do jump out at you and which ideas jump out at you over time. So I would say that read and then, on a small scale in a way that can't hurt you financially, do some of it yourself. Charlie?

CHARLIE MUNGERWell, Sandy Gottesman, who is a Berkshire director, runs a large and successful investment operation, and you can tell what he thinks causes people to learn to be good investors by noticing his employment practices. When a young man comes to Sandy, he asks a very simple question, no matter how young the man is. He says, "What do you own and why do you own it?" And if you haven't been interested enough in the subject to have that involvement already, why, he'd rather you go somewhere else.

WARREN BUFFETTYeah. It's very — that whole idea that you own a business, you know, is vital to the investment process. If you were going to buy a farm, you'd say, I'm buying this 160-acre farm because I expect that the farm will produce 120 bushels an acre of corn or 45 bushels an acre of soybeans and I can buy — you know, you go through the whole process. It'd be a quantitative decision and it would be based on pretty solid stuff. It would not be based on, you know, what you saw on television that day. It would not be based on, you know, what your neighbor said to you or anything of the sort. It's the same thing with stocks. I used to always recommend to my students that they take a yellow pad like this and if they're buying a hundred shares of General Motors at 30 and General Motors has whatever it has out, 600 million shares or a little less, that they say, "I'm going to buy the General Motors company for $18 billion, and here's why." And if they can't give a good essay on that subject, they've got no business buying 100 shares or ten shares or one share at $30 per share because they are not subjecting it to business tests. And to get in the habit of thinking that way, you know, Sandy would have followed it up with the questions, based on how you answered the first two questions, that made you defend exactly why you thought that business was cheap at the price at which you are buying it. And any other answer, you'd flunk.

When you don't need a huge margin of safety

WARREN BUFFETTNumber 11.

AUDIENCE MEMBERMr. Buffett and Mr. Munger, I'm Marc Rabinov from Melbourne, Australia. I just wanted to ask you, how do you judge the right margin of safety to use when investing in various common stocks? For example, in a dominant, long-standing, stable business, would you demand a 10 percent margin of safety and, if so, how would you increase this in a weaker business? Thank you.

WARREN BUFFETTWe favor the businesses where we really think we know the answer. And, therefore, if a business gets to the point where we think the industry in which it operates, the competitive position or anything is so chancy that we can't really come up with a figure, we don't really try to compensate for that sort of thing by having some extra large margin of safety. We really want to try to go on to something that we understand better. So if we buy something like — See's Candy as a business or Coca-Cola as a stock, we don't think we need a huge margin of safety because we don't think we're going to be wrong about our assumptions in any material way. What we really want to do is buy a business that's a great business, which means that business is going to earn a high return on capital employed for a very long period of time, and where we think the management will treat us right. We don't have to mark those down a lot when we find those factors. We'd love to find them when they're selling at 40 cents on the dollar but we will buy those as much closer to a dollar on the dollar. We don't like to pay a dollar on the dollar, but we'll pay something close. And if we really get to something — you know, when we see a great business, it's like if you see some — somebody walk in the door, you don't know whether they weigh 300 pounds or 325 pounds. You still know they're fat, right, you know? And so if we see something we know it's fat, financially, we don't worry about being precise. And if we can come in, in that particular example, at the equivalent of 270 pounds, we'll feel good. But if we find something where the competitive aspects are — it's just the nature of the business that you really can't see out five or 10 or 20 years because that's what investing is, is seeing out. You don't get paid for what's already happened. You only get paid for what's going to happen in the future. The past is only useful to you in the extent to which it gives you insights into the future, and sometimes the past doesn't give you any insights into the future. And in other cases, like the stable business that you postulated, it probably does give you a pretty good guideline as to what's going to happen in the future, and you don't need a huge margin of safety. You should have something that — you always should feel you're getting a little more than what it's worth, and there are times when we've been able to buy wonderful businesses at a quarter of what they're worth, but we haven't seen those — well, we saw it in Korea here recently — but you don't see those sort of things very often. And does that mean you should sit around and hope they come back for 10 or — you know, wait 10 or 15 years? That's not the way we do it. If we can buy good businesses at a reasonable valuation, we're going to keep doing it. Charlie?

CHARLIE MUNGERYeah. You're — that margin of safety concept boils down to getting more value than you're paying. And that value can exist in a lot of different forms. If you're paid four-to-one on something that's an even money proposition, why, that's a value proposition, too. It's high school algebra. And people who don't know how to use high school algebra should take up some other activity.

Health care is too tough for Berkshire

WARREN BUFFETTNumber 12.

AUDIENCE MEMBER— morning. Good morning.

WARREN BUFFETTMorning.

AUDIENCE MEMBERMy name is Mike Klein, and I'm a general surgeon from Salinas, California. Given your resources and experience in underwriting insurance, do you have any thoughts of entering into, or helping to solve, our health care mess? Time is right for a new approach with Berkshire's clarity brought to the formula. Let's acknowledge the stakes are huge with implication for our economy and our future as a country.

CHARLIE MUNGERLet me try that one. It's too tough.

WARREN BUFFETTI would —

CHARLIE MUNGERWarren and I can't solve that.

WARREN BUFFETTYeah, we can't solve that one. We try to look for easy problems because those are the ones we find we have the answers for. And you can do that in investments. We don't really try tough things. Now, sometimes life hands you a problem, not in the financial area in our case, usually, but it will hand you a problem that is very tough and that you have to wrestle with. But we don't go around looking for tough problems. I would say this: we do very, very little in health insurance. You know, if we were to have — if we were looking for a solution through the private sector, we would be looking for something with very, very low distribution costs. I mean, you do not want a lot of the revenue soaked up in frictional costs between the benefits paid and the premiums received. I don't know how to do that, and I haven't seen anybody else that's very good at doing it, and you can say if you're paying close to 15 percent of GDP for health costs, you know, somebody ought to be able to figure out something, but I haven't heard it. Maybe we'll hear it in the upcoming political campaign but Charlie's views reflect mine at the present.

Munger on what's driven Berkshire's "extreme" success

WARREN BUFFETTNow we're going to go to the grand ballroom. We have these two overflow rooms that are full — or more or less full — and the grand ballroom is number. 13. Would they come in, please?

AUDIENCE MEMBERThis is Phil McCall (PH) from Connecticut. I wondered if you could comment on a subject I don't think you like to talk about very much, which is intrinsic value, and the evolution over the past 10 or 12 years of going to — off and on — but giving us investments and then giving us the operating income and suggesting that might be a good guide to us. I find it extremely helpful. I'm not sure other people do when looking out the 20 years you're talking about, looking ahead on both those two parts. Any comments you might have, I'd surely appreciate.

WARREN BUFFETTYeah. Well, the intrinsic value of Berkshire, like any other businesses, is based on the future amount of cash that can be expected to be delivered by the business between now and judgment day, discounted back at the proper rate. Now, that's pretty nebulous. Another way of looking at it is to try and figure out the value of the businesses we own presently, and we try to give you the information that will enable you to make a reasonably close estimate at that. We own lots of marketable securities. It's probably safe to say that they're worth more or less what they are carried for. And then we own a number of operating businesses, and we try to give you the figures on those businesses that are the figures that we use in making our own judgments about the value of those businesses. Now, that tells you what we have today and more or less what it's worth. But since Berkshire retains all of its earnings, it becomes very important to evaluate what will be done with those earnings over time. I mean, it is not only a question what the present businesses are worth. It's a judgment on the efficiency or the effectiveness with which retained earnings will be used. If you had looked at the intrinsic value of Berkshire in 1965, we had a textile business that was probably worth about $12 a share. But that was not the only part of the equation, because we intended to use any cash generated to try and buy into better businesses than we had, and we were fortunate to be able to buy in the insurance business in 1967 and build on that. So it was not only a combination of the business we had, but the skill with which retained earnings would be used, that determined what the present value actually should have been at Berkshire going back that far. It's the same situation today. We will put to work billions and billions of dollars this year and next year and the year after. If we put that to work effectively, each dollar has a greater present value than a dollar has simply in cash or distributed. If we do ineffectively, it has a value of something less. The businesses today, you know, we have whatever the figure is in the annual report — roughly $80,000 in marketable securities. If our insurance business breaks even, that $80,000 is free to us, in terms of using it. And we have a group of operating businesses and we show their earnings in the report and we're going to try to add to those and they'll try to add to their earnings. But if Charlie and I were each right now to write down on a piece of paper what we think the intrinsic value of Berkshire is, our figures would not be the same. They'd be reasonably close. And I think with that, I'll turn it over to Charlie.

CHARLIE MUNGERYeah. What's hard to judge at Berkshire is the likelihood that you'll have anything like the past to look forward to in the future. Berkshire has gotten very extreme, in terms of investment results. In fact, it's gotten so extreme that it's hard to think of another similar precedent in the history of the world. And the balance sheet is gross, considering the small beginnings of the place. Now, what on earth has caused this extreme record to go on for such a very long time? I would argue that the young man who was reading everything he could read when he was 10-years-old became a learning machine, and he got a lot of power early, and then he got a very long run when he kept learning. If Warren had not been learning all the while, I'm telling you having watched the process closely, the record would be a pale shadow of what it is. And Warren has improved since he passed the retirement age of man. In other words, in this field, at least, you can improve when you're old. Now, most people don't even try and create that kind of a record. They pass power from one 65-year-old to one 59-year-old and then do it over and over again. But you get an enormous advantage from practice in this field. And so what happened accidentally in the case of Warren has helped you shareholders greatly because you had this long run with power extremely concentrated, and with the man holding the power being a ferocious learner. Our system ought to be more copied than it is. (Applause) This idea of passing the power from one old codger to another, in a settled way, is not necessarily the right system at all.

WARREN BUFFETTWe have a very strong culture now of rationality, of being owner-oriented, that will go on long after I'm not around. And we have a talent on the operating side in place to do a lot of wonderful things over time. We will need, in capital allocation, to keep doing intelligent things. We won't get to do brilliant things because you don't get to do brilliant things with the kind of sums we're talking about. Maybe once in a blue moon or something, you know, you'll get a chance. But we will need somebody that never does — basically doesn't do any dumb things, and occasionally does something that's reasonably good. That can be done. And we have — we're on that road already. It does not — fitting into this organization as an investment officer or a capital allocator, you're getting in the right vehicle. It has the right standards. It will reject ideas that really are irrational. I've been on a lot of boards. Charlie's been on a lot of boards. You would be amazed at the number of things that are responding to "animal spirits" rather than to rationality that take place. And we have our animal spirits but we devote them to other areas.

"Deficient" auditing of derivatives will cause problems

WARREN BUFFETTLet's go on to number 14. That's in — that's in the junior ballroom.

AUDIENCE MEMBERYes. Hi, Mr. Buffett and Mr. Munger. This is Whitney Tilson, a shareholder from New York. For many years both of you have been warning about the dangers of derivatives, at one point calling them "financial weapons of mass destruction." Yet every year, tens of trillions of dollars of derivatives are bought and sold. It just seems to be getting bigger and bigger and almost certainly improperly accounted for. And so I was wondering if you could comment, and, specifically, if you have any thoughts on how much longer this might go on. Do you see anything imminent that could derail this ever inflating bubble? What might trigger it? And who should be doing what to try and mitigate this looming danger?

WARREN BUFFETTWell, we've tried to do a little to mitigate it ourselves by talking about it, but the — you're right, the — and it isn't the derivative itself. I mean, there's nothing evil about a derivative instrument. As I mentioned, we have 60-some of them at Berkshire, and on Monday I'll go over with the directors — I'll go over all 60-some and, believe me, we'll make money out of those particular instruments. But they — usage of them on an expanding basis, more and more imaginative ways of using them, introduces, essentially, more and more leverage into the system. And it's an invisible — or largely invisible — sort of leverage. If you go back to the 1920s, after the crash, the United States government held hearings. They decided that leverage — margin, in those days, as they called it — leverage contributed to, perhaps, the crash itself and certainly to the extent of the crash. And it was like pouring gasoline on a fire was — when people's holdings got tripped, you know, when stocks went down 10 percent people had to sell, another 10 percent, more people had to sell and so on. Leverage was regarded as dangerous and the United States government empowered the Federal Reserve to regulate margin requirements, regulate leverage, and that was taken very seriously. And for decades it was a source of real attention. I mean, if you went to a bank and tried to borrow money on a stock, they made you sign certain papers as to — that you weren't in violation of the margin requirements, and they policed it. And it was taken quite seriously when the Fed increased or decreased margin requirements. It was a signal of how they felt about the level of speculation. Well, the introduction of derivatives and index futures, all that sort of thing, has just totally made any regulation of margin requirements a joke. They still exist and, you know, it's an anachronism. So I believe — I think Charlie probably agrees with me — that we may not know where, exactly, the danger begins and where — and at what point it becomes a superdanger and so on. We certainly don't know what will end it, precisely. We don't know when it will end, precisely. But we probably — at least I believe — that it will go on and increase to the point where at some point there will be some very unpleasant things happen in markets because of it. You saw one example of what can happen under forced sales back in October 19, 1987, when you had so-called portfolio insurance. Now, portfolio insurance — and you ought to go back and read the literature for the couple years preceding that. I mean, this was something that came out of academia and it was regarded as a great advance in financial theories and everything. It was a joke. It was a bunch of stop-loss orders which, you know, go back 150 years or something, except that they were done automatically and in large scale by institutions and they were merchandise. People paid a lot of money to people to teach them how to put in a stop-loss order. And what happened, of course, was that if you have a whole series of stop-loss orders by very big institutions, you are pouring gasoline on fire. And when October 19th came along, you had a 22 percent shrink in the value of American business, caused, essentially, by a doomsday machine. A dead hand was selling as each level got hit. And three weeks earlier, you know, people were proclaiming the beauty of this. Well, that is nothing compared — it was a formal arrangement to have these — this dynamic hedging or portfolio insurance — sell things. But you have the same thing existing when you have fund operators operating with billions in aggregate, trillions of dollars, leveraged, who will respond to the same stimulus. They have what we would call a "crowded trade," but they don't know it. It's not a formal crowded trade. It's just that they're all ready to sell if a certain given signal or a certain given activity occurs. And when you get that, coupled with extreme leverage which derivatives allow, you will someday get a very, very chaotic situation. I have no idea when. I have no idea what the exogenous factor — I didn't know that shooting some archduke, you know, would start World War I, and I have no idea what will cause this kind of a thing, but it will happen. Charlie?

CHARLIE MUNGERYeah. And, of course, the accounting being deficient enormously contributes to the risks. If you get paid enormous bonuses based on reporting profits that don't exist, you're going to keep doing whatever causes those phony profits to keep appearing on the books. And what makes that so difficult is that most of the accounting profession doesn't even recognize how stupidly it is behaving. And one of the people in charge of accounting standards said to me, "Well, this is better, this derivative accounting, because it's mark-to-market, and don't we want current information?" And I said, "Yes. But if you mark-to-model, and you create the models, and your accountants trust your models, and you can just report whatever profit you want as long as you keep expanding the positions bigger and bigger and bigger, the way human nature is, that will cause terrible results and terrible behavior." And this person said to me, "Well, you just don't understand accounting." (Laughter.)

WARREN BUFFETTIf four years ago, or whenever it was, when we started to liquidate Gen Re's portfolio, we had reserves set up for in the hundreds and millions and all sorts of things. And our auditor — and I emphasize any other of the Big Four auditors absolutely would have attested to the fact that our stuff was mark-to-market. You know, I just wish I'd sold the portfolio to the auditors that day. (Laughs) I'd be 400 million better off. So it's a real problem. Now there's one thing that's really quite interesting to me. If I owe you, on my dry cleaning bill or something, $15, and they're auditing the dry cleaners, they check with me and they find out that I owe you $15 and it's all fine. If they're auditing me, they find out I owe the dry cleaner 15 bucks. There are only four big auditing firms, you know, basically in this country. And I will — so in many cases, if they're auditing my side of the derivative transaction, you know, what I'm valuing it at, the same firm may often be valuing — or attesting to the value of the mark by the person on the other side of the contract. I will guarantee you that if you add up the marks on both sides, they don't equate out to zero. We have 60-some contracts, and I will bet that people are valuing them differently on the other side than we value themselves, and it won't be to the disadvantage of the trader on the other side. I don't get paid based on how ours are valued, so I have no reason to want to game the system. But there are people out on the other side that do have reasons to game the system. So if I'm valuing some contract at plus a million dollars for Berkshire, that contract on the other side, it's just one piece of paper, should be valued at a minus 1 million by somebody else. But I think you probably have cases — and this is — I'm not talking about our auditors, I'm talking about all four of the firms — but they have many cases where they are attesting to values that — of the exact same piece of paper — where the numbers are widely different on both sides. Do you have any thoughts on that, Charlie?

CHARLIE MUNGERWell, I — as sure as God made little green apples, this is going to cause a lot of trouble in due course. As long as it keeps expanding and ballooning and so on and the convulsions are minor, it can just go on and on. But eventually there will be a big denouement.

Dangers of short-term investing and advanced mathematics

WARREN BUFFETTLet's go back to number one.

AUDIENCE MEMBERHi. I'm Stanley Ku from Hong Kong. My question is about a proliferation of short-term mindset to investing. As more and more money is being placed under absolute return mandate, these managers, as you just said, responded the same response, and tried to trade issues. So with credit spread on — I should say, risk premium — on various products declining across the board and correlation across markets increasing, can we read into it and say what is healthy or not healthy for the economy or the markets? And can we arguably say the portfolio insurance dynamics is already in place today?

WARREN BUFFETTWell, I think you put your finger on it. And, you know, we do think it's unhealthy. Obviously, if you take — and no way of precisely measuring this, but I'm quite certain I'm right — if you take the degree to which, say, either bonds or stocks, the percentage of them that are held by people who could change their minds tomorrow morning based on a given stimulus, whether it be something the Fed does or whether it be some kind of an accident in financial markets, the percentage is far higher. There is an electronic herd of people around the world managing huge amounts of money who think that a decision on everything in their portfolio should be made, basically, daily or hourly or by the minute. And that has increased turnover on the New York Stock Exchange — and I don't know the exact figures — but I think it was down around the 15 or 20 percent range 40 years ago and it's increased it to a hundred percent, I believe, plus, now. So — and certainly in the bond market, the turnover of bonds has increased dramatically. People used to buy bonds to own them and they'd buy bonds to trade them. And there's nothing evil about that, but it just means that the participants are playing a different game, and that different game can have different consequences than in a buy-and-hold environment. And I do think it means that if you're trying to beat the other fellow on a day-to-day basis, you're watching news events very carefully or watching the other fellow very carefully. If you think he's about to hit that key, you know, you're going to try to hit the key faster, if that's the game you're playing and if you're getting measured on results weekly. So I think that you describe the conditions that will lead to a result that we've been talking about expecting at some point. It's not new to markets, though. I mean, markets will do crazy things over time. Every time — when Charlie and I were at Salomon, they'd always talk to us about five sigma events or six sigma events, and that's fine if you're talking about flipping coins, but it doesn't mean anything when you get human behavior involved. And people do things that — and intelligent people do things — very intelligent, educated people do things — that are totally irrational, and they do them en masse. And you saw it in 1998. You saw it in 2002. And you'll see it again. And you'll see it — it's more likely to happen when you have people trying to beat currency, bond, stock markets, day by day. It's — I think it's a fool's game. But — you know, it may be what's required to attract money. When I set up my partnership, I told the partners, you know, you'll hear from me once a year. And I even thought — in 1962 I put the partnerships together and in May of 1962 the market got terrible — and I actually thought of sending all my partners a letter, and then sending it down to Brazil to have it reshipped back up, just to sort of test them out, but — how they felt about things. But, you know, I had a few with bad hearts. I decided it wasn't worthwhile. Charlie?

CHARLIE MUNGERYeah. When people talk about sigmas, in terms of disaster potentialities in markets, they're all crazy. They got the idea that bad results in markets would be predicted by Gaussian distributions. And the way they decided on that outcome was it made everything so easy to compute. They don't follow Gaussian distributions. You have to believe in the Tooth Fairy to believe that. And the disasters are bigger and more irritating than [German mathematician Carl Friedrich] Gauss would have predicted.

WARREN BUFFETTIt was easier to teach as well.

CHARLIE MUNGERIt's easier to teach, too.

WARREN BUFFETTYeah.

CHARLIE MUNGERI once asked a distinguished medical school professor why he was still doing an obsolete procedure, and he said, "It's so wonderful to teach." (Laughter)

WARREN BUFFETTThere's more of that in finance departments than you might think. It's very discouraging to learn advanced mathematics and, you know, how to do things that none but the priesthood can do in your field, and then find out it doesn't have any meaning, you know. And what you do when confronted with that knowledge, after you've invested these years to get your Ph.D., you know, and you've maybe written a textbook and a paper or two, having a revelation that that stuff has no utility at all, and really has counter-utility, I'm not sure, you know, too many people can handle it well. And I think they just generally keep on teaching.

Quantitative approach to intrinsic value and investments

WARREN BUFFETTNumber 2.

AUDIENCE MEMBERHello. Burkhardt Whittick (PH) from Munich in Germany. I would like to get some more transparency on how you make investment decisions, particularly how you determine intrinsic value. You mentioned that the theoretically correct method is discounted cash flow, but at the same time you point out the inherent difficulties of the methodology. From other books, I see that you use multiples on operating earnings, or (inaudible) multiples. Your [former] daughter [in law] Mary, in one of her books, describes another methodology where you apply compounding economics to the value of the equity. Could you give us a bit more transparency which quantitative approach you use and how many years out you try to quantify the results of the investments you're interested in?

WARREN BUFFETTI understand the question, but I'm going to pretend I don't and let Charlie answer first. (Laughs) I really do.

CHARLIE MUNGERYeah. When you're trying to determine something like intrinsic value and margin of safety and so on, there's no one easy method that could be simply mechanically applied by, say, a computer and make anybody who could punch the buttons rich. By definition, this is going to be a game which you play with multiple techniques and multiple models, and a lot of experience is very helpful. I don't think you can become a great investor very rapidly any more than you could become a great bone tumor pathologist very rapidly. It takes some experience and that's why it's helpful to get a very early start.

WARREN BUFFETTBut if you're — let's just say that we all decided we're going to buy a — or think about — buying a farm. And we go up 30-miles north of here and we find out that a farm up there can produce 120 bushels of corn, and it can produce 45 bushels of soybean per acre, and we know what fertilizer costs, and we know what the property taxes cost, and we know what we'll have to pay the farmer to actually do the work involved, and we'll get some number that we can make per acre, using fairly conservative assumptions. And let's just assume that when you get through making those calculations that it turns out to be that you can make $70 an acre to the owner without working at it. Then the question is how much do you pay for the $70? Do you assume that agriculture will get a little bit better over the years so that your yields will be a little higher? Do you assume that prices will work a little higher over time? They haven't done much of that, although recently, it's been good with corn and soybeans. But over the years agriculture prices have not done too much. So you would be conservative in your assumptions, then. And you might decide that for $70 an acre, you know, you would want a — if you decided you wanted a 7 percent return, you'd pay a thousand dollars an acre. You know, if farmland is selling for 900, you know you're going to have a buy signal. And if it's selling for 1200, you're going to look at something else. That's what we do in businesses. We are trying to figure out what those corporate farms that we're looking at are going to produce. And to do that we have to understand their competitive position. We have to understand the dynamics of the business. We have to be able to look out in the future. And like I've said earlier, some businesses you can't look out very far at. But the mathematics of investment were set out by Aesop in 600BC. And he said, "A bird in the hand is worth two in the bush." Now our question is, when do we get the two? How long do we wait? How sure are we that there are two in the bush? Could there be more, you know? What's the right discount rate? And we measure one against the other that way. I mean, we are looking at a whole bunch of businesses, how many birds are they going to give us, when are they going to give them to us, and we try to decide which ones — basically, which bushes — we want to buy out in the future. It's all about evaluating future — the future ability — to distribute cash, or to reinvest cash at high rates if it isn't distributed. Berkshire has never distributed any cash, but it's grown in its cash producing abilities, and we retain it because we think we can create more than a dollar present value by retaining it. But it's the ability to distribute cash that gives Berkshire its value. And we try to increase that ability to distribute cash year by year by year and then we try to keep it and invest it in a way so that a dollar bill is worth more than a dollar. You may have an insight into very few businesses. I mean, if we left here and walked by a McDonald's stand, you know, and you decided, would you pay a million dollars for that McDonald's stand, or a million-three, or 900,000, you'd think about how likely it was there would be more competition, whether McDonald's could change the franchise arrangement on you, whether people are going to keep eating hamburgers, you know, all kinds of things. And you actually would say to yourself this McDonald's stand will make X — X plus 5 percent — maybe in a couple years because over time prices will increase a little. And that's all investing is. But you have to know when you know what you're doing, and you have to know when you're getting outside of what I call your circle of competency, you don't have the faintest idea. Charlie.

CHARLIE MUNGERYeah. The other thing, you've got to recognize that we've never had any system for being able to make correct judgments on the values of all businesses. We throw almost all decisions into the too hard pile, and we just sift for a few decisions that we can make that are easy. And that's a comparative process. And if you're looking for an ability to correctly value all investments at all times, we can't help you.

WARREN BUFFETTNo. We know how to step over one-foot bars. We don't know how to jump over seven-foot bars. But we do know how to recognize, occasionally, what is a one-foot bar. And we know enough to stay away from the seven-foot bars, too.

What Buffett wants as he hires portfolio managers

WARREN BUFFETTNumber 3.

AUDIENCE MEMBERJohn Stevo (PH), shareholder from Chicago. Mr. Buffett — Mr. Buffett, Mr. Munger, thank you for the great weekend. In your annual shareholders letter, you stated that you're looking for someone younger to possibly work at Berkshire, and I was wondering if you could expand on that, and how would I apply for that job? (Laughter)

WARREN BUFFETTI think you just did. (Laughter) The — we're looking for one or more. I mean, I would — I don't think it's at all impossible we might even find three or four that we would decide to have run some money and to take a closer look. We're not looking for someone to teach. I probably didn't make that clear enough in the annual report. We're not — we're not going to be mentors or teachers or anything of the sort. We're looking for somebody that we think knows how to do it. And there are people like that out there. We've heard from 6- or 700. I did hear — I heard from one that had a four-year-old son. I thought that was quite a compliment that — I mean, I knew a caveman could do my job, but a four-year-old? (Laughter) The — but we're looking — and we've heard from a number of very intelligent people. We have heard from a number of people that have had good investment records for — in recent years, and in some cases some time. The biggest problem we have is whether they would scale up, because it's a different job to run a hundred billion than it is to run a hundred million. And incidentally — and you can't do as well running a hundred billion as a hundred million, in terms of returns. You can't come close to doing it. That doesn't bother us. But we do want to find somebody that we think can run large sums of money mildly better than the general performance in securities. And I emphasize mildly. There's no way in the world somebody's going to beat the S&P by 10 percentage points a year with a hundred billion dollars. It isn't going to happen. But we think maybe we can find somebody or some group, several of them, that can maybe be a couple percentage points better, but we really are interested in being sure that we have somebody that, under conditions that people haven't even seen yet, will not blow it. You know, anything times zero is zero. And I don't care how many wonderful figures are in between. So we are looking for somebody that's wired in a way that they see risks that other people don't see that haven't occurred, and they're plenty cognizant of the risks that have occurred. And those people are fairly rare. Charlie and I have seen a lot of very smart people go broke, or end up with very mediocre records where, you know, 99 out of the 100 things they did were intelligent but the hundredth did them in. So our job is to filter through these hundreds and hundreds of applications, find a couple of them that we think can do the job who are much younger, perhaps give them a chunk — two, three, five billion — have them manage it for some time, have them manage it in the kind of securities that they would scale up to a larger portfolio because — and then either one or more of them will get the job turned over to them at some point. Charlie?

CHARLIE MUNGERYeah. Our situation in looking for this help reminds me of an apocryphal tail about Mozart. And a young man of 25 or so once asked to see Mozart and he said, "I'm thinking of starting to write symphonies, and I'd like to get your advice." And Mozart said, "Well, you're too young to write symphonies." And the guy says, "But you were writing them when you were ten-years-old." And Mozart says, "Yes, but I wasn't asking anybody else for advice how to do it." (Laughter.)

CHARLIE MUNGERAnd so if you remind yourself of young Mozart, why, you're the man for us.

WARREN BUFFETTWe will come up with, probably, a couple of people. And, you know, it's — I've known people over the years. I've been in the job before. I mean, in 1969 I wound up my partnership, and I had a lot of people that trusted me, and I wasn't going to just mail the money back to them and, you know, say good-bye, because they would have been sort of adrift, most of them. And so I had the job of finding somebody to replace me. And there were three absolutely stand-out candidates. Any one of the three would have been a great choice. Charlie was one of them. Sandy Gottesman was one of them. And Bill Ruane was one of them. Charlie wasn't interested in having more partners. Sandy was interested in individual accounts and took on the accounts of some of my partners and they were very, very happy and they're still happy that he did it. And Bill Ruane set up a separate mutual fund called Sequoia Fund to take care of all of the partners, whether they had small amounts or not. And he did a sensational job. So I really identified three people in 1969 that were not only superior money managers, but that were also the kind that could never get you a terrible result and that were terrific stewards of capital. Now, they were about my age at the time so it was a universe that I was familiar with, and now I have the problem that at — the people I know that are even close to my age, we don't want anyway, and besides, most of them are already rich. They don't care about having a job. So I have to look into an age cohort where I don't really know lots of people, but it can be done. And like I say, we did it successfully with three people in 1969. And it was done successfully in 1979 with Lou Simpson for GEICO. And I never knew Lou Simpson before I met him down at the airport here, and I spent a few hours with him, and it was clear that he was a steward of capital. He was going to get an above-average result, and there was no chance he was going to get a bad result. And he's been managing money for GEICO now for 28 years, roughly. So it's doable. It's a little more work than I like to do. I've been kind of spoiled. But I'll — I've got a job to do on it, and I'll do it.

Buffett and Munger differ on climate change

WARREN BUFFETTNumber 4?

AUDIENCE MEMBERGood morning. I'm Glen Strong (PH) from Canton, Ohio. Please tell us where you stand on the global warming debate or where your managers at General Re stand. In particular, perhaps you can give us your thoughts on the science of global warming and how serious you believe it is, and whether warming is actually more harmful than helpful. Thank you.

WARREN BUFFETTYep. Well, I believe the odds are good that it is serious. I'm not enough of a — I can't say that with 100 percent certainty or 90 percent certainty, but I think that there's enough evidence that it would be very foolish to say that it's 100 percent certain or 90 percent certain that it isn't a problem. And since it's — if it is a problem, it's a problem that once it manifests itself to a very significant degree, it's a little too late to do something about it. In other words, you really have to build the ark before the rains come, in this case. I think if you make a mistake, in terms of a social decision, you should, what I call err, on the side of the planet. In other words, you should build a margin of safety into your thinking about the future of the only planet we've got a hundred years from now. So I think — I take it seriously. In terms of our own businesses, you mentioned General Re. Gen Re writes less — way less business — that would be subject to the annual increments in global warming that would have an effect on their results than the reinsurance division of National Indemnity, where we write far more of the catastrophe business. It's not going to affect, you know, in any measurable degree at all, you know, excess casualty insurance, property insurance. You're thinking much more of whether it's going to produce atmospheric changes that change materially the probabilities of really — of catastrophes, both their frequency and their intensity. In my own mind, and in the minds of the people that run National Indemnity’s reinsurance division, we crank — we think the exposure goes up every year because of what's going on in the atmosphere, even though we don't understand very well what goes on in the atmosphere. And the relationship between damage caused and the causal factors is not linear at all. I mean, it can be explosive. So if temperatures in the waters of the Atlantic or something change by relatively small amounts, or what seem like small amounts, it could increase the expectable losses from a given hurricane season by a factor of two, three, four or five. So we're plenty cautious about it. It's not something that keeps me up, in terms of our financial prospects, at all at Berkshire. But it's something that I think every citizen ought to be very cognizant of and make a decision on. Charlie?

CHARLIE MUNGERWell, of course carbon dioxide is what plants eat. And so — and generally speaking, I think it's a little more comfortable to have it a little warmer instead of a little colder. (Laughter)

WARREN BUFFETTI hope you don't get a chance to test that after death, Charlie. (Laughs)

CHARLIE MUNGERIt isn't as though there's a vast flood of people trying to move to North Dakota from southern California. And so you're talking about dislocation. It's not at all clear to me that, net, it would be worse for mankind in general to have the planet a little hotter. But the dislocations would cause agonies for a great many places, particularly those that would soon find themselves underwater.

WARREN BUFFETTYeah. I was going to ask you. How do you feel about the sea level being 15 or 20 feet higher? (Laughs)

CHARLIE MUNGERWell, that's very unfortunate, but — (Laughter) Holland lives with what, 25 percent of the nation below sea level? With enough time and enough capital, why, these things can be adjusted, too. I don't think it's an utter calamity for man that threatens the whole human race or anything like that. You know, you'd have to be a pot-smoking journalism student or something to — (Applause)

CHARLIE MUNGER— believe that.

WARREN BUFFETTWe're finally unleashing him, folks. (Laughter) Well, we'll continue to have people in charge of insurance who are plenty worried about global warming, I promise you. But it — we don't know — we do know that 2004 and 2005, there was a frequency, and more particularly, there was an intensity of hurricanes that would not be expected at all by looking at the previous century. And we were spared — even though we had Katrina — we were spared what could have been a far worse case by a couple of Category Fives that didn't hit the mainland. So I do not regard Katrina as being anywhere near a worst-case scenario. And, like I say, I don't know whether — how much of — I don't know whether the water is a half a degree or 1 degree Fahrenheit warmer than 30 years ago, but I don't know — and I don't know all the factors that go into hurricanes. I mean, I know that, obviously, the water temperature, you know, contributes to energy and all that sort. But there could be 50 variables. All I know is, on balance, I think they're probably getting more negative for us and I know we ought to be very careful about it. And I know that it would be crazy to write insurance in 2007 at the same rates that it was being written a few years ago, in relation to catastrophes. And since we're in the catastrophe business, that is something I think about, and the people that actually write the policies think about it as well. So it's a factor with us.

Bank problems don't mean China will collapse

WARREN BUFFETTFive.

AUDIENCE MEMBERHi. I'm John Golob from Kansas City. I have a question about the Chinese economy. Some observers have suggested that the Chinese banking system looks a little like Japan back in the 1990s. Are you concerned that China could experience similar disruptions as Japan in '90 or is China possibly — with different institutions — possibly more resistant to economic disruptions?

WARREN BUFFETTI would have to say I don't know the answer to that. I mean, it's a very interesting question. It's a very important question. But, you know, I didn't necessarily understand what was going to happen in Japan before it happened, and my insight into Chinese banks is about zero. We've been offered chances to buy into various Chinese banks and, again, because I don't know anything about them, I pass. It's no judgment that there's anything bad. It just means that sitting in Omaha, Nebraska, not knowing what some item of loans and advances — what composes it or anything about the real operation of the place — that I can make a decision whether it's worth X, half of X, 2X, a quarter of X, I just don't know. And I really don't know — I just have no notion as to the answer to your question, but maybe Charlie does.

CHARLIE MUNGERWell, if you stop to think about it, all of the remarkable economic progress that we've seen in China in the last 15 years has been accompanied by practices in their government banks that would make you shutter if you compared them to normal banking standards. So everything you see in terms of progress has occurred despite — the banks were almost doling out money for aid as distinguished from doing normal banking. So I'd be very leery of predicting that that's sure to cause a huge economic collapse in Japan — in China. They've been doing it for a long time, and they may actually be getting better now.

WARREN BUFFETTYeah. We've had our share of banking troubles in this country. I mean, it wasn't that long ago in terms of the savings and loan crisis and all kinds of things. And strong economies come through those things. So, you know, if ahead of time you'd seen all the problems with foreign loans that the commercial banks got into and all the problems with real estate loans that the savings and loans got into, you could have said, you know, it's going to be terrible for the American economy, and it did produce a lot of dislocations and all of that. But if you look at the regular American economy, it's come through all kinds of financial crises with the real output per capita rising at a very substantial rate just decade after decade. I don't know what will happen in China, but I think it's pretty amazing in terms of the gains that have been made. And I think they'll be — I think they'll continue to be made, and I don't know what will happen with the banking system, though.

Easy decision: stocks over bonds

WARREN BUFFETTNumber 6.

AUDIENCE MEMBERGood morning, Warren and Charlie. My name is Frank Martin from Elkhart, Indiana. I'm a shareholder.

WARREN BUFFETTYeah. You've written a good book too, Frank. (Laughs)

AUDIENCE MEMBERThanks, Warren. I'll do my best to be succinct with this question. As you know, my long suit is not brevity in the written word. Recently, I sequentially read everything that you and Charlie have written, or that has been written about you, since 1999, including your help wanted ad in the annual report, which sought not a Ted Williams, but the consummate defensive player in your forcefully worded quotations in last Monday's Wall Street Journal. When contemplating the chronology, I sensed a gradual but unmistakable sea change in your perspective on the investment environment for marketable securities. The intensification of your preoccupation with managing risk is conspicuous by its absence among the other biggest players at the margin — hedge funds, private equity, mutual funds — who are shamefully mute both about what are likely to be anemic prospective returns and the unconscionable risks assumed to achieve them, all the while charging a king's ransom for such low value-added services. When I give free rein to my intuition, the post-1999 Warren Buffett reminds me of the Warren Buffett of post-1969. Back then, when Berkshire was a small fraction of its current size, you spoke of the difficulty in playing a game you did not understand, that there was little margin of safety in the equity markets in general. You weren't forecasting what in its own time became the bear market of '73-'74, but you were surely intuitively aware of what [former Federal Reserve Chairman Alan] Greenspan years later has repeatedly warned: the inevitable day of reckoning that follows long periods of low equity risk premium. Imagine yourself, if you are willing, cast overnight into a new role with a clean slate as head of the investment committee of a $10 billion pension fund. Today, would your decisions reflect the same risk-averse mindset that dominated your behavior in the post-1969 period? And might you anticipate that following all of this might appear opportunities that were as mouthwatering as appeared in '73-'74? Please explain, and I hope Charlie will weigh in on the subject as well. Thank you.

WARREN BUFFETTYeah Frank, when I closed up to the partnership, if I'd had an endowment fund to run then, the prospective return — and actually, I wrote this in a letter to my partners that I'd be glad to send you a copy of — the prospective return — and I was looking at them as individuals on an after-tax basis — was about the same, I felt, from equities and from municipal bonds over the next decade, and it turned out to be more or less the case. I would say that I do not regard that as being the same situation now. If I were managing a very large endowment fund, for one thing it would either be a hundred percent in stocks or a hundred percent in long bonds or a hundred percent in short-term bonds. I mean, I don't believe in layering things and saying I'm going to have 60 percent of this and 30 percent of that. Why do I have the 30 percent if I think the 60 percent makes more sense? So — and if you told me I had to invest a fund for 20 years and I had a choice between buying the index, the 500, or a 20-year bond, you know, I would buy stocks. You know, that doesn't mean they won't go down a lot. But if you — I would rather a have an equity investment — I wouldn't rather have an equity investment where I paid a ton of money to somebody else that took my stock return down dramatically. But simply buying an index fund for 20 years of equities or buying a 20-year bond, I would — it would not be a close decision with me. I would buy the equities. I'd rather buy them cheaper, you know, but I'd rather buy the bond with a bigger yield, too. But in terms of what's offered to me today, that's the way I would come down. Charlie?

CHARLIE MUNGERYeah. I don't think that was the answer that was expected, but that's the answer. (Laughter)

WARREN BUFFETTIt doesn't have a thing to do with what we think stocks — we don't think at all — but where stocks could be or bonds could be. We don't have the faintest idea where the S&P will be in three years, or where the long-term bond will be in three years, but we do know which we would rather own on a 20-year basis.

CHARLIE MUNGERWarren, we'd also expect that the current scene will cause some real disruption, not too many years ahead.

WARREN BUFFETTThat's true, but if you go back a hundred years, you could almost say that, you know, in almost any period, you will get disruptions from time to time, and it's very nice if you have a lot of cash then and you have the guts to do something with it. But predicting them or waiting around for them, that sort of thing, is not our game. And I mean, we bought $5 billion worth of equities in the first quarter, something like that. And, you know, we don't think they're anything like — well, they aren't — they're not — it would be a joke to even compare them to 1974 or a whole bunch of other periods. But we decided we would rather have them than cash, or we would rather have them than sit around and hope that things get a lot cheaper. We don't spend a lot of time doing that. It — you can freeze yourself out indefinitely. So any time we find something — what we think is intelligent to do, we just do it, and we hope we can do it big.

Buffett bought and sold silver early: "Other than that, a perfect trade"

WARREN BUFFETTNumber 7.

AUDIENCE MEMBERMy name is Nathan Narusis from Vancouver, Canada. Mr. Buffett, Mr. Munger, my question concerns your previous silver bullion investment. I'm curious to hear more about why you sold when you did. More specifically, whether you sold your bullion to the organizers of the silver exchange-traded fund in return for cash plus, perhaps, important noncash consideration in order to keep silver markets from either rising or falling sharply. Thank you very much for anything you would care to share with us.

WARREN BUFFETTI'm not sure who we sold it to, but whoever we sold it to was a lot smarter than I was. (Laughs) I bought it too early. I sold it too early. Other than that, it was a perfect trade. (Laughter) Charlie, do you have anything to add? Charlie had nothing to do with the silver decision, so that one falls entirely on me.

CHARLIE MUNGERI think we demonstrated how much we know about silver.

WARREN BUFFETTYeah. (Laughter) The very fact you asked us a question on silver flatters us because nobody asks us about silver anymore. (Laughs) But we'll come up with something else at some point. You know, the last part of your question, there was a small implication, I think, of perhaps a silver conspiracy. We — as soon as we started — it got known that we bought silver, we started getting all these letters in the mail from people who had all these different theories about the fact that hedging was killing things or these kind of traders were doing something. In the end, silver responds as supply and demand just like oil responds to supply and demand. Oil is — the price of oil at 60 or $65 is not a product of a bunch of oil executives conspiring or anything of the sort. It's supply and demand on a huge commodity. Silver is a small commodity, but on any kind of commodity like that, supply and demand is what determines prices over time. Although the Hunt brothers, I must admit, for a short period there, in a few years, managed to change the equation and they forever wished they hadn't.

Why Buffett "outsourced" his philanthropy

WARREN BUFFETTNumber 8.

AUDIENCE MEMBERHello, Mr. Buffett. Eben Pagan, Santa Monica, California. You seem amazing at keeping your composure in tough situations. I would be very interested to know what your thought process was when you were in that incredibly stressful situation, you knew the world was watching, and you went head-to-head with LeBron James. (Laughter)

WARREN BUFFETTThe game was rigged. (Laughter) He was the one that had a problem. (Laughs)

AUDIENCE MEMBERWhat I'd really like to know is, I'm a real big fan of you and Mr. Gates and your philosophy of channeling all the value you've created back into the world. And I have a successful business, and I'd like to do the same, but maybe in 20 or 30 or 40 years, and with a time horizon like that, I'd love to know what advice you'd give someone like me.

WARREN BUFFETTWell, there's nothing wrong with your time horizon, in my view, as long as you're going — as long as you plan to give it back, I mean, A) the decision is yours entirely, anyway, whether you want to do it. But assuming you want to give it back, or give it to society in some way, if you're compounding your money at a rate greater than people generally do, you are, in effect, an endowment fund for society. And, you know, all kinds of organizations in the nonprofit area have endowment funds, and they think it's wise to have it, and they do that in order to get standard returns, usually. And if you can compound it more and you're going to give it back later on, let someone else take care of current giving, and you can take care of giving in 20 or 30 years. But, you know, I regard that as a personal decision. I always felt that I would compound money at a rate higher than average, and it would have been foolish to give away a significant portion of my capital to somebody who would spend it within, you know, months, when there could be a really much larger amount later on. And, on the other hand, the time had come, I'd really thought my wife would be doing that, and when that didn't work out, the time had come to do something with it. And, fortunately, I had some great options available, and I get to keep on doing what I love doing and I let some — I farm out all the work. But, you know, when my wife had a baby, we hired an obstetrician. I didn't try and do it myself. I mean, when a tooth hurts, you know, I don't have Charlie fix it. I go to a dentist. So when I have money to give away, I believe in turning it over to people who are — and I've got five different organizations, including my three kids — and I believe in turning it over to people who are energized, working hard at it, smart, you know, doing it with their own money, the whole thing. And I get to keep doing what I like doing. So as far as I'm concerned, I haven't given away a penny. Charlie?

CHARLIE MUNGERWell, I think it's wonderful for the shareholders that somebody else is giving away the money. (Laughter) I tell you, if all Warren wanted to talk about was interfacing with applicants for donations, we would have a different life. And we wouldn't be very well adapted to it, either.

WARREN BUFFETTYeah. You know, actually on the smaller ones I send them all to my sister Doris, and she does a great job with it, and enjoys it, spends lots of time on it, good at it, and I'm glad she does it and I don't. You know, the truth is, I haven't given away anything in a practical matter. I have everything in life I want. You know, there's no way I can sleep better, I can eat better. Other people might think I could eat better. (Laughter) I haven't given up anything. Now, if you think about it, you know, somebody that gives up having an evening out, somebody that, you know, gives up their time working on something, somebody that doesn't take their kids to Disneyland this year because they've, you know, they've given the money instead to their church, I mean, those people are changing their lives in some way with what they give. I haven't changed my life at all. I don't want to change my life. I'm having a lot of fun doing what I do. And, you know, it's just a bunch of stock certificates that one way or another they're going to go someplace. And what I really want to do is keep doing what I enjoy doing, and feel that the claim checks that I accumulate that comes about for this, are going to get used effectively for the same general purposes that I would want to use them for if I really had the energy and the interest in doing the job myself. But somebody else can keep doing the work.

You can always earn big returns with small amounts of money

WARREN BUFFETTNumber 9.

AUDIENCE MEMBERHi. I'm Eric Schleien from Larchmont, New York. My question is directed at Mr. Buffett. Mr. Buffett, you claim you can do 50 percent a year. If you had to start over with a small portfolio, would you still be doing buy and hold, buying quality companies at a good price, or would you be doing arbitrage and really getting down to the nitty-gritty Benjamin Graham cigar butts that you did in the Buffett Partnership?

WARREN BUFFETTYeah. If I were working with a very small sum — and you should all hope I'm not — (laughs) — if I were working with a very small sum, I would be doing entirely — almost entirely — different things than I do. I mean, there's — your universe expands. I mean, if you're looking, there's thousands and thousands and thousands of times as many options to think about if you're investing $10,000 than if you're investing a hundred billion. And, obviously, if you have that many — you've got all the options you got with a hundred billion, except buying entire businesses, and you've got all of these other options. So you can earn very high returns with very small amounts of money, and it will always be such. I don't mean that everybody can do it, but if you know something about values and investments, you will find opportunities with small sums, and it will not be with a portfolio that Berkshire itself owns. We can't earn phenomenal returns putting 3 billion, 4 billion, 5 billion in a stock. It won't work that way. It won't even come close to working that way. But if Charlie or I were in a position of working with a million dollars or $500,000 or 2 million, we would find little things here and there — and it wouldn't always be stocks — where we would earn very high returns on capital. Charlie?

CHARLIE MUNGERYeah. But it's — there's no point our thinking about that now. (Laughter)

WARREN BUFFETTBut he's thinking about it, Charlie. (Laughter)

Subprime mortgage defaults won't be "huge anchor"

WARREN BUFFETTOK. We'll take one more, and then we will go to lunch and then we'll — after that we'll come back. So we'll go to number 10 now. Is the microphone open on 10?

AUDIENCE MEMBERHello? Hello?

WARREN BUFFETTDo we have a problem here?

AUDIENCE MEMBERWarren and Charlie, my question is, what's your opinion regarding the subprime market relative to the foreign national market?

CHARLIE MUNGERWe can't hear that.

WARREN BUFFETTWe can't hear that.

AUDIENCE MEMBERWhat's your opinion regarding the subprime market relative to the foreign national market? Sorry. My name is Calvin Chong (PH). I'm from New York.

WARREN BUFFETTWell, the subprime market, encouraged by both lenders, intermediaries, and borrowers themselves, resulted in a lot of people buying a lot of houses that they really didn't want to own or that they can't make payments on for once the normal payments were required. And the people, the institutions, in some cases the intermediaries, are going to suffer in various degrees. Now, the question is whether it spills over and starts affecting the general economy to a big degree, and I would — my guess would be — it's quite severe some places. But my guess would be that if unemployment doesn't rise significantly, and interest rates don't move up dramatically, that it will be a — it will be a very big problem for those involved, and some people are very involved. Some institutions are very involved. But I don't see it — I think it's unlikely that that factor alone triggers anything of a massive nature in the general economy. I think it — you know, I've looked at several financial institutions. I've looked at their 10-Qs and 10-Ks, and I've seen that a very high percentage of the loans they made in the last few years allowed people to make very tiny payments on the mortgages, but, of course, those subnormal payments increased principal so that they had to make above average payments later on at some point. And I think that's dumb lending, and I think it's dumb borrowing, because somebody that can only make 20 or 30 percent of their normal mortgage payments the first year is very unlikely to be able to make 110 percent of their normal mortgage payments a few years later. Those people and those institutions were largely betting on the fact that house prices would just keep going up, and it really didn't make any difference whether they could make the payments. And that worked for a while until it didn't work. And when it doesn't work, you have an abnormal supply of housing coming on the market, similar to what happened in manufactured housing, the business we're in, six or seven years ago, and that changes the whole equation. From people on the demand side, you no longer have people thinking they're buying something that's bound to go up, and then you have the supply coming on from the people who were anticipating that before and really don't want to hold the asset unless it's going to go up. So you'll see plenty of misery in that field. You've already seen some. And I don't think — I don't think it's going to be any huge anchor to the economy. Charlie?

CHARLIE MUNGERYeah. A lot of what went on was a combination of sin and folly, and a lot of it happened because the accountants allowed the lending institutions to show profits on loans where nobody in his right mind would have showed any profit until the loan had matured into a better condition. And, once again, if the accountants lay down on their basic job, why, huge excess and folly is going to come inevitably, and that happened here. The national experience with low-interest starter home loans to what I would call the deserving poor, has been very good. But the minute you pay a bunch of people high commissions to make loans to the undeserving poor, or the overstretched rich, you can get loan losses that are staggering. And I don't see how the people did it and still shaved in the morning, because looking back at them was a face that was evil and stupid.

WARREN BUFFETTYeah. (Applause)

WARREN BUFFETTYou've seen some very interesting figures in the last few months on the number — on the percentage — of loans where people didn't even make the first or second payment. And there's really — that shouldn't happen. That happened, incidentally — you had a prelude to this in the manufactured housing industry. I mean, in the late 1990s — and securitization accentuated the problem, because once you had somebody in Grand Island, Nebraska, selling a mobile home — or a manufactured home — to someone and they needed a $3,000 down payment and the salesman was going to get a $6,000 commission, believe me, you start getting some very strange things going on. Now, if the person doing that had to borrow the money in Grand Island, the chances are the local banker would have seen what was happening and said, you know, we don't want any of this where the salesman fakes the down payment and all that. But once you just package those things and securitize them so they get sold through major investment banking houses and sliced up in various tranches and so on, you know, the old — the discipline leaves the system. And securitization really accentuates that, and we have had that in subprime loans, just as we had it in manufactured housing six or seven years ago. And, like I say, that has not all worked its way through the system, but I don't think it's going to cause huge troubles. Now, we do see certain areas of the country where it will be at least a couple of years before real estate recovers. I mean, the overhang is huge compared to normal monthly volume in certain sections. And the people that were counting on flipping things there are going to get flipped, but in a different way.