Berkshire Hathaway Annual Meeting 2005 Transcript

Warren Buffett [00:00:00] Morning. I’m Warren, he’s Charlie. We work together, we really don’t have any choice because he can hear and I can see. I want to first thank a few people. That cartoon was done by Andy Heyward, who has done them now for a number of years, and he writes them, he goes around the country and gets voices dubbed in. It’s a labor of love. We don’t pay him a dime. He comes up with the ideas every year, he’s just a terrific guy. He’s unable to be here today because his daughter’s having a Bat Mitzvah. But he’s a very, very creative fellow. He did something a few years ago called Liberty’s Kids, and if you have a child or a grandchild that wants to learn American history around the time of the Revolution, it’s a magnificent series. I think it’s maybe as many as 40 or so half-hour segments, and it’s appeared on public broadcasting, it will be appearing again, you can get it in video form. And like I say, it’s just a wonderful way to… I’ve watched a number of segments myself. It’s a wonderful way to get American history. The only flaw in it is that the part of Ben Franklin is handled by Walter Cronkite, and Charlie is thinking of suing. A little, a little upsetting when Charlie is available.

Incidentally, we have Poor Charlie’s Almanack on next door in the exhibition hall, and it’s an absolutely terrific book that Peter Kaufman has put together, and I think it’s going to be a seller, a huge seller long after most books have been forgotten. It’s Charlie at his best, and Charlie’s at his best most of the time, but it’s a real gem.

I want to thank Kelly Muchemore, who puts all of this together. I don’t give it a thought. Kelly takes charge of this. She works with over 200 people from our various companies that come in and help make this a success. She does it flawlessly. As I mentioned in the annual report, Kelly’s getting married in October, so this is just a warm-up. I mean, we’re expecting a much bigger event than this come October.

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

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

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

I can give you a little preliminary view of the first quarter with certain caveats attached. These figures, our 10-K or 10-Q will be filed the end of next week. And I caution you that, particularly in insurance underwriting, it’s been a better quarter than, considerably a better quarter than I would normally anticipate. One of the reasons for that is that our business actually does have some, the insurance business has some seasonal aspect. Now, it doesn’t have a seasonal aspect particularly at GEICO or at National Indemnity primary business, but when you get into writing catastrophe business, and we’re a big writer of catastrophe business, the third quarter, the biggest risk we write in the big cat area is, there’s hurricanes, and those are concentrated. They’re actually concentrated in the month of September in this part of the world. 50% of the hurricanes roughly occur in September, and about maybe 17.5% in October and August, and the balance maybe in November and July. But there’s a concentration in the third quarter. So when we write an earthquake pilot, I mean, when we write a hurricane policy, for example, we may be required to bring the earnings in monthly on the premiums, but all of the risk really occurs, are a very great percentage of it, late in the third quarter. And we don’t have any risk in the first quarter of hurricanes. So we earn some premium during that quarter that really has no loss exposure, and then we get that in spades come September.

Even allowing for that, we had an unusually good quarter, and I would still stick by the prediction I made in the annual report, where I said that if we don’t have any really mega catastrophes, I think we’ve got a decent chance of our float costing us zero or less this year, which means, in effect, we have $45 billion or so of free money. In the first quarter, our insurance underwriting years are pre-tax, our insurance underwriting income came to almost $500 million, which was about $200 million better than a year ago. And GEICO had a very good quarter for growth. We added 245,000 policyholders, which is almost 4% in one quarter to our base. We were helped very much by that, by this huge reception we’re getting in New Jersey, because we weren’t in there a year ago. So we’re getting very good size gains there. We’re not getting 4% in a quarter from around the country, but the boost from New Jersey took us up to that. And GEICO actually wrote it a 13% underwriting profit in the first quarter, which is considerably better than we expect over the full year. And we’ve reduced rates some places, and it’s been an extraordinary period for auto insurers generally.

But all of our companies and the insurance business did well in the first quarter. Our investment income was up something over $100 million pre-tax. Our finance business income was up maybe $50 million pre-tax. MidAmerican was about the same. And all of our other businesses combined we’re up about, close to $50 million pre-tax, led by Johns Manville, had the biggest increase there. That business is very strong currently. So if you take all of our businesses before investment gains, which I want to explain, if you take them all before investment gains, our pre-tax earnings were up $400 million or a little more.

Now, investment gains or losses, we don’t give a thought as to the timing of those. We take all investment actions based on what we think makes the most economic sense, and whether it results in a gain or a loss recorder is just totally meaningless to us. A complicating factor, slightly complicating factor, is that certain unrealized investment gains or losses go through the income and statement, whereas others don’t. That’s just the way the accounting rules are. Our foreign exchange contracts are valued at market really every day, but you see it at quarter end. And those foreign exchange contracts, which total about $21 billion now, a little more than $21 billion, had a mark-to-market loss of a little over $300 million in the first quarter. And they bob up and down. I mean, sometimes they bob as much as $200 million or more in a single day. And those mark-to-market quotations run through our profit and loss statement, whereas if we own some Coca-Cola stock and it goes up or down, that does not run through our income statement. But with foreign exchange contracts, it does. So there’s a $310 million mark-to-market, it shows as realized, it actually isn’t, investment loss on that. And overall, the investment losses, including that 310, came to about 120. In other words, there’s $190 million or something like that in other gains. As I say, that means, at least to us, that means nothing.

And to underscore that point, if later in the year the Procter & Gamble Gillette merger takes place, we are required under accounting rules, when we exchange our Gillette for Procter & Gamble stock, we are required under accounting rules to show that as a realized gain. Now, that will show up as probably $4 and a fraction billion. We haven’t realized any gain at that time, in my view. I mean, we’ve just swapped our Gillette stock for Procter & Gamble stock, which we expect to hold for a very long time. So it’s no different, in our view, than if we kept our Gillette stock. But the accounting rules will require that. So if, in the third quarter of this year, the P&G Gillette merger goes through, you will see this very large supposed capital gain recorded in our figures at that time. And I want to assure you that it’s meaningless, and you should ignore that as having any significance in terms of Berkshire’s performance.

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

The microphone that is live, people can line up to get their questions asked. I think we’ve got two microphones also in the overflow room. And like I say, after lunch, everybody should come in here, because there’s enough people that get so enthralled with shopping that they don’t return. They’d rather shop than listen to me and Charlie, and we’ll have plenty of seats for everybody in this main hall after lunch. And so with that, let’s go to… Have I forgot anything, Charlie? Oh, okay. That may be the last you hear from me, you never can tell. But the, we’ll go to, we’ll go to microphone number one, please.

[00:16:56] Shareholder (Simon Denison-Smith, London): Simon Denison-Smith from London. You talk a lot about the importance of selecting terrific managers. I’d just like to understand what your three most important criteria for selecting them, and how quickly you can assess that.

Warren Buffett [00:17:13] Yeah, I’ll give you two different ads. The most important factor, subject to this one caveat I’m going to give in a second, is a passion for their business. We are frequently buying businesses from people who we wish to have continue managing them, and where we are, in effect, monetizing a lifetime of work for them. I mean, they’ve built this business over the years, they’re already rich, but they may not be rich in a liquid sense. They may have all their money or a bit of a tied up in the business. So they’re monetizing it. They may be doing it for estate reasons or tax reasons or whatever, family reasons, whatever. But we really want to buy from somebody who doesn’t want to sell, and they certainly don’t want to leave the business. So we are looking for people that have a passion that extends beyond their paycheck every week or every month for their business. Because if we hand somebody a hundred million or a billion dollars for their business, that they have no financial need to work, they have to want to work. And we can’t stand there with a whip. We don’t have any contracts at Berkshire. They don’t work, as far as where I’m concerned. So we hope that they love their business, and then we do everything possible to avoid extinguishing or in any way dampening that love.

I tell students that what we’re looking for when we hire somebody, beyond this passion, we’re looking for intelligence, we’re looking for energy, and we’re looking for integrity. And we tell them, if they don’t, you know, if they don’t have the last, the first two will kill you. Because if you hire somebody without integrity, you really want to be dumb and lazy, don’t you? I mean, the last thing in the world you want us to be smart and energetic. So we look for those qualities. But we have, generally, when we buy businesses, it’s clear to us that those businesses are coming with managers with those qualities. And then we need, we need to look into their eyes and say, do they love the money or do they love the business? And if they love, there’s nothing wrong with liking the money, but if they’re, if they, what it’s really all about is that they built this business so they can sell out and cash their chips and go someplace else, we have a problem, because seeing people at headquarters, and we don’t have anybody to go out and run those businesses. So we, it’s necessary that they have this passion, and then it’s necessary that we do nothing to, in effect, dampen that passion. Charlie?

Charlie Munger [00:19:50] Yeah, the interesting thing is how well it’s worked over a great many decades, and how few people copy it.

Warren Buffett [00:20:03] Go to microphone two, please.

[00:20:05] Shareholder (Walter Chang, Houston, Texas): Good morning, Warren and Charlie. My name is Walter Chang, and I’m from Houston, Texas. Can you describe how you made your investment decision to invest in Anheuser-Busch, and how you estimated its intrinsic value? How long did it take you to make this decision? And is Budweiser inevitable like Coca-Cola?

Warren Buffett [00:20:36] I’m still drinking Coca-Cola. The meeting might get a little exciting if I, we were drinking Bud here. (Laughter) We don’t get into much in the way of description of what things we might be buying or selling, but the decision takes about two seconds. But I bought 100 shares of Anheuser about, I haven’t looked it up, but I would say maybe 25 years ago, when I bought 100 shares of a whole lot of other things. And I do that so I can get the reports promptly and directly. You can get them through your brokerage firm, but I’ve found that it’s a little more reliable to put the stock in in a direct name. So I’ve been reading the reports for at least 25 years, and I observe just generally consumer habits.

And at a point currently, the beer industry sales are very flat. Wine and spirits have gained in that general category at the expense of beer. So if you look at the industry figures, they’re not going anywhere. Miller’s has been rejuvenated to some degree. So Anheuser, which has had a string of earnings gains that have been quite substantial over the years, and market share gains, is ex… experiencing, as they’ve described, and they just had a conference call the other day, experiencing very flat earnings, having to spend more money to maintain share, in some cases having promotional pricing. So they are going through a period that certainly less fun for them than it was the case a few years ago. And it’s a fairly easy to understand product, and consumer behavior is fairly easy to understand. It’s a very, very exceptionally strong business.

In fact, what’s happened in the beer industry over the last 50 years has been fascinating to me and to Charlie, because this is a brewing town that we grew up in, and Charlie knew the members of the Storz family, a number of them, well. Storz had over 50% of the Omaha market in beer post World War II, and basically disappeared as the national brands took over. So it’s an interesting phenomenon. Beer business is not going to grow significantly in the U.S. Worldwide, beer is popular, great many places, and Anheuser will have a very strong position in it. But I would not expect the earnings to do much for some time, but that’s fine with us then. Charlie, you?

Charlie Munger [00:23:41] Yeah, at our scale of operation now, if we’re ever going to buy into a terribly well-regarded company, we almost need a little patch of unpleasantness.

Warren Buffett [00:23:53] That’s been the best time to buy Berkshire, incidentally, too. I mean, it, we do, what we’re looking for is businesses with a durable competitive advantage. I don’t think there’s any question that Anheuser has a very, very strong consumer position. Now, as I said, Miller has been rejuvenated to some degree. But the other thing about it is, of course, in beer, you do not see the prevalence of private labels or generic products that you see in a great many consumer products that are being, that have had strong positions over the years, that are being attacked. That’s a small plus. But beer consumption per capita is going no place, and there’s nothing that will change that.

Interestingly enough, the average person in this climate drinks about 64 ounces of liquid a year, and I think it’s roughly 27% of that will be carbonated soft drinks. So almost, and of course that Coca-Cola will be about, Coca-Cola products will be 40-odd percent. So of the 64 ounces of liquid that Americans are drinking every day, you can figure something like 11 ounces of that, man, woman and child, will be a Coca-Cola product. Beer, as I remember, I could be wrong on this, but I think beer is about 10% of all liquids. So one out of every 10 ounces of that’s consumed by Americans of any kind of liquid is, I believe, is beer. Coffee, incidentally, despite what you read about, you know, the popularity of Starbucks, which is very real, of course, but coffee has just gone down and down and down over the last 30 or 40 years. Charlie, do you have any thoughts about your consumption habits and that you can talk about?

Charlie Munger [00:25:59] Well, there are people here that may remember Metz beer. And in this country, we had more breweries, there were hundreds, and small places would have two or three brands. And this trend toward concentration into a few giants is, I think, permanent.

Warren Buffett [00:26:16] Yes. Schlitz was number one, as I remember, after World War II for a while. I think Anheuser was number four at that time. There’s an interesting book, if you’re a beer enthusiast, came out a few years, a few months ago, maybe a little longer than that, by a Wall Street Journal reporter that sort of toured the country sampling beers that, I don’t know how it affected his writing, but it’s a pretty good book if you like reading about the history of beer. Let’s go to number three.

[00:26:56] Shareholder (Norman Rentrop, Bonn, Germany): Hey, greetings from Bonn, Germany. I’m Norman Rentrop. Thank you for another great year added to your track record of investing, and thank you again for allowing us to be partners at these favorable terms. This year, I want to ask you another question about how you see Berkshire positioned versus others. Last year, I asked you how you see the increased competition for buying companies through the rise of the private equity industry, and how that affects Berkshire’s ability to buy great businesses at fair prices. And you basically said that there are still enough business owners who would rather sell to Berkshire versus a private equity fund. This year, I would like to hear your views on the hedge fund industry. We see hedge funds going into all investment strategies. We know that you have spoken about the fees of the hedge fund industries, but I would like to hear from you how you see Berkshire positioned. Are returns in strategies like merger arbitrage, like convertible bonds, are returns going down because of the increased competition? And are there other factors where Berkshire can be unique versus the hedge funds?

Warren Buffett [00:28:25] Well, that’s a great question. That’s the $64 question at the… There’s no doubt about it that there is far more money looking at deals now than five years ago, and they’re willing and to pay up more for the good but mundane businesses that we’ve been successful at buying in the past. And you mentioned the private equity firms, and they’re bigger than ever. The hedge funds have gotten into the game to some degree. And if someone is auctioning off a business today, this has changed just very slightly in the last four or five weeks because of the some change in the junk bond market, but not in any significant degree, there were people lined up to bid on almost anything. In fact, you have private equity firms selling their businesses to other private equity firms. And there are a lot of companies that are being sold to someone who’s buying them to resell in a fairly short period of time. We can’t compete in that field, and that’s, you know, that’s a source of distress to us, but that’s the way it is. We will, it won’t go on forever, in our view. We still occasionally, as this deal I mentioned to you, they, the party on the other side and we just, we made a deal that did not go through an auction process. And we see that occasionally, but we don’t see it anything like we saw it four or five years ago.

So in terms of the near-term outlook for Berkshire, in terms of doing what it’s important that we find, it, extraordinary, both Charlie and I have, over the decades, just how fast things can change. It, there have been at least three times, maybe more, where it’s looked to me in my own career where it looked like there was so much money sloshing around that it would be impossible to do intelligent things with money. And I actually terminated a partnership back at the end of 1969 because I felt that the money was coming out, you know, of the woodwork. There were all kinds of people that wanted to use it and compete, and I just didn’t feel we could do intelligent things. Within four years, I saw the greatest opportunities that I’ve ever seen in my lifetime. And we’ve had several experiences like that.

You know, in 1998, when Long-Term Capital Management got in trouble in the fall of 1998, and other things were happening, he had incredible opportunities available in the investment world. Now, people were just as smart then. They had all these people, 150 IQs, running around, and they actually had money. But the world became paralyzed for a short period, and you literally had so-called on-the-run governments, which were the most recent issue, and off-the-run governments, which were issued by the same government, the United States government, payable in dollars. You had a 30 basis point differential between the 30-year and the 29.5-year, both bonds issued by the U.S. government, you know, one and a half a year shorter, both quite liquid, but the on-the-run being more likely. And the 30 basis point differential in yield means about a three point difference in price. Well, you wouldn’t believe that could happen in the United States of America in 1998, but it did happen.

And I think I have a slide here. Mark, if we can put that up, that shows what high-yield bonds, the situation in those, just really less than three years ago, in the fall of… Yeah, there it is. In the fall of 19…, of the fall of 2002, you had all these high IQ people in the financial world, you had lots of money. And I don’t know how easy it is to read those figures, but you’ll see that a bunch of high-yield bonds, this is, this actually is a table that involves a friend of mine, but we were doing pretty much the same thing. And you can see he was buying bonds that, anywhere from a 25% to 60% or 70% yield basis, and within 12 or 14 months had sold these same bonds on a 6% yield basis. You don’t need to do that very many times in a lifetime. But that was two and a half years ago, after all these people who graduated with MBAs and studied modern finance theory and had money coming out of their ears and all had a desire to make money, and yet conditions like that could exist. We bought about $7 billion of junk bonds during that period, because it was a fairly short period. But things do happen that changed the landscape dramatically, I mean really dramatically, in financial markets from time to time. But right now, we are positioned very badly in terms of buying businesses, and it’s a big negative, and your Berkshire stock will not do as well under these conditions as it would do if the conditions of five years ago or 20 years ago existed. And I don’t have any magic solution for that, except just to tell you what the facts are. Charlie?

Charlie Munger [00:34:17] Yeah, a lot of the buying by private equity funds in both real estate and stocks and for companies, fee motivated. In other words, the investment manager will rationalize any price paid… tried to buy warehouses with a lot of family money, and he just stopped, but every bed was always stopped by some professional manager managing other people’s money on a fee basis. So this is a very peculiar era, where all these asset classes have been driven to very high valuations by all historical standards. Some investment operations are very ethical in this regard. I think Howard Marks is here today. He sent a lot of money back, and stops listing money from his clients in certain activities where the opportunities went away. That’s the right way to behave, but it’s not normal.

Warren Buffett [00:35:15] Yeah, I don’t think you’ll mind, I didn’t know Howard was here today, but those actually are Howard’s figures for one of his funds. And like I say, we were doing similar things. We didn’t know it at the time, but we find out we had some similar positions later on.

About five or six years ago, when the terms of these deals were somewhat different, I actually had a fellow call me whose name most of you would recognize, and he started asking me questions about the reinsurance business, because he was in, he said he was thinking about buying a given company, which got sold, and he didn’t really know much about the business, but that unless he spent these X dollars, he was going to have to give it back to his investors in a few months, because the term of the initial signup period expired at that point, and any unexpended funds were to be returned, and he was going to get 2% a year on those funds regardless of how they did. So he was looking at businesses that he didn’t understand with the hope that he can place the money.

Charlie and I are at disadvantage in buying businesses because we have almost all of our net worth in the downside as well as the upside. So, you know, if we had a 2% fee and 20% of the profits and the good-bye kiss for the losses, you know, that’s a different equation that exists at Berkshire. We run it as if it’s 100% our money, which it is, close to 100% of our net worth, and we will own the downside, and we don’t get, we don’t get paid for spending the money, we get paid for making money. And it’s tough. The competing right now is tough and likely to be relatively futile, although we have one or two things that could happen that could involve the expenditure of real money.

Charlie Munger [00:37:20] I don’t think any of the businesses that have sold to us over the years, which are run by the kind of people we like being associated with, would have wanted to sell to a hedge fund. So there is this a class of assets out there that doesn’t want to deal with head fund, hedge funds or private equity funds, thank God.

Warren Buffett [00:37:45] Yeah, we’ve seen no deal anybody else’s main the last year that we wish we had made. Now, that was not the case 15 or 20 years ago. There used to be plenty of deals made with other people that we would have liked to have made if they’d come to us. But I have seen nothing, I’ve seen nothing that if it sold for 10% less than the advertised price that we would have had any interest in buying. So we are in a different world right now. Number four.

[00:38:14] Shareholder (Dudley Schroder, Council Bluffs, Iowa): I’m Dudley Schroder from Council Bluffs, Iowa. What, when you were younger, what first sparked your interest in investing, and what advice would you give a younger person if they wanted to invest in the stock market? Thank you.

Warren Buffett [00:38:34] Well, I’m not exactly, I got interested probably when I was maybe seven or thereabouts. I wasted my time before that, a little like W.C. Fields, when he inherited some money, somebody asked him what he did with it, and he said he spent half of it on whiskey and the rest he wasted. So there I was dawdling around. But I got in, my dad was in the business, so I would go down to his office, and I would see these interesting books, and I would read them. And I would go down, he was on the fourth floor of what’s now known as the Omaha Building at 17th and Farnam, and on the second floor was Harris Supplement Company, and they had a board, and I would go down there. The market was open on Saturdays in those days, so I could, for two hours, so I could go down on Saturday, and I saw these interesting things going across the tape. And I just read a lot. I took, probably took every book in the Omaha Public Library, though, and every book they had on investing or the stock market, basically. I was very interested in New York Stock Exchange. I thought maybe I’d want to become a specialist when I grew up, and maybe I still will. But the, I took all the books out, I read them, and finally, when I was 11, I bought three shares of stock. And I didn’t know, I was fascinated by the subject. My dad got elected to Congress, so now the library became even bigger, and I took all the books I could out of there on markets, and I’d used to chart and do all that sort of thing. And then finally I read Graham’s book when I was at the University of Nebraska, The Intelligent Investor, when I was 19, and that just changed my whole framework.

But the advice I would give is to read everything in sight, you know, and to start very young. It’s a huge advantage in almost any field to start young. And if that’s where your interest lies, and you start young, and you read a lot, you’re gonna, you’re going to do well. I mean, there are no secrets in this business that only the priesthood knows. I mean, you know, we do not go into temples and look at tablets that are only available to those who have passed earlier tests or anything. It’s all out there in black and white, is a, it’s a simple business. It’s not, it requires qualities of temperament way more than it requires qualities of intellect. I mean, if you’ve got more than 125 IQ, you can throw away the rest of the points or give them to your other members of the family or do something, because you don’t need it in investing, that. But you do need, you do need a certain temperament that enables you to think for yourself. And then you have to develop a framework, and I developed it from reading Ben Graham. I didn’t come up with it myself. Very simple framework. And then you have to look for opportunities to, that fit within that framework as you go through life. And you can’t do something every day. You know, you can learn every day, but you can’t act every day.

And I’m not, I talked about reading the annual reports of Anheuser-Busch for 25 years, but I’ve read the reports of Coca-Cola and Gillette and all kinds of companies long before we invested in them. And if you enjoy the game, you know, you’ll find that, like playing bridge or playing baseball or whatever. And if you don’t enjoy it, you probably won’t do well on it. But I would advise you to start early, read everything in sight, look for the successful framework that’s been successful for people, and there’s nothing like Graham’s, in my view, and you’ll have a lot of fun, and you’ll probably make a lot of money. Charlie?

Charlie Munger [00:42:28] Well, I’m at a little disadvantage here. Warren has made himself into kind of a dean of investors, starting as a boy, and he has a greater respect for the process than I do. I have a good bit of Kansas attitude that money management is sort of a low calling compared to being a surgeon or a lot of other things. I think the corporate types, the corporate managers ought to study investing better, because they’d be better managers. And I think that everyone who thinks about, through the investment process, learns more about how the world really works, and I think that’s very worth having. But I do not like as big a percentage of GDP as we now have going to money management and its attendant frictions. And I don’t like the percentage of the nation’s brainpower that is now in all of these different forms of highly compensated money management. I don’t think it’s a good thing for the country. And I hate the fact that we’ve contributed to it by our own predilections.

Warren Buffett [00:43:37] Is only sitting up here next to me as part of his outreach program.

Charlie Munger [00:43:43] Actually, please don’t take any pictures that you could blackmail up with, being associated with me.

Warren Buffett [00:43:50] Charlie made a very good point there about how managers could do better if they understood investments. I find it absolutely fascinating, and I’ve seen this throughout my life, I’ve seen it close up. I will have friends who are CEOs of companies, and they’ll have somebody else handle their money. If you say to them, you know, should you buy a Coca-Cola or a Gillette or something like that, they’ll say, that’s much too tough, I don’t understand that sort of thing, what do I know about investing? And then some investment bankers walk in the next day with the idea they buy a $3 billion company, which is just buying a lot of shares of stock of one company, and they’ll run through some little two-hour presentation and turn it over to a strategic planning group, and think that they are then the ones that should make that decision as to whether to buy multi-billion dollar businesses, when they really don’t feel they’re qualified to make $10,000 decisions with their own money. And it’s extraordinary what you see in corporate America in the acquisition activity. It’s not, it’s, you know, it’s a little like they say about making sausage and making laws, it’s better unobserved. Charlie, you have any further thoughts on that? You’ve seen a lot of it with me.

Charlie Munger [00:45:15] Well, I do think that the present era has no comparable precedent in the past history of capitalism. I think we have a higher percentage of the, of attention of our intelligent classes into buying little pieces of paper, and getting, trying to get rich doing it, and in promotional activities with big profit sharing fees. I can recall no past era which had a similar concentration of this type of activity. Can you, Warren?

Warren Buffett [00:45:53] No, but I think you would say, probably, too, that when we’ve seen sort of baby versions of this, something subsequently happened that…

Charlie Munger [00:46:02] Oh, yes. If you want to talk about what are the future implications, a lot that I see now kind of reminds me of Sodom and Gomorrah.

Warren Buffett [00:46:14] And we weren’t there, incidentally, I mean.

Charlie Munger [00:46:18] No, but that was a published account. And I think when you get as much sort of regrettable activity going on, and sort of feeding on itself, and frenzies of envy and imitation, that it has happened in the past that there came bad consequences.

Warren Buffett [00:46:41] On that cheery note, we’ll move to number five.

[00:46:45] Shareholder (Molly Fenner, Long Island, New York): Good morning. My name is Molly Fenner, I’m 11 years old, and I’m from Long Island, New York. I have two questions today, and I have put them in the form of a poem. Mr. Buffett, Mr. Munger, to get here we have to fly. I came to hear your thoughts, a PetroChina was at an all-time high. My second regards a job that I know is just right for me, to be a See’s Candy taster, my sisters and I would work for free.

Warren Buffett [00:47:32] Well, if you come up front, I’ll put you to work.

[00:47:39] Shareholder (Molly Fenner, Long Island, New York): Boyce Charms was for my mom, and my father loves his stock. I have a future tasting chocolate, this weekend has really rocked. Thank you very much. And really, what is your view on PetroChina?

Warren Buffett [00:47:58] If you come up at the break, Charlie and I will have taken all the pieces out of here that we like best, and you will be, you will get the rest. Charlie, do you have anything to add to that?

Charlie Munger [00:48:19] She wants to know what you think about PetroChina.

Warren Buffett [00:48:24] Funny, I saw her out there in the shopping area, and I knew that she had PetroChina on her mind. We bought PetroChina a few years ago, again, after reading the annual report, and fortunately it was in English. It was the first stock, Chinese stock, and really the last, I mean, it won’t necessarily be the last time, it’s the only one that we’ve owned so far. We put about $400 million into it at the time. And still, it produces about 3% of the world’s oil, which is a lot of oil. It produces probably 80% or so as much as ExxonMobil will produce, and it’s a huge company. Last year, it earned $12 billion. Now, if you look at the Fortune 500 list, my guess is you won’t find more than about five companies in the United States that earn $12 billion or more. So it’s a major company. At the time we bought it, the total market value was $35 billion, so we bought it about three times what it earned last year. It does not have unusual amounts of leverage. It, in the annual report, they say something which very, very few companies do say, but which I think is actually fairly important. They say they will pay out about 45% of the amount they earn. So if you can buy it at three times earnings, would turn out to be three times earnings, you get 45% of 33%, you know, you’re getting a 15% yield on your cash, yield on your investment.

It’s a very good annual report. Chinese government owns 90% of the company. We own 1.3%. If we vote with them, the two of us control the business. And that, it’s a thought that hasn’t occurred to them, but I’ll keep pointing it out. But it’s, you know, it’s a very major business at a very, very attractive, at what was a very attractive price. Unfortunately, the government’s shares and our shares have the same economic interest, but they are classified differently, so that the government’s 90% are called one thing, and the 10% with the public are called H shares. And we have to report in Hong Kong when we own 10% of a company, or we did then, 10% of a company’s share. So unfortunately, the 10% applied only to the 10% of H shares, and so we had to reveal our ownership when we only had 1% of the economic interest in the company. So we would have bought more, but the price jumped up, and we are happy to have our 1.3% or whatever it is. And we think that they’ve done a good job in running the business. They’ve got large gas reserves, which they’re starting to develop now. But it’s a very major enterprise, employs almost 500,000 people. And the interesting thing was, a few years ago, relatively few people in the investment world probably even thought about the fact that PetroChina was over there and was a much larger business than most of the, just about any oil company in the world except for BP and ExxonMobil. Charlie, do you have any thoughts on that?

Charlie Munger [00:51:53] Yeah, it would be nice if this sort of thing happened all the time, but that hasn’t been true in recent years.

Warren Buffett [00:52:00] But we never, I should emphasize, I mean, the annual report of PetroChina, which, like I say, it’s easy to read, understandable, they declare their policies, anybody could get it, you can read it. We did not, we did not go over, and we never had any contact with the management before we bought the stock. We’d never attended an investment, investor presentation or anything of the sort. I mean, it’s right there in black and white in a report that anybody can get, and we just sit in the office and read those things. And we were able to put 400 million out, that’s now worth about a billion two or something like that.

It was interesting, at the time, I think I’m right on this, at the time, Yukos, which is the big oil company in Russia, was probably far better known among the investing community in the United States than PetroChina. And I compared the two at the time, thought to myself, would I rather have the money in Russia or have in China? PetroChina, in my view, was far cheaper, and I felt the economic climate was likely to be better in China. You know, would I have, if it had been selling at the same multiple as a U.S. domestic company, would I regard it as more attractive? No. I mean, there’s some disadvantage, as always, to being in a culture that you don’t perfectly understand, or where tax laws can change, your ownership rules can change. But the discount at which PetroChina was selling compared to other international oil companies was, in my view, at the time, ridiculous. So that’s why we bought it. And we will have the candy available for you at the break. Number six.

[00:53:45] Shareholder (Matt Sauer, Durham, North Carolina): Good morning, gentlemen. My name is Matt Sauer, and I’m from Durham, North Carolina. Many businesses are reporting rising costs and surcharges on such inputs as fuel, metals and wood. They are often unable to pass along these costs to their consumers. If commodities stabilize at price levels above those of the past decade, will corporate margins be compromised into the future?

Warren Buffett [00:54:12] Well, it’s a great question. I would say that that would depend very much on the industry you’re talking about. But in our carpet business, for example, we’ve just been hit time after time, as I mentioned the annual report, with raw material increases, because there’s a big petroleum derivative factor there. And we have lagged in terms of being able to put through those increases to our customers, simply because we want to, we want to protect the Nebraska, Nebraska Furniture Marts are those that have ordered for a reasonable period of time. And that squeezed margins in carpet. We used lots of natural gas in, at Johns Manville, use lots of natural gas at Acme Brick, and that’s tended to squeeze margins some. I think over time, I think there has been a lot more inflation in these basic materials. Steel has been off the chart. I think over time, the businesses with strong competitive positions managed to pass through increases in raw material costs, just as they pass through increases in labor costs. But you get these temporary situations where sometimes the costs are increasing faster. I don’t think Amer…, I don’t think the American industry, I mean, a higher cost for oil, when we import 10 million barrels a day or more of oil, if we’re paying or so more per barrel than we were a year or two ago, and that’s $200 million a day, is a tax, but it’s more of a tax on the American consumer, probably, than on American business. The American business will probably be able to pass through most of those raw material cost increases.

It is worth pointing out that corporate profits as a percentage of GDP are right at the all-time high, leaving out a few aberrational periods. And I would ex…, you know, if I had to bet on the direction of corporate profits as a percentage of GDP over the next five years, I would bet they would go down somewhat, but that’s because they’re right at this very, very high level. Interestingly enough, while corporate profits as the percentage of GDP are at this very high level, corporate taxes as the percentage of total taxes raised in America are very close to an all-time low. So American businesses managed to pull off a situation where they’re making extremely good profits and paying a very small percentage of the total tax bill, as measured in this country historically. And I’m not sure whether that could or should or will continue. But it’s a very, very favorable period right now for corporate America. But that’s nothing to get bullish about, because you might expect some, something of a reversion to the mean. Charlie?

Charlie Munger [00:57:18] Well, I can’t add to that, but I can restate it. It’s hard to know just which companies can pass through the increases in costs that come from higher commodity prices.

Warren Buffett [00:57:33] And it’s also important to know, we like buying, buying businesses where we feel that there’s some untapped pricing power. We haven’t been able to do much of that lately. But back in 1972, when we bought See’s Candy, I think it was either, was it at honor 95 a pound, something like that? Yeah. Yeah. And they were selling 16 million pounds of candy a year, making $4 million pre-tax, with about $25 million purchase price, which I would have very foolishly refused to budge on, and in history, and cost us a lot of money. But one of the questions we asked ourselves, and we thought the answer was obvious, was, you know, if we raise the price 10 cents a pound, would sales fall off a cliff? And of course, the answer was, in our view at least, was that no, there was some untapped pricing power in the product. And it’s not a great business when you have to have a prayer session before you raise your prices a penny. I mean, it, you were in a tough business then.

And I would say you can almost measure the strength of a business over time by the agony they go through in determining whether a price increase can be sustained. And frankly, a good example of that is the newspaper business right now. Because 30 years ago, when the, whatever the local daily would be, had an absolute lock on the economics of the community, because it had the megaphone through which merchants had to talk if they were going to get their message across to their audience, at that time, rate increases, both circulation and advertising, were something that were almost a big yawn to most publishers. They did it annually. They did not worry about the fact that Sears or Walmart or Penney’s or whomever with polar advertising. They did not worry that people would drop their subscriptions to the paper. And they went merrily along increasing prices, and they increased them when newsprint went up, and they increased them when newsprint went down, and it worked. And you got these very fat profit margins, and it looked like about as strong a business as you can imagine.

Now publishers find themselves in a position where they agonize over rate increases, either, both in advertising and in circulation, because they’re worried about driving away advertisers into other media, and they’re worried about people, when they get a 20% increase, you know, per month or whatever it may be, and their circulation price, just deciding, well, I think I’ll just drop it. And when they drop it, they don’t usually take it up again. So that world has changed. And you could recognize the change in that world simply if you could get inside the mind of the publisher in terms of how they felt about price increases. You can learn a lot about, you learn a lot about the durability of the economics of a business by observing the behavior of the price behavior. I mean, you’re seeing that, we’re talking about the beer business. You know, the beer has moved up in price every year, but there have been some rollbacks in certain areas in the last year, which means that, you know, it’s getting a little bit more difficult to increase prices, even though they increase them at rates below inflation. And those are not, that’s not a good economic sign. Charlie?

Charlie Munger [01:01:28] I have nothing to add to that.

Warren Buffett [01:01:32] Okay, we’ll go to number seven.

[01:01:35] Shareholder (Pete Banner, Boulder, Colorado): My name is Pete Banner, from Boulder, Colorado. First of all, Mr. Buffett, Mr. Munger, we shareholders consider you our heroes. We appreciate and very much value who you are and what you do in the world. So thank you.

Warren Buffett [01:01:53] Well, thank you. Thank you, Peter. I will say in return that we think we’ve got the best group of shareholders in the world, and to some extent it’s evidenced by the fact we have the lowest turnover, and I think the most knowledgeable group, incidentally, too, of shareholders. So with that, our mutual love affair can go on.

[01:02:13] Shareholder (Pete Banner, Boulder, Colorado): Thank you very much. Secondly, with taxes as they are today, 15% on dividends, how do you feel about declaring a dividend?

Warren Buffett [01:02:23] Oh, you were setting me up. Well, there’s no question about the fact that dividends are lightly treated now for taxation purposes. So, but we have always said, and it’s been true, that if there were no tax on dividends, to this point at least, we would have followed an identical dividend policy, because the test with us is whether we think we can retain a dollar and have it worth, in present value terms, more than a dollar. If we can’t do that, we should distribute any money that we can’t destroy, we can’t utilize on that basis. Now, when the cash piles up like currently it has, currently, you can say it’s pretty dumb to hold, you know, billions of dollars that last year the rates were less than 1% after tax. And, you know, what are you doing for shareholders with that? And I would say that the burden of proof will certainly shift if, within a few years, we can’t use a lot more money intelligently than we are now.

But if we were, at the time at which we feel that the present value of the earnings we retain is not greater than a dollar comes, and it could come, and it’s more likely to come when you get large like we are, then we should have not only a, you know, dividend policy that’s X percent of earnings, we should pay out very substantial sums. The test is whether the money can be used effectively within the business. So far it has been. That doesn’t mean it was yesterday or the day before, but so far it’s produced more than a dollar’s worth of market value for every dollar retained. But that will be discussed. Our directors meet Monday. That will be discussed then. And you’re certainly, if we sit here a couple of years from now and we have not successfully deployed more cash, then I think that the burden of proof has shifted dramatically to us to explain why we would be retaining earnings at that point. Charlie?

Charlie Munger [01:04:49] I’ve got nothing to add to that, too.

Warren Buffett [01:04:53] Number eight.

[01:04:53] Shareholder (Ole Larsen, Salt Lake City): My name is Ole Larsen, from Salt Lake City, originally from Sweden. I read your annual report where you mentioned how the current account deficit or trade deficit has to eventually come to an end. And they report, you were reluctant to give views or forecasts of how this would come down from $2 billion a day. Would you nevertheless be willing to share some thought or what, how it might come down, if you have any views on this?

Warren Buffett [01:05:30] Well, that really is a $64 question, because it, we are, in my view, and Charlie, Charlie doesn’t, he’s not as on board on this as I am, and so that it’s important that you listen to him on this too. But the, it does seem to me that a $618 billion trade deficit, or in a larger current account deficit, rich as we are, strong as this country is, that something won’t happen that will change that in a major way at some point. And that the longer that it goes before changing, the more likely it is that something fairly significant happens. But most economists, most observers would still say that some kind of a soft landing is possible, or like they would say it’s likely. They never, to my mind, they never quite explain, you know, what the soft landing is. They just say it’s, you know, it’s likely to be a soft landing, but it could be something different, but we still think it’ll be a soft landing. But I don’t know what a soft landing is exactly, in the sense of how the numbers come down quite significantly. And if they don’t come down, the current account surplus or deficit means that we are transferring more and more wealth abroad, and that we will, in addition to our trade deficit, we will at some point have a very significant deficit in terms of the net investment position that the rest of the world holds on us. So it becomes a compounding effect.

I do recommend, there’s a, there was an op-ed piece in the Washington Post on April 10th by Paul Volcker, and he has expressed himself some on this, and he gets into the question of whether it can be a soft landing or not. But I think he certainly expresses some real apprehension about whether a soft landing will be the likely result in the kind of world we live in, with so much of the assets of the world, whether they be foreign exchange or whether contracts or whether they be stocks or bonds or junk bonds or whatever, I think is higher percentages on what I would call a hair trigger now as it ever existed. In other words, I think there are more people that go to bed at night with a position in foreign exchange or bonds or a carry trade or stocks or whatever, that some event that could happen overnight would cause them to want to change that position in the next 24 hours. I think that’s the highest, perhaps, in history. Somebody’s referred to it as the electronic herd that is out there. I mean, people can, with, they can give vent to decisions involving billions and billions and billions of dollars, you know, with the price of a key, virtually. And that electric, I think that electronic herd is at an all-time high. I think that some exogenous event, it was almost Long-Term Capital Management in 1998, but some exogenous event, and we will have them, we’ll cause it. I think it could very well cause some kind of stampede by that herd. And that, you can’t get rid, if you’re the rest of the world, you can’t get rid of dollars. I mean, if you’re sitting in Japan, China or some place, and you own a lot of U.S. government bonds, if you sell them to somebody in the United States, you get U.S. dollars, so you still have U.S. assets. If you sell them to somebody in France, you’ve now got euros, but they’ve got the, the government, you can’t get rid of those assets. But you can’t have people trying to head for the door very quickly with them under certain circumstances.

Volcker said in this thing, he said in the second paragraph, “Yet under the placid surface, there are disturbing trends: huge imbalances, disequilibrium, risk, call them what you will. All together, the circumstances seem to me is dangerous and intractable,” and I don’t emphasize intractable, “as any I can remember, and I can remember quite a lot.” Well, Paul Volcker can remember quite a lot, and I agree with that. I don’t, I have no idea, I have no idea on timing whatsoever. And in economics, it’s far easier to tell what will happen than when it will happen. I mean, you can see bubbles developing and things, but you do not know how big the bubble will get. For example, you know, this happened five years ago in the market. So you, predicting timing is, I’ve just never been successful at it, nor do I try to do it. Predicting what will happen, I think, is a much easier sort of thing. And I would say that what is going on in terms of trade policy is going to have very important consequences. It was not addressed in the last presidential campaign by either candidate in any meaningful way at all. Now, I’m not sure, if, you know, you were standing up in front of the American people and somebody’s giving you three minutes to explain this whole situation, when 90% of your audience couldn’t define current account, you know, it’s not an easy game. But it’s an important one. Now, Charlie is less enthusiastic about our foreign exchange position, somewhat, than I am. So I’m, I want to yield the floor here for a significant period of time while he gives you the other view.

Charlie Munger [01:11:02] Well, I’m, if anything, a little more repelled than you are by the lack of virtue in the way our nation uses consumer credit and the way we run the public finances. And I have a feeling that eventually a lack of virtue is going to hurt one. Where we differ is that I agree with Adam Smith that a great civilization has a lot of ruin in it. I mean, it will bear a lot of abuse. And so I think there are dangers in the current situation that make it unwise for anybody to swing for the fences. But I don’t think that we have a certainty that the system won’t stand a lot more of the kind of abuse it’s getting now. What do you think the end will be?

Charlie Munger [01:11:53] Bad.

Warren Buffett [01:11:53] I knew I could count on him. Now we are truly in this country like an incredibly, I mean incredibly, rich family that owns, we’ll say metaphorically, millions of acres of land. They can’t see, they can’t travel to the outer reaches of their domain, but nevertheless they sit on the front porch and wait for the produce to come in from this fast holding. And when they get it all, they still want to consume about 6% more than everything that’s been produced on the farm. And they have the ability to do that by simply selling off a little piece of the farm every day and every year that they can’t even see. So they don’t feel any poor at the end of the day or at the end of the year, because it’s still, as far as their eyesight can see, they own everything that God ever created. And they can sell that little piece, or they can mortgage it, they can send IOUs to these people that are giving them the extra goods to consume.

And we are a very, very, very rich family, and we produce a whole lot, and we consume a little bit more than we produce, and we trade away a little bit of the farm or put a little bit of a mortgage on every day. And the rest of the world is happy to take a little piece of our farm or take a mortgage on it a little harder to send us something so that we can consume a little bit more than we produce. It’s been going on a while. It’s accelerated a lot in the last few years, and more and more the rest of the world is owning part of us, and we are going to have to service that ownership, either through interest if they took it in IOUs, or in some other way. And it can go on a long time, but if it goes on a long time, the world will own a good bit of us, and our children will be paying one way or another for the fact that we got to consume more than we produced.

And it could happen. You could have… you’ve obviously had some less interest in the rest of the world accepting dollars by the fact that the dollars declined somewhat in value in the last few years. In other words, that the… in the investment in us is always going to be equal to the over consumption. I mean, it’s an equation. But if people get a little less excited about one, enthused about one side of the equation, it reflects itself in the pricing mechanism. And the world has demonstrated a diminishing enthusiasm for dollars in the last few years as they get flooded with them, because they… we send $2 billion out every day, whether we like it or not and whether they like it or not. Now, the question is, does that reach some tipping point at some point, or to some exogenous event come about that causes people to want to rush for exits? Who knows. All I know, I have a hard time thinking of any outcome from this that involves an appreciating dollar. But as Charlie will point out in just a second, there have been times when we’ve been surprised. Charlie?

Charlie Munger [01:15:25] Yeah, the counter argument is that what does it matter if the foreigners own 10% more of the United States if at that time total wealth of the United States is 30% higher than it is now. And so, well, people have that point of view, just roll with it. And some of them think that if we didn’t manufacture anything in the United States and just out here running hedge funds, we would have a wonderful economy because it comports with Republican principles.

Warren Buffett [01:15:58] Will you cut each other’s actually… I mean, yeah. But back in the late 18th century, obviously the idea of taxation without representation caused a certain amount of trouble. And ownership of the rest of the world by the rest of the world of this country would be seen as a form of taxation, I think, 20 years from now by the people who resided here. If we in… if instead of fighting the Revolutionary War we’d simply made a deal with England and said, “We’ll give you 3% or 5% of our national product forever, and you let us be free, and we’ll just mail, send the royalty over every day,” that might have looked like a good alternative to war, you know, in 1776. But I don’t think that subsequent generations would have reacted well. I mean, something would have happened over time.

And I have a feeling that the idea of America paying tribute to the rest of the world because of the over-consumption patterns of a previous generation seems to be… I don’t think that’s a particularly stable scenario. But that’s why we have only $21 billion in foreign exchange contracts. Charlie might have a little less, or maybe none if he were running it entirely, and I might have somewhat more if I didn’t know I’d have him sitting up here next to me next year. Let’s go to number nine.

[01:17:26] Shareholder (Johann Freudenberg, Germany): Hello, my name is Johann Freudenberg from Germany. What do you think would be the consequences of a strong decline of the housing market for sales of carpet retailers and manufacturers? Thank you.

Warren Buffett [01:17:40] Well, if there’s a strong decline in the housing market, my guess is that whatever we lose in carpet we’ll be making up for somewhere else, because it would… a lot of the psychological well-being, as well as the financial well-being, of the American people is tied up with the fact, or comes from the fact, that they feel so good about what has happened with their home ownership over the years. And with many people, it’s been by far the best behaving asset that they’ve had. So if there is indeed some kind of a bubble, and it’s pricked at some point, my guess is that we would feel that in various ways in our operating businesses, but that in terms of what we could do with our capital, the net effect of Berkshire might well be quite positive.

We’re not big on macro forecasts. I mean, this foreign exchange thing is quite different than what we’ve done over time and the way we’ve made money. So we are… it isn’t like we’ve got some great track record of predicting macro factors and made a lot of money doing that. We’ve made money by looking at things like PetroChina or whatever it may be and just deciding that here’s a very good business selling at a very cheap price.

Certainly at the high end of the real estate market in some areas, I mean, you’ve seen some extraordinary movement. And I’ve referred to this before, but 25 years ago or so we saw the same thing in farmland in Nebraska and Iowa and surrounding areas, and we had people running from cash. Cash is trash. And people, you know, they were worried about the fact that inflation was out of control in the late ’70s, and before Volcker did his stuff, people were fleeing from cash. And one of the ways they gave bit to that fear was to rush into farmland. And there was a farm about 30 miles north of here that sold for about $2,000 an acre in roughly 1980, and a few years later I bought it from the FDIC for $600 an acre.

And you can say, how can you go crazy about farmland? It’s going to produce about 45 bushels an acre of soybeans, about 120 bushels an acre of corn, and there’s no way you could dream about a tripling or the internet causing, you know, corn yields to go up or something of the sort. But people went crazy on it, and the consequences were huge in terms of banks failing, lots of banks failing in this area, banks that have gone through the Great Depression. But the people went… they just went a little crazy. People go crazy in economics periodically and all different kinds of ways. And, you know, you had the Resolution Trust Corp come out of the savings and loan nuttiness that took place in real estate, where they financed everything that was put before them.

And, you know, I will not… I don’t know where we stand in terms of the residential housing cycle. It has different behavior characteristics, simply because people live in the houses in many, great many cases, so will not behave necessarily the same as other markets. But when you get prices increasing at far, far greater rates than construction costs or inflationary factors, sometimes there can be some pretty serious consequences. Charlie?

Charlie Munger [01:21:28] Yeah, it’s… in a place like Omaha, there’s not much of a housing price bubble, is there one?

Warren Buffett [01:21:36] No, there’s not been a bubble, but I would say that real estate probably is… has increased in price at a rate quite a bit faster than the general inflation rate.

Charlie Munger [01:21:49] Yeah, but if you get to Laguna, California, or Montecito, California, or the better suburbs of Washington, D.C., you have a real asset price bubble. I have a relative that, to move to a good school district in the suburbs of Virginia, she have to pay four times as much as she can get from selling her nice Omaha house. Yeah, well, that’s a price bubble.

Warren Buffett [01:22:15] I sold a house a few months ago in Laguna for $3.5 million, out sold the first day, so I probably listed it too cheap. So don’t count on me for residential real estate advice. But that house, the physical house, would probably cost a half a million or thereabouts, so in effect the land went for $3 million implicitly. And the land is probably on the area of 2,000 square feet, which is a little less than one twentieth of an acre. Now, you’ve got streets and all that sort of thing involved, but basically I think that land sold for about $60 million an acre, which that fellow that you saw in the farm outfit in the movie finds like… sounds like a pretty fancy price for almost any kind of land. Charlie, you’ve witnessed it firsthand though out there.

Charlie Munger [01:23:05] Well, yeah, there’s a… one of the Berkshire directors lives adjacent to what I regard as a pretty modest little house which sold for $27 million recently. Now, these are houses that look right at the ocean, and there isn’t a great deal of available shoreline in California, and there are a lot of people. But you have some very extreme housing price bubbles going on, and you would think there might be a real possibility that it could go in the other direction someday.

Warren Buffett [01:23:40] At $27 million, I’d rather stare in my bathtub. (Laughter)

Number 10.

[01:23:44] Shareholder (David Winters, Mountain Lakes, New Jersey): David Winters, Mountain Lakes, New Jersey. How do you try to manage risk at Gen Re and National Indemnity to be comfortable and maximize returns? Especially, how do you prevent a catastrophic loss or unexpected correlation? Thank you.

Warren Buffett [01:24:04] Yeah, well, that’s a very good question, because we are doing things in different parts of our insurance operation where there is correlation. And there’s not only correlation among the insurance risks. I mean, just, you know, take a major, really major earthquake in California in the wrong place. There have been about 25 6.0 or larger in the last 100 years, but most of them don’t occur where a lot of people are. But if you get the wrong one in the wrong place, it would not only hit National Indemnity and Gen Re, as you mentioned, but it might very well have a severe effect on See’s Candy. It might very well have a severe effect on Wells Fargo. We don’t own Freddie or Fannie now, but we owned Freddie at one time. It could have had a severe effect on Freddie. It can have all kinds of secondary and tertiary effects that you might not think of initially. So we find when there’s trouble, everything correlates.

And it’s part of my job, is to have at least a general idea of the sort of risk that the various enterprises might be running operationally, and then integrate that in to my own notion of the risk that we run in terms of investments, in terms of all kinds of things. And, you know, that is my job. The most likely mega cat at any time is a hurricane. We have more exposure to that. On the other hand, if you’re talking $25 billion and up, maybe $100 billion and up insured catastrophes, you know, that a quake might be just as likely as some force five hurricane that would come in at the wrong place.

But that my job is to think absolutely in terms of worst case, and to know enough about what’s going on in both investments and operations to make sure that no matter what happens, you know, I don’t lose sleep that night, you know, over what can… you know, whether there’s a 9.0 quake someplace, or whether there’s a force five hurricane that actually goes up the East Coast and enters at places that very solemn does it entertain. Long Island, for example, a huge amount of exposure. How often is Long Island going to, you know, really have a major hurricane? Not very often. I think there was one back in the ’30s, but there were potato fields there in the ’30s, and now there’s all kinds of insured value.

And, you know, everything will, everything that can happen will happen. I mean, the… in terms of our… what we know of history in this country, last three or four hundred years, you know, the most severe quake by far was at newman New Madrid, Missouri. And who would have guessed, you know, that that quake would happen? And there were two subsequent quakes. They’re far enough apart so they didn’t exactly seem like aftershocks. All three of those were higher than eight on the Richter scale. Nobody thinks about that. But they’ve had them in Charleston, South Carolina. They’ve had… I mean, it’s… you will see things, maybe not in your lifetime, but in… if you take the centuries, some extraordinary things can happen. And it’s Berkshire’s job to be prepared absolutely for the very worst.

And by and large, I would think hurricanes and quakes are the biggest thing now. But a few years ago, we did not have nuclear, chemical and biological risks excluded in policies, and we had huge exposure, subsequently gotten rid of. But we take on large risks. I’ll give you a couple of examples. Just the other day, and nobody else will write this stuff, basically because they would want to reinsure it with somebody else and they’re not set up to do it. But one large airport, one large international airport, came to us, and we wrote a policy for $500 million excess of $2.5 billion from any action that was not caused by nuclear, chemical or biological sources. So if that airport is taken out in some way, but not by nuclear, chemical or biological activities, the first $2.5 billion somebody else worries about, and we get the next half billion. There’s a sub limits, only a billion six can be counted for business interruption. So you would need… and that airport would have to be out for a couple of years to have a billion six of business interruption, so you need $900 million of physical damage on top of that. But somebody is willing to buy that policy, and there’s a real risk.

We insured the NCAA Final Four down in St. Louis against being canceled, not postponed or having the games, those Final Four games, move to another city, but if it was cancelled totally, and again not through nuclear, chemical or biological, we would have paid $75 million. Same thing at the Grammys. I mean, we take on risks that very few people want to write. But in the end, we’re willing to lose a lot of money in one day, but we’re not willing to do anything that causes us any discomfort in terms of writing checks the following morning.

Incidentally, while I’m on the nuclear… well, we’re talking about the pleasant subjects. I recommended in the annual report that book, “Nuclear Terrorism.” And if you go to lastbestchance.org, you can obtain, or will soon be able to obtain, a tape free that the Nuclear Threat Initiative has sponsored, which has a dramatization of something that is now fictional, but it’s not… it’s not fanciful. It’s something that could happen, in which the Nuclear Threat Initiative is working to minimize the chances of. And on that program, in addition to this dramatization of what could happen in that field, you have Sam Nunn and Senator Lugar with Tom Brokaw discussing the subject. It’s an important subject. It didn’t get a lot of attention again in this last campaign, although I think both candidates fully recognize the importance.

But we would regard ourselves as vulnerable to extinction as a company if we did not have nuclear, chemical and biological risks excluded from virtually all of our policies, although we intentionally take on the risk periodically, but only in an amount that we feel we can handle. We do not write it and give it away for free, and we do not want to write it promiscuously, because there could be events happen that would make it impossible for our checks to clear the next day, and we’re not going to get ourselves in that position. Charlie?

Charlie Munger [01:31:49] Yeah, we’re likely to do better than most other people in dealing with what concerns you. We care more about it, that kind of correlation. We just naturally have minds that think about tidal waves in California, where they’ve never had one in modern California civilization. Can you imagine what a 60-foot tidal wave would do in California? There’s nothing physically impossible in having a 60-foot tidal wave in an earthquake zone where which catholic California is in. But it’s never happened in modern history. But it’s the kind of thing that we do think about. And do you think any other company has as much and as rigorous nuclear and so on exclusion as we do?

Warren Buffett [01:32:36] Well, nobody… nobody’s attacked it any more vigorously than we’ve attacked. I would… yeah. I mean, what you have here is, individually, we probably worry more about the downside than just about any manager you can find, and collectively, you know, it’s Armageddon around here every day. But that’s, you know, we care about that. We’ve never used a lot of borrowed money. Back when I started out, I mean, I had $10,000, but I just didn’t want to borrow any significant amount of money. There’s no reason to. You know, we’re living fine. We were living fine when I had $10,000. And the idea that you risk what you need and is important to you for something that you don’t need and is unimportant is just craziness. And we try to run Berkshire that way.

And, you know, I had a 98 year old aunt, my Aunt Katie, that died last year. She had everything she had in Berkshire, you know. And the idea that I should be doing something to try and add a few dollars to my net worth or a few percentage points to the record and be risking the fact that she would go back to Social Security is, you know, I just… I think that’s kind of crazy for a manager. But, you know, maybe if I had a two and twenty percent arrangement with my Aunt Katie, I’d be differently, but I hope not. Number eleven.

[01:33:58] Shareholder (Martin Wiegand, Chevy Chase, Maryland): Hello, my name is Martin Wiegand from Chevy Chase, Maryland. On behalf of the assembled shareholders, we appreciate you and the Berkshire staff hosting this weekend and would like to thank you for building this community of shareholders.

Warren Buffett [01:34:12] Martin, thank you. I should point out that I dated Martin’s aunt, but she only went out with me once. But maybe you could explain that, Martin.

[01:34:22] Shareholder (Martin Wiegand, Chevy Chase, Maryland): New board member Bill Gates has been talking about education reform in America, and columnist George Will quoted you in an article about Patrick Byrne’s efforts to reform education America. Could you share with us some of your thoughts about these two efforts or your efforts to reform education? Thank you.

Warren Buffett [01:34:41] Well, interestingly enough, we just dedicated a school here in Omaha yesterday, which is named after my Aunt Alice, who taught in the Omaha public schools. And we’ve… I think we’ve maintained quite an excellent public school system around in Omaha. We also have an outstanding parochial school system here. You know, it takes the interests of parents, and frankly it takes the interest of the well to do in the school system to keep a first class school system. I’ve said that to some extent a public… a good public school system is a lot like virginity: it can be preserved but not restored. You know, and in Omaha we’ve preserved it, but you preserve it by having the parents interested and involved in the public school system.

And Patrick’s got an ingenious idea to make sure that more of the money goes to teaching and less to administration and overhead. There’s a variety of ideas around about how to correct a system where it’s broken. And Charlie is, as a big Ben Franklin enthusiast, has always said that an ounce of prevention is worth a pound of cure, and I think we’ve been spending that ounce of prevention. We’re providing it here in Omaha. I think it’s a… you know, Charlie will have a lot more to say on this.

I admire the fact that people like Patrick and Bill Gates and a lot of other people, John Walton and Teddy Forstmann, all kinds of people, Bob Wilmers up in Buffalo, attacking the problem. It’s probably the next to the nuclear, chemical and biological problem. I mean, it’s the number one problem of the country, is making sure that the educational system is the best in the world. We’ve got the resources, and we’re not providing it. We’re not delivering it. So it’s a… it’s very complicated when you operate through thousands and thousands of school districts, and you work with many, many unions, and you’ve had, to a great extent in many areas, the rich opt out of a system and set up a separate system.

You know, I am not as concerned about the public golf courses and almost I might be if I play them every day instead of playing at a country club. And if you have a two-tier school system, one for the rich and one for the poor, it’s going to be hard to pass bond issues that benefit the people that don’t have the money to send their kids to private schools. I’m a big believer in the public school system, though, in terms of equality of opportunity in this country. Charlie’s thought about education. He’s actually come close to running a school, cares about it enormously, so I’ll turn it over to him.

Charlie Munger [01:37:48] Well, I learned something rather interesting about Omaha public schools on my way to this meeting. I stopped to sign some books in a warehouse in South Omaha, and one of the very nice people in the warehouse was married to an eighth grade teacher in the Omaha public schools, and we got to talking about No Child Left Behind. And he said his wife, this eighth grade teacher, had a very interesting system for the numerous children who couldn’t read. She records books on tape, speaking slowly in her own voice, and when some children are reading the books, other children are listening to the tapes, and that way the children who listen to the tapes are not left out when they ask questions about what went on in the books. Well, this is No Child Left Behind in a sense, but it’s also failure in a sense. And I think it’s very hard for a civilization to fix the situation once somebody is in the eighth grade and can’t read. So I think there’s a lot of failure even in relatively advantaged places like Omaha, and it’s very serious failure. We never should have allowed it to happen.

Warren Buffett [01:39:03] Yeah, my friend Bill Ruane, who is here, I believe he’s here, is doing something extraordinary in terms of a program he has teaching kids to read. In fact, journalists are here, should seek out Bill and learn something about the story of what he’s done in the last 10 years in terms of moving reading abilities and kids’ enthusiasm for reading, which is more important, because it’s… you know, I talked about our managers. The important thing is that they have a passion for their business. Well, passion for reading can be developed, and bellows is showing that in programs that he… I think he first started him in Harlem. He sort of adopted a block up there, and then went from there. And he would be a very interesting fellow to get some views from on this subject.

You know, we’ve had this great success story in this country, and a lot of it has become is because of people have had something closer to equality of opportunity in the United States than they’ve had in most parts of the world. And you do not have equality of opportunity when my kids get to go to some school where I can attract outstanding teachers and where they’re in the company of other kids that are also motivated and they’re getting encouraged at home and all sorts of other things, and somebody else who is born into a less advantageous family really doesn’t have a chance. They go into something that’s close maybe to an armed camp, and where the teachers are just sort of pushing them through, and there’s no stimulus from the other kids except to do things that are counter to the interests of society. And that just isn’t a situation that really should be allowed to exist in a country where the GDP is almost $40,000 per capita.

Let’s go on to number twelve. Oh, incidentally, I have to make one… it was mentioned about Bill Gates being a director, and I did… I got a little survey here that came out. Price Waterhouse and the Financial Times cooperate on the survey, and they asked CEOs around the world to ch… if they could pick anybody to choose from history or today to join their company’s board, who would they choose? And I’m happy to report that Bill came in number two. And actually, number three was Winston Churchill. Carlos Ghosn came in fourth. Jesus Christ came in fifth. Napoleon Bonaparte was sixth. And I won’t give you the rest of the list, but…

Charlie Munger [01:41:45] Who was one?

Warren Buffett [01:41:46] Well, one was Jack Welch. I knew you’d ask. But we didn’t ask Jack, we asked Bill. So actually, I thought this was quite an interesting list, because I think many of the CEOs of the world would prefer people that are dead to be on their board. It’s too funny. Now let’s see where we were. We’re going to number 12.

[01:42:10] Shareholder (Robert Peyton, Chicago, Illinois): Hello, my name is Robert Peyton from Chicago, Illinois. And on that note, maybe a merger of some sorts between Berkshire and Microsoft is in the works.

Warren Buffett [01:42:22] I keep hinting, but it doesn’t do any good.

[01:42:26] Shareholder (Robert Peyton, Chicago, Illinois): The question that I have is, do you think the shift in the banking system during the ’90s to finance home purchases with zero percent down impacted the overall savings rate, as home purchases are the largest investment most people make, and the overall rise of home prices driven by these marginal buyers? If so, how would you suggest that we correct the problem?

Warren Buffett [01:42:52] Yeah, of course, anytime a home is constructed, it represents somebody’s savings. I mean, it… the home buyer may buy it for nothing down, but that means he’s borrowing 100% of the mortgage through a mortgage that somebody else has saved somewhere, maybe intermediate three or four times or something of the sort. But home construction comes about through savings. Now, there’s no question that terms have become easier and easier, and I’ve talked to certain mortgage bankers about this subject, but terms have become easier and easier as prices have increased. Now, that is absolutely counter to, you know, how people think about lending in general. Generally, the more the asset class becomes inflated, the less a prudent banker will lend.

But of course, in this country now you have mortgages intermediated in a way that the person buying the mortgage, in the case of… I’m thinking of fred Freddie and Fannie and other forms like that, so we’re not the lower priced houses, but the mortgage buyer does not need to care about what kind of mortgage, what kind of a financial transaction the purchases. All they have to do is look at the guarantee, and they look at that rather than whether somebody’s put any money down or anything of the sort. So I think you’ve had easy financing facilitating a boom in real estate prices, even at the higher levels.

And I think that, that which has occurred in other asset classes in the past. I mean, that farm bubble I talked about was facilitated by the fact that banks and small towns, who generally have been very conservative in lending, went crazy around 1980, and they lent amounts that the farm itself could never repay. They started saying a farm was an asset appreciation investment, not an income investment. And once you talk about something that’s an asset appreciation investment, ignoring the underlying economics of what you’re lending on, you’re really talking about the bigger fool game. You’re saying, you know, this is a silly price, but there’ll be a bigger fool that comes along. And that actually can be a profitable game for a while, but it’s nothing that bankers should engage in.

So I would say that easy lending obviously does contribute to overall in the country to a lower savings rate. But in the… in effect, somebody has to send, save for somebody else to borrow. And what is happening now is the rest of the world is saving so than in the US, in global terms I’m talking. But the rest of the world is saving, and they’re sending us $2 billion… I mean, we’re sending them, in effect, claims or ownership of $2 billion. They’re investing $2 billion a day in the United States. But they… a lot of economists will say, well, that’s what’s really going on. The world loves our assets so much, and they have so much confidence in America, that the present current account deficit is driven by the fact they want to invest. I don’t believe that at all. I think it’s just silly, frankly, to make that argument. The… they are investing because they have to, because of our consumption habits, and not because they want to. And I think the declining dollar is evidence of that. Charlie?

Charlie Munger [01:46:18] I’ve got nothing to add to that. It’s obvious that the easy lending on houses causes more houses to be built and causes housing prices to be higher, probably, in the new field. Eventually, of course, the… if you construct enough new anything, you can have a countervailing effect. But if you built way too many houses, you’d eventually cause a price to climb.

Warren Buffett [01:46:42] I’ll give you a fanciful illustration. Let’s just assume that Omaha had a totally constant population. No one was allowed to leave, no one was entered, birth rate equal death rate, all of that sort of thing. So the population was constant, and nobody could build any more houses. We just passed a city ordinance to that effect. But every year, everybody sold their house to their neighbor. So first year, everybody sold their $100,000 house to their neighbor, and they both switched houses, and that was fine. And then the next year they agreed we were going to do it at $150,000. And you can say, well, how could that be? Well, we would all go to fran Freddie or Fannie and get our mortgages guaranteed for a larger amount, and somebody in New York or Tokyo or someplace would buy the Freddie or Fannie paper, and we’d have an influx of $50,000 per household.

We’d all have the same number of houses. We’d all be living one house to a family, and we’d have marked up our houses, and we now have a bigger mortgage, but we’d have $50,000 more of income that year just to service a little higher mortgage. And we do the same thing the following year for $200,000, and so on. Now, that would be very transparent, and people might catch on to the fact there was something funny going on in Omaha. But you can have an accidental aggregation of behavior that somewhat leads to the same effect. If you keep marking up something, and in the process the payment for the marked up price comes from someone else who feels they are bearing no risk because they’ve got the government guarantee in between, the money can just flood in, and everybody feels very happy for a long time. And we don’t have anything like the fanciful thing I’ve set forth in terms of Omaha, but we have certain aspects of that, I think, going on in the economy. Charlie, would you… I’m throwing this one at you. Would you agree or not?

Charlie Munger [01:48:40] Yeah, I do agree with that. You have buried Ponzi effects in various parts of any modern economy, and they’re very important, and they’re very little studied in economics.

Warren Buffett [01:48:50] Let’s try number 13. I think maybe that’s in the other room, and we’ll see whether we get a response, and if not…

[01:48:58] Shareholder (Martin O’Leary, Austin, Texas): Good morning, Mr. Buffett and Mr. Munger. My name is Martin O’Leary, and I’m from Austin, Texas. Mr. Buffett, given your past essays concerning the US dollar and foreign exchange forward contract holdings that you have, and many countries’ economic policies that have a tendency to debase their currencies, do you think that gold can be considered a viable investment alternative to paper currencies?

Warren Buffett [01:49:28] Yeah, we’re not enthused about gold. And people historically have felt that was the first refuge from a currency that was going to be declined in value. But, you know, sows a barrel of oil, sows an acre of land, sows a piece of Coca-Cola, so, so See’s Candy, seeds can… if the dollar goes down 50%, we will be selling See’s Candy for double at the present price. We’ll be getting the same real price for See’s Candy. People will work the same number of minutes or hours per week in order to buy a pound or a two pound box of the candy. So we would much prefer a… some asset that is going to be useful whether the currency is worth what it is today, or 10% of what it is today, or whether people are using seashells in order to transact business. Because people will go on eating, and they’ll go on drinking and doing various things, and their preferences will translate in real dollars into more or less the same economics for us. And we would not trade the ownership of those kind of assets for us for a hunk of yellow metal, which has very little real utility except for people who are looking to flee from the dollar, and in our view really haven’t thought through the consequences of what fleeing would… where they should flee. Charlie?

Charlie Munger [01:51:06] Yeah, if you have the opportunities of Berkshire Hathaway, averaged out, gold is a dumb investment.

Warren Buffett [01:51:14] My dad was a huge gold enthusiast, so I sat around the dinner tab… my two sisters are here too, they will testify too. We sat around listening to the virtues of gold, and that was in, we’ll say, 1940, and gold at that time was $35 an ounce. And we’d had some storage and insurance costs, and, you know, here it is 65 years later, world wars, nuclear bombs, all kinds of things, and the compound rate from $35 to a little over $400, unless those expenses, is not something that causes me to salivate.

Number fourteen. Do we have a second microphone in the overflow room? Oh, there’s only one in there. Okay, then we’ll go back to number one.

[01:52:08] Shareholder (Andrew Noble, England): Andrew Noble from England. Apart from the catastrophic insurance events or Armageddon scenarios that you’ve been talking about earlier, in relation to the operations of Berkshire Hathaway, what are your greatest fears?

Warren Buffett [01:52:24] Well, the greatest, I would say… we don’t worry about the economics of the businesses we have. We’ve got a very diverse group. By and large, they’re very good businesses. By and large, they’re run by some of the best managers in the country. But we worry about something going wrong. I mean, you know, you heard about the Salomon thing in the movie. And I mean, we’ve got 180,000 people out there, and I’ll guarantee you something is going wrong someplace as we talk. That’s just the nature of it. But what you hope is that it’s relatively unimportant, or that we catch it, and… but that’s, you know, that is something that we know will happen. We try to have a culture that minimizes that, and I think we do have a culture that minimizes that.

We… it’s very important in our view to have the right incentives, and many places we think have incentives that aren’t so good. I mean, when I get on an airplane, and we own the company, like NetJets, the last thing in the world I want to tell the pilot is that I’m running late and I hope we can get to New York a little faster. I mean, that is dumb, to incent a pilot who may be worried, you know, somehow you affect his job or something, to get in a hurry about the takeoff or the checklist or whatever it may be. And companies do that time after time in their compensation plans or things that they… they incent people, in our view at least, some of the wrong things. That doesn’t mean nothing wrong will happen under any circumstances, but you should not have a system that causes people to, for example, worry about quarterly earnings.

None of our managers do not submit budgets into Omaha. I have no idea what we’re going to earn next quarter. And I have no implicit body language out there or anything of the sort to our managers that I’m hoping to earn X dollars per share in the quarter. Because in the insurance business particularly, you can report any numbers basically that you want to, if you write long tail business, for a short period of time. And, you know, we’ve got $45 billion of loss reserves. Well, who knows whether the right figure is $45 billion or 46 or 44? And if the desire is to report some given number in a given quarter, instead of saying $45 billion you say 44 and three-quarters billion or something of the sort.

So we have no incentives in terms of the how people are paid, or in terms of the fact they just don’t want to let me down. Let’s assume at the start of the year I asked everybody to submit budgets, and then I went out on Wall Street and preached a bunch of numbers. Even if their compensation didn’t depend on it, the managers would feel, you know, “We don’t want to let Warren down on this, so, you know, we’ll take an optimistic view of reserves,” and that’s easy to do at the end of the quarter, “and we won’t let him down, and then he won’t look like a jerk in front of Wall Street.” So we try to avoid that sort of thing. But even then, that is what we worry about.

We don’t worry about this place making money. I mean, we’ll make money, and if we don’t, it’s my fault. And that’s not the problem. The problem right now, in addition to the one we just talked about, the problem is deploying capital, and that’s my job too. And, you know, I haven’t done a very good job of that recently, but with a little luck, you know, we will, in a different kind of market situation, we will get a chance to do that. Charlie?

Charlie Munger [01:56:04] Yeah, well, if you stop to think about it, the history of much of which we don’t like in modern corporate capitalism comes from an unreasonable expectation communicated from headquarters that earnings have to go up with no volatility and great regularity, corporate earnings. I mean, that kind of an expectation from headquarters is not just the kissing cousin of evil, it’s the blood brother of evil. And we just don’t need that blood brother in our headquarters.

Warren Buffett [01:56:42] Businesses do not meet expectations quarter after quarter and year after year. It just isn’t in the nature of running businesses. And in our view, people that predict precisely what the future will be are either kidding investors, or they’re kidding themselves, or they’re getting both. And Charlie and I have been around cultures, sometimes on the board, where the ego of the CEO became very involved in meeting predictions which were impossible really over time. And everybody in the organization knew, because they were very public about it, what these predictions were, and they knew that their CEO was going to look bad if they weren’t met. And that can lead to a lot of bad things. You get enough bad things anyway. I mean, but setting up a system that either exerts financial or psychological pressure on the people around you to do things that they probably really don’t even want to do, in order to avoid disappointing you, I mean, I just think that that’s a… it’s a terrible mistake. And, you know, we’ll try to avoid it. And that the…

[01:58:16] Shareholder: …ability is largely innate. So if it’s… if these characteristics are inherent, and you were to attempt to consistently identify future great managers or entrepreneurs before there’s a track record, how would you go about doing it? And in particular, could there be a way to know that before someone’s made a lot of money, before they’ve built a business that they love and feel passionate about, that they will develop those types of qualities later in life?

Warren Buffett [01:58:45] That’s a terrific question, and we have dodged it largely over the years by actually buying businesses from people where we’ve seen the record. In other words, I’m not sure I can go… in fact, I’m quite sure I can’t go to an MBA class of 50 and sit down and talk with each one, examine their grades, examine their extracurricular activities and whatever, talk to their parents. I’m not sure I could rank those 50 very well in terms of their potential for future business success. And of course, some of it would depend on what areas they entered into in business. So I think it’s tough. I think it’s tough to go out to the practice tee, where people are not actually hitting balls but just taking practice swings, and say which one is, as you know, is a two handicap and which one’s a 15 handicap and which ones, you know, can make it on the tour. I think I can tell a little bit maybe, but not… but it’s very hard to calibrate.

And I don’t think we’ve had much success, but we have also haven’t tried very much to identify people before they’ve had a record, to try and identify the ones that are superstars. Instead, we’ve taken the easy way, and we go… and somebody comes to us with a business that’s done phenomenally for 10 or 15 or 20 years, or maybe for 50 years, and we’ve seen how… what their batting average is. We’ve actually seen about a 350 or whatever it may be in the major leagues. And we just to make the assumption that we won’t screw it up by hiring them, and we also make the assumption that they’ll live to be 120 or something, and we buy the business. And that’s far easier. It is far easier to tell the great baseball batters after you’ve seen a couple seasons of their batting than it is to go to college, even college baseball teams or high school baseball teams, and pick out the superstars.

The one interesting thing, and I wish I could remember where I saw this study, and it may not even be a valid study, but I do remember seeing something many, many years ago where they tried to correlate business success with various variables. And they took grades in school and whether they got MBAs and all that sort of thing, and they found that the best correlation was with the age at which they started their own business first. The people that got very interested in starting lemonade stands or whatever tended to have better… that tended to correlate better with business success than other variables. We have found ourselves… we’ve got a lot of MBAs running businesses for us, but they ran them for a long time before we hired them or before we made the deal, and we’ve got others that never set foot in a business school.

And I do think there’s a lot to wiring. I think there’s also a lot to working with the wiring you have and developing it, and over time I don’t think that it’s… I don’t think it’s all innate, and I don’t think you can’t improve. I know you can improve on what you’re given at birth. But I do think an awful lot of it’s wiring, more so than I would have thought 30 or 40 years ago. And I’ve certainly seen it in business. I can… there are people, no formal business training. Charlie never went to business school. I mean, but he thought about it. I mean, I never heard him, Charlie, say anything dumb about business yet, except when he disagrees with me. The which… the truth is, I’ve never heard him say anything about business, period. And there are other people, I’ve never heard Tony Nicely say anything dumb about business ever. They just… they’re wired so that they, that the, you know, it doesn’t flicker. I mean, they get the answers. It doesn’t mean they can, you know, they’d be a great ballroom dancer or a great baseball player or, you know, a great politician, but they are wired for business. Charlie?

Charlie Munger [02:02:44] Yeah, part of its intelligence and part of it is temperament. I don’t know if Bill Ginn is in the audience, but by the time I was 14 years of age, I knew Bill Ginn would be rich. He was a classmate of mine in high school, a very intelligent man, and he wanted to be rich, and he was sensible in the way he handled life. I think sensible people with the right temperament and the right intelligence, if they live long enough in our system, will get rich. But temperament is, I think, to some extent inherited too, don’t you?

Warren Buffett [02:03:19] Yeah. His daughter, incidentally, is a partner with my daughter in a knit shop, which I hope you patronize while you’re… we’ve united Ginn and the Buffett family. Charlie, when did you first think business was something of interest to you?

Charlie Munger [02:03:38] Very early. I loved games of chance, and I loved trying to learn how to win at them.

Warren Buffett [02:03:46] Yeah, it’s interesting for me, you know, simply to think about the question of whether the Final Four of the NCAA will be cancelled as opposed to postponed or transferred in locale, and to decide, if we’re going to pay out $75 million the next day if it is cancelled, but how much we want to receive in today to take care of that. And that probably wouldn’t interest all kinds of people… that wouldn’t be interesting too. And since my dad wouldn’t let me become a bookmaker, I went into investments. Number three.

[02:04:25] Shareholder (Jens, Germany): Good morning. Jens from Germany. After buying almost all of Cologne Re, how happy are you about the progress, and what are the plans for the remaining minority shareholders?

Warren Buffett [02:04:44] ladies of Cologne Re, a large German company that they bought this 80 odd percent in a few years earlier. It’s actually slightly more complicated than that, because there was an arrangement where a certain purchase was deferred, but it’s a practical matter, they owned in the 80s. Right now Gen Re owns about 91% of Cologne Re. And that’s a subject that obviously it’s not pressing with us, because we owned it for seven years without taking our interest up, except periodically through small purchases. And there’s no particular reason to… why 100% would be better than 91%. But if the price is attractive and shares are offered to us, we will always kind of play buying it. But it’s not key to any strategy. Number four.

[02:05:46] Shareholder (Christian Tuckenberger, Switzerland): I’m Christian Tuckenberger from Switzerland, Europe. What do you think of the two insurance, reinsurance, AIG and Converium from Switzerland? Thank you.

Warren Buffett [02:05:56] Well, I’m going to give you a chance at a second question, because I don’t really think I should comment on AIG. There’s, you know, they have said that they’re going to have their 10K, they hope to have it by, I guess, today. I haven’t received any late word whether it’s been filed, but they have… there’ll be more disclosure on the situation at AIG, and I really don’t know anything about what will be in that statement, and I’ll just… I’ll wait to read it, and I’ll read it with interest. But I don’t… I haven’t… I have no particular insights on that. Converium has had troubles in the United States, has been announced, but they also raised additional money. But again, I don’t really have any specific commentary on those two companies. Charlie?

Charlie Munger [02:06:51] Well, I’ll be bold enough to make one comment about AIG. I think whatever comes along, people are going to find that a lot that was very right was done over the years by A.G. AIG. There’s a lot of ability in that place.

Warren Buffett [02:07:10] Oh yeah, it’s extraordinary. I mean, Hank Greenberg was… he was the number one man in insurance. I mean, he and he developed an extraordinary company, and in his lifetime. It wasn’t that much when it was handed to him, and he became the most important factor, I would say, by some margin, in the property casualty business. But in terms of evaluating it, stands now and what will be revealed when the 10K comes out, I just have no idea. Number five.

[02:07:46] Shareholder (Mike Nolan, Montclair, New Jersey): Good morning. My name is Mike Nolan. I’m here from Montclair, New Jersey, with my 18 year old son Brian, who’s experiencing his first Berkshire annual meeting. My question, and you touched on a little bit in a couple of earlier questions, deals with the current regulatory environment in Washington, which appears to be growing much more negative on Fannie Mae, Freddie Mac, Farmer Mac and so forth. What might the implications for the U.S. consumers specifically and the U.S. economy generally be if the GSEs are effectively bridled or significantly restricted from their past charters? Could this prick what you earlier referred to, when some private economists are calling a real estate bubble, and what will be the fallout?

Warren Buffett [02:08:34] The GSEs in effect expanded their original charter and reason for being. The thought originally was that they would guarantee mortgages, and they had this very limited, I think, $2.25 billion line of credit from the Treasury. But they were brought in, to an extent, to do what FHA and VA had done for mortgages in their arena, was to give people confidence in borrowing money or in lending money far away from their own geographical location. I mean, when the local… when I borrowed money on my house in 19… bought in 1958, I mean, I went down to see Mr. Brownlee at the Occidental Building alone, and he, you know, he knew something about me, and he knew something about my parents, and he knew where the house was and all of that. But as the mortgage market became more institutionalized, and it became more… the source of funds became geographically far more distant from the user of the funds, in order to have a market in which would be efficient, the GSEs were a very logical development.

And the GSEs came in, Freddie and Fannie, and the idea was that for a fee, which used to average about 25 basis points, they would guarantee these mortgages, so somebody living in 3,000 miles away could buy them through securities and not worry about the individual property. And then the portfolio operations developed over the following years, and of course they enabled the GSEs to earn high rates of return on capital, because in effect the GSEs were looked at as government guaranteed, so that people would lend them money without worrying about the degree of leverage employed. And in effect, the GSEs became huge… they hugely developed what might be called the carry trade, using the government’s credit, in effect, and the spread between what they paid on their money and what they got on mortgages. So that became the dominant source of their earnings.

They got very carried away with delivering promised rates of growth. I remember reading in the Freddie Mac report some years ago where they talked about delivering in the mid teens or low teens or something like that. And I thought to myself, you know, that this is madness, because you can’t do that when you’re running a big carry trade operation. Interest rate, the slope of the curve will develop. There’s no way to lend money for 30 years to somebody who can pay you off 30 seconds later, to actually match assets and liabilities in a way that’s risk-free. The only way you could do it would be to issue a 30-year bond of your own which you could call 30 seconds later, and people don’t buy those bonds. So as a practical matter, you could not perfectly handle the risk of significant interest rate changes.

But the GSEs got caught up with delivering increasing earnings all the time to Wall Street. So they first enlarged their portfolios, and later, as we’ve seen, they got involved in some accounting shenanigans, which really sort of boggle the mind when you think of two of the most important institutions in the country, with all kinds of financial experts on the board and top named auditors and everything, and turning out that billions and billions and billions of dollars were misreported. It shows you what can happen in a system.

Now, Congress is reacting, administration is reacting, Alan Greenspan is reacting, in terms of saying that, you know, what have we created? What is this, the situation where these two companies have a trillion and a half or more of mortgages they own, and people really think the federal government is on the hook, and the federal government doesn’t want… wants to say it isn’t on the hook, but the truth is it is on the hook, and institutions worldwide on the credit only securities based on this implied promise. And it was all being done just because basically these companies wanted earnings per share to go up. Now, they say they did it to maintain an orderly market and all that stuff in the mortgages, but that they were really set up to guarantee mortgage credit.

And there’s going to be reaction in Congress. There’ll be a huge fight. Both of those institutions have been heavy supporters of various legislators over the years. They’ve got lots of clout, not as much clouds they had a year ago, but they’ve got lots of clout in Congress. And on the other hand, people have lost faith to some degree in what they’ve done, and they’ve also seen that the consequences of the government issuing a blank check, the two institutions that are trying to produce annual gains in earnings per share of 15% and doing it by accounting means when they ran out of the ability to do it by other means. So it’s something that Congress should be giving a lot of attention to.

They can’t cut them off, in my view, and I think most people’s view. They can’t say, “Get rid of your portfolios,” or anything like that. So my guess is that some kind of a curtailment comes in, some kind of tougher accounting requirements come in. Sometimes it may be tougher capital ratios. And that over a long period of time, the government tries to figure out something that sort of eases them out of this position where they were basically backing two entities that at times like acted like the two biggest hedge funds in history. Charlie?

Charlie Munger [02:14:25] Yeah, well, he was asking partly is what happens if the government reigns these two institutions way and enforces a big reduction in asset base.

Warren Buffett [02:14:34] I don’t think… I don’t think they’ll… but I don’t think the government is going to do something where they sell off hundreds of billions of dollars or mortgages at all. But if they curtail, let’s just say they say that from now on you gotta operate in a runoff mode for a few years, there are plenty of people out there to buy mortgages. They’re already buying the securities of Fannie Mae and Freddie that are financing the mortgages. So it isn’t like Fannie and Freddie independently were coming up with the funds to finance these mortgages. They got them from somebody else, and that somebody else can leave Freddie and Fannie out of the picture and by the mortgages through some other form. It would not be the end of the world at all if Freddie and Fannie no longer had new portfolio purchases. I don’t think it would change things in any significant way in terms of the cost of home ownership or anything else. How about you, Charlie?

Charlie Munger [02:15:25] Well, I agree. I don’t think it would have enormous macro effects if future growth were curtailed. I do think a lot of the troubles that came came from the large use of derivative books, and from Fannie and Freddie both believing a lot of silver tongue salesmanship from derivative traders. And as many of you know, I think there is much wrong with derivative accounting and derivative trading operations in the United States, and I don’t think the full penalties have yet been paid. When you can have a $5 billion miss mark in one direction at one of the… in one direction at one of these, and bear in mind these are among the most scrutinized companies in the world, and with outstanding people on their boards in terms of financial expertise, if you can have a $5 billion mismark in one direction while at the same time the other one has a $9 billion missed mark in the other direction, you know, I would say we’ve come a long way from Jimmy Stewart and “It’s a Wonderful Life.”

Warren Buffett [02:16:31] Yeah. Number six.

[02:16:32] Shareholder (Peter Webb, London, UK): Hi, this is Peter Webb from London, UK. The question I wanted to ask you: I’ve been an investor for many years and done very well following a similar sort of style to yourself, so thank you for that. The big question I have is…

Warren Buffett [02:16:47] Would you want to quantify that? You can always send us a check. (Laughter)

[02:16:52] Shareholder (Peter Webb, London, UK): But if there’s a deal to be had, maybe we can speak afterwards. Okay, the question that I have for yourself and Charlie is, over the time I’ve bought many different companies in the UK and Europe, and I’ve seen many American value funds buying the same companies, but I see very little activity from Berkshire and its subsidiaries. And I didn’t know whether that was a reflection on your views on UK and the Europe in the world, whether you just see lack of investment opportunity, is it outside your sphere of competence, or is there some other reason that I see less activity from you in Europe?

Warren Buffett [02:17:30] That’s a good question. We own, of course, as you know, 80% or so of MidAmerican Energy, which has a very large business in the UK, but that’s an operating business. As you know, in the UK there’s a rule that requires reporting when you own 3% of a company’s stock. And actually, there’s some conditions under which the ownership will be reported even sooner than that 3%. There’s a provision that, that I think if there’s an inquiry or anything that has to be responded to. So if you take a company with a market cap of, you know, 5 billion pounds, if we bought 150 million pounds of it, we would have to report, and that tends to mess up subsequent purchases.

So we bought stock… we own stock in Diageo, which was Guinness at the time. We’ve owned stock in some other UK companies. But we’ve thought twice before going over 3% because of the reporting requirements, and then we… then we’d have to report if we were selling and all that. So that’s a deterrent, but it’s not an overwhelming deterrent. And if we… if, you know, if we get a chance to buy a significant piece of something that we think is cheap, particularly if we could buy it in one purchase… But there’s a lot of special rules that kick in over in the UK that do not in the United States.

Incidentally, there was something in the Journal the other day that said that we had to report if we bought over 5% of a company within 10 business days in the US. That is not true. That was a mistake in the report. But it is the case in the UK that a 3% were reporting is triggered. But they’re… we would feel very comfortable with lots of UK businesses, and, you know, they’d have… it’d be the same criteria we applied it over here, a durable competitive advantage in a management that we like and trust and a reasonable price. And we have seen some of those. There was an insurance company in the UK a year or so back that I would very much have liked to have bought, but we couldn’t come to terms on price. But we have no bias whatsoever against the buying business in the UK. And as I say, we, at Yorkshire and Northern Electric, you know, we have a business that shows in our report made close to $300 million after tax. And actually, considering my views on currency, you know, I would have… I’d give a slight edge to buying something where the earnings would be in sterling in the future rather than in dollars. Charlie?

Charlie Munger [02:20:18] Well, I regard it as kind of amusing that we ended up preferring the currencies of Europe when that’s so much more socialized than the United States is. That’s a queer occurrence.

Warren Buffett [02:20:30] You actually prefer them or not, Charlie?

Charlie Munger [02:20:33] Well, we certainly, in recent… over a considerable period of recent months, we’ve actually preferred the currencies of socialized Europe to our own currency. I just regard that as an odd occurrence for both of us. That wouldn’t have happened…

Warren Buffett [02:20:50] No, no, no. Up till three years ago, if I came back from Europe and I had a euro in my pocket, I couldn’t wait to run the bank or someplace. I was afraid I would depreciate before I could get rid of it, man. The… But I changed my views a few years ago. We hope to buy businesses and stocks other places in the world. And Charlie mentions the difference in political climate.

One thing, you read about slow growth in Europe and Japan and all those, and it’s true, but usually… but the growth figures that you see are usually not on a per capita basis. And since the population of Europe has been generally very little change, whereas the population United States grows 1% or 1.5% a year, if you look at growth figures in the United States and somebody says 3 and a fraction percent, that’s not on a per capita basis. I mean, you’ve got to have to deflate that by the growth in population. Whereas if you read about the growth in Europe generally, you’re dealing with a population base that hasn’t changed. So the differences in growth rate on a per capita basis are not as wide as the headlines would suggest. Number 7.

[02:22:09] Shareholder (Mike McCloskey, Toronto, Canada): Gentlemen, my name is Mike McCloskey. I’m from Toronto, Canada. My question is, what obligation does a financial intermediary or a party to a transaction have to ensure that the other party to the transaction properly accounts for it?

Warren Buffett [02:22:29] Well, that question may come up in a very real sense. But, you know, I would… We have lots of reinsurance transactions. Obviously banks have lots of transactions with people. And certainly if you knowingly are doing something that causes a company… are participating in it, you know, you may have very serious obligations on that. Where… but on the other hand, if you’re… I mean, we reinsure hundreds of companies. They have legal departments, they have auditors, and there could be somebody out there today… Well, they could be doing anything with their accounting. It probably wouldn’t be limited to the contract they had with us. It might well be other things. But, and, but I… it really gets down to whether there’s knowing participation, I would say. Isn’t that right, Charlie?

Charlie Munger [02:23:37] Well, as you say, it’s a subject rife with ambiguities and different issues. You have had some bartender liability. If you serve a drink to somebody that’s already inebriated, by some… people say the bartender is liable. On the other hand, radio stations are allowed in America to sell advertising time to people who use it for perfectly obvious fraud, and nobody ever sues the radio station. It’s very hard to predict what things are going to get legally shifted around, so a supplier B gets… it gets liability for his customer’s behavior.

Warren Buffett [02:24:24] Number 8.

[02:24:25] Shareholder (Rezab, Sacramento, California): My name is Rezab. I live in Sacramento, California. My question is related to the issue of U.S. trade deficit again and its implications on the future value of the dollar. Do you think an individual or a business owner here in U.S. should be concerned about the purchasing power of his future dollar earnings or savings, and diversify his or her investments in non-dollar based securities?

Warren Buffett [02:24:55] I think it’s very tough for individuals to either select individual stocks, select individual times to enter the market, select currencies. I mean, I just… I think that’s a game that they tend to get interested in at the wrong time. There’s some adverse selection in terms of when people who are… who do not follow stocks carefully get interested in stocks. And I think that, you know, the best investment you can have, for most people, is in your own abilities.

I mean, when I talk to students, you know, I would pay a student, in many cases I would be glad to, you know, pay them $100,000 for cash up front for 10% of all their future earnings. So I’m willing to pay $100,000 for 10% of them. I’m valuing the whole person at $1 million, just capital value standing there in front of me. And those… anything you do to develop your own abilities is probably going to be, or your own business, is probably going to be more productive for you than starting to think about individually making commitments into foreign exchange.

If you have a good business in this country earning money in dollars, you’ll do okay. I mean, you may live in a world 20 years from now where a couple percent of the GDP is going to service the debts and the ownership that we’ve created now by running these deficits. But you’ll do fine in America. So I wouldn’t worry about that much. Charlie?

Charlie Munger [02:26:32] Well, if you look at Berkshire, you will find that it really doesn’t do much of conventional asset allocation, the categories. We are looking for opportunities, and we don’t much care what category they’re in. And we certainly don’t want to have our search for opportunities governed by some predetermined artificial bunch of categories. In this sense, we’re totally out of step with modern investment management, but we think they’re wrong.

Warren Buffett [02:27:06] Yeah. And incidentally, we have 80% of our money or more, well over 80%, tied to this country and to the dollar. So it’s not like, you know, we’ve left the country or anything of this sort. But when have you done a big asset allocation strategy?

Charlie Munger [02:27:25] Never.

Warren Buffett [02:27:25] Yeah, yeah. We end up with peculiar asset mixes. I mean, if the junk bond thing had gone on a little longer, instead of having $7 billion in there, we might have had $30 billion in. But we were doing that simply based on the fact that it was screaming at us. And we do the same thing with equities. I mean, back for many years we had more than the net worth of Berkshire in equity positions, and… but they were cheap.

Charlie Munger [02:27:54] And I want you to remember one of my favorite sayings as you do this asset allocation: if a thing’s not worth it doing it all, it’s not worth doing well.

Warren Buffett [02:28:05] Yeah, you can see why Ben Franklin turned the mantle over to Charlie. We’re going to take a break now, so you can all go out there and enjoy yourself in the adjoining room and have lunch. And we’ll be back here at 12:45. And those in the other room might come back to this area, because I think we’ll have enough seats for everybody after lunch. Thank you, and I’ll see you at 12:45.

Okay, we’re going to start in just a minute or two, if you have a chance to sit down. Okay, let’s go to station 9. And I’ll… we will go till 3 o’clock. We’ll break until 3:15, when we’ll convene the business meeting. No one has submitted any proposals for that meeting, so it may be relatively short. At 4 o’clock, Charlie and I will meet in another room here, I’m not sure where, with any of those of you from outside North America that are here. We would like to especially thank you for coming this long distance. So with that, we’ll go to area 9.

[02:29:54] Shareholder (Ken Goldberg, Sharon, Massachusetts): Good afternoon. My name is Ken Goldberg from Sharon, Massachusetts, Massachusetts having the distinction of being the birthplace of Benjamin Franklin, and, thanks to New Jersey, the only state in the union where one cannot buy GEICO auto insurance. Earlier this morning you discussed policies that have eroded and that threatened to continually erode the U.S. dollar. In some of your earlier letters to shareholders, you warned about the dangers of inflation and caution that shareholders should fully take inflation into account when evaluating the performance of a business. To what degree do you expect a large decline in the value of the dollar to trigger inflation that would adversely impact Berkshire’s equity holdings and its businesses? And to what extent should we calibrate Berkshire’s overall performance against the backdrop of a weakening dollar?

Warren Buffett [02:30:58] Well, we think by and large we have businesses that will do pretty well in inflation. But inflation destroys value, but it destroys it very unequally. The best business to have during inflation is one that retains its earning power and real dollars without commensurate investment to, in effect, fund the inflation, produce nominal growth. The worst kind of business is where you have to keep putting more and more money into a lousy business. In effect, the airlines have been hurt by inflation over the last 40 years, because now they have to put a whole lot of money in a lousy investment, which is a plane, compared to 30 or 40 years ago. And they have to stay in the game, they have to keep buying new planes, and the new planes cost far more now, and the returns continue to be inadequate.

So the best protection is a very good business that does not require big capital investment. And, you know, the best investment of all, I mean, if you’re the leading brain surgeon in town or the leading lawyer in town or the whatever it may be, you don’t have to keep re-educating yourself to be that in current terms. You bought your expertise when you went to medical school or law school in old dollars, and you don’t have to keep reinvesting, and you retain your earning power and current dollars.

We, Charlie and I, are always suspicious that inflation will regain some of the momentum it had a couple of decades ago. We always think it’s in sort of remission. We thought the talk about deflation was total nonsense. And certainly the trade picture is one that you would think would accentuate any inflationary trends that might otherwise be experienced. I mean, obviously the price of oil in euros has gone up far less than the price has gone up in dollars, and you and I are buying gasoline in dollars. So we have seen a bigger increase in our fuel costs because of the decline of the dollar. I mean, if we’d lived in Europe… I mean, if we lived in Europe or some other, or Australia for that matter.

So it’s… inflation is always a factor in calculating the kind of investment, kind of business that we want to buy. But it doesn’t… it isn’t like it crowds out all other factors. I mean, that… it’s always been with us. We’ll think about it always. See’s Candy has done fine during an inflationary period, because it does not have huge capital investments that have to be made in current dollars. Other businesses we have, you know, for the public utility business, for example, it costs a lot more money to maintain capital expenditures now in dollar terms than it would have 30 years ago. So you have to keep putting more and more money into a public utility, and you better hope that the rate of return allowed is commensurate in times of high inflation, the same way that it might have been in low inflation with a lower rate of return. Charlie?

Charlie Munger [02:34:43] Yeah, well, so far the facts that are driving the dollar down in relation to other currencies have been restraining inflation in the United States. In other words, it’s the competitive export advantages of the other people that are… that have so far restrained inflation here. So it’s…

Warren Buffett [02:35:02] Yeah, you’re paying less for shoes. You know, we got killed in parts of our shoe business. And 30 years ago, of the billion-plus pairs of shoes used in the United States, a very high percentage were made here, and now virtually none are. But if they were all being made here, you would be paying more for shoes. There’s no question about them. Number 10.

[02:35:27] Shareholder (St. Louis): Thank you. I’m a physician from Saint Louis, and I want to thank you and everyone here, because I’m one of these doctors that really doesn’t know anything about money or finance. The money comes in, but I don’t know what to do with it. I’m not able to really evaluate the financial strength of a company, but I can evaluate the ethical strength of the company, and that’s why I feel real comfortable, I think most of us here, having our savings in Berkshire Hathaway. And thank you. (Applause)

This question has probably been asked in different ways already, but several years ago a fellow I know who was… had been manager of Magellan Fund warned that we were going to have a terrible decade or so in the stock market, because of all the things people have brought up so far: the increasing interest rates and runaway spending and decreasing dollar, and stagflation may be right around the corner, Social Security problems, and even what Charlie Munger referred to, is that most of our best and brightest graduates, I find, are going into money management rather than… they’re not becoming doctors or molecular biologists or PhDs and chemical engineering. And so, in view of the fact that a year or two ago people there were still in a billions of emotion about the stock market going up and making everyone rich just by having their money in the stock market, it seems like that of bullies has dropped in, and I’m hearing in anticipation of a bear market. And you wrote, I think, several years ago that it’s hard to make money in a bull market and the real opportunities come in a bear market. So I’m wondering if you would give us a clue as to what your strategies are going to be if it’s really true that the market gets dismal over the next few years.

Warren Buffett [02:37:29] Well, if the market gets cheaper, we will have many more opportunities to do intelligent things with money. Now, whether we will blow on the money in the meantime or something is another question. But, you know, we are going to be buying things, one thing or another, operating businesses, stocks, high-yield bonds, whatever. We’re going to be buying things for as long as I live, just as long… just like I’m going to be buying groceries. Longer than that one. Yeah, Charlie’s just waiting to take over after I… (Laughter) And I’m going to be buying groceries the rest of my life. Now, would I rather have grocery prices go up or down? If I’m going to be buying groceries tomorrow and next week and next month, the next year, the answer is obviously, if I’m a net buyer, I’m… I would… I will do better if prices are lower.

We have no… we’re not good at forecasting markets. I mean, we knew that we were getting enormous bargains in the mid ’70s. We knew that the market went crazy to some extent in the late ’90s. But we don’t have much… we don’t spend any time… Charlie and I spend no time thinking or talking about what the stock market is going to do, because we don’t know. We do know sometimes that we’re getting very good value for our money when we buy some stocks or some bonds, as it may be. But we are not operating on the basis of any kind of macro forecast about stocks.

And there’s always a list of reasons, you gave a few, there’s always a list of reasons why the country will have problems tomorrow, and there… but there’s always a list of opportunities which don’t get mentioned quite as often. So we don’t sit down and make a list of the bad things that are happening in the economy and the good things that are happening, and therefore expecting the stock market… It might not… it doesn’t behave that way, even if you could correctly forecast some of the bad things or good things.

Overall, I’m an enormous bull on the country. I mean, over time, I mean, this is the most remarkable success story in the history of the world, if you think about it. I mean, in 1790, we had less than 4 million people in this country. We had… there were 290 million people in China, there were 100 million people in Europe, you know, and they all had the same intellect we had, they’re in the same general climate, they had lots of natural resources. And 215 years later, those 3.9 million people, I think, actually, you know, I have 30% or so of the world GDP. So it does not make sense to bet against America. That doesn’t mean all our policies are smart or anything. But I would not… I do not get pessimistic on the country.

You know, I worry about the… I mean, the big worry is what can be done by either terrorists or government… governments that have access to nuclear, chemical or biological weapons. But in terms of the basic economics of the country, your children are going to live better than you live, and your grandchildren are going to live better than your children live. And we do not focus on macro factors that… Charlie?

Charlie Munger [02:40:47] Well, I agree with you that the economics of the country are probably going to increase for a considerable period ahead. But I suspect that in very important ways, we are at or near the apex of a great civilization.

Warren Buffett [02:41:07] You heard it here first, folks. (Laughter) If you leave the NCB, nuclear, chemical, biological… But I do not feel that way. But you’ll get to see which one of us is right 20 or 30 years from now. But it… I have seen more people pass up opportunities because they get focused on a single economic variable or a single problem that the country faces, and they forget about the good thing. If you can buy very good businesses at attractive prices, it’s crazy to say, “I think I’ll sit this out because it might get a little cheaper next year,” or something of the sort, and because the world’s going to go to hell. We just… we’ve never operated that… We’ve never decided not to buy a business we like because of a macro view. Have we?

Charlie Munger [02:42:19] Not yet.

Warren Buffett [02:42:19] Okay. It’s hard to get him to really agree with you. I’ve been working on it for years. Number 11.

[02:42:27] Shareholder (Randall Bellows, Chicago): Hello. My name is Randall Bellows. I’m from Chicago. And many years ago, Warren, my wife did a portrait review drinking a can of Coke. Next year I’ll bring one drinking a can of Bud.

Warren Buffett [02:42:39] I think you better stick with Coke.

[02:42:42] Shareholder (Randall Bellows, Chicago): Okay. I would like you to speculate on a couple of questions. The first is, given the competitive disadvantage of General Motors and Ford with their huge health care liability costs for their employees and retirees, what do you think might happen there? Do you think there might be a bankruptcy to get rid of the liabilities, or a government bailout? And along that line, Charlie, you spoke several years ago about tort issues. Do you feel there’s anything coming in the way of asbestos reform or correction for those issues, and the insurance companies that have been paying those billions? Thank you.

Warren Buffett [02:43:25] Well, I would say that Rick Wagoner at General Motors and Bill Ford at Ford both have been handed the past extremely difficult hands to play. They’re not the consequences of their own doing at all. But they have walked into what people call legacy situations, but they have inherited a cost structure brought about by contracts that were put in place maybe decades ago that make it very difficult for them to be competitive in today’s world. I mean, just imagine if Ford or General Motors had signed contracts that made them pay several thousand dollars a ton more for steel than their competitors did. I mean, it would… people would immediately feel that was untenable.

So General Motors and Ford are in the position of having commitments which are in strong contractual terms to pay sums for retired, particularly, workers, in both the annuity field and in the health field, that are staggeringly high compared to some of their competitors. And their competitors can buy steel at the same price, and they can buy aluminum at the same price, they can buy rubber at the same price. And when you get all through with it, if they have huge advantages on the health care and the annuity side, it’s not going to be a fair fight. And those contracts to some day… to some extent go back to when General Motors had, for example, 50%-plus of the U.S. auto market, and now it has 25%. But I think even if it had 50% today, it would be having trouble.

So it’s a very, very tough situation. I’m not sure what I would do if you put me in charge of… I mean, as Bill Buckley said many years ago when he ran for governor… mayor of New York, they said, “What’s the first thing you’re going to do if you get elected?” He said, “I’ll ask for a recount.” Well, that’s a little the way I would feel if I got elected CEO of General Motors. From the standpoint of the UAW, you know, they have a contract. They made a deal. And they’ve got $90 billion in the pension fund. It’s kind of interesting, the pension fund of General Motors possesses roughly $90 billion. The health care fund has a little more too, another 20-some billion, as I remember. The whole equity of General Motors is selling for about $14 billion. So after all these years, there’s $90 billion set aside for the retirees, and there’s $14 billion of equity value that’s been heading south for the owners.

And it would seem that if General Motors had a steel contract that called for… let’s say there’s a ton of steel in every car, I’m not saying there is that, and they were paying $2,000 a ton over market or what their competitors were paying, people would say that that is not a viable situation for the long term. But they’re in a similar situation because of contracts they voluntarily signed. And part of the reason they signed those, undoubtedly, was that they bore no accounting consequences at the time. It’s a terrible mistake for managers not to think in terms of reality rather than the accounting numbers. But back in the ’60s, you did not have to account for pensions on an accrual basis, and up till the ’90s you didn’t have to account for health care, or the late ’80s, whenever it was, on an accrual basis. And so people said, “Well, if we don’t have to counter it, it doesn’t… it isn’t real.” Well, believe me, it’s real. And the managers today are facing the consequences of that.

So, you know, it… they’ve got very tough hands to play. And, you know, I read about it in the papers. I don’t know what’s going on there necessarily. But something will have to… in my view, something we’ll have to give in that matter. And before you answer the asbestos thing, Charlie, what do you think about them?

Charlie Munger [02:47:55] Warren gave a very optimistic prognosis, in my view. I think just because it hasn’t happened yet doesn’t mean that the problem isn’t real. You jump out of the window on the 42nd floor, and you’re still doing fine on the way down as you pass the 20th, it doesn’t mean you don’t have a serious problem. If I were the governor from the United States or a director of General Motors or Ford or a family member of Ford, I would want to address the problem right now. I do not think it’s getting better, or that Yehudi is going to come over the mountain with a magic wand and make it go away. I think it would be better faced.

Warren Buffett [02:49:00] You want to try the asbestos? Give us another cherry around the off… it was another cherry. Around the office he’s known as Pollyanna.

Charlie Munger [02:49:17] Well, the bestest asbestos thing has involved terrible behavior by some lying doctors, terrible behavior by a bunch of lawyers who suborn virginia perjury, and gutless behavior by certain important courts, and even more gutless behavior by politicians who take care of themselves first, naturally. And if these are the forces that are bearing on a problem, it’s obviously not going to be handled very well. So it’s a perfectly terrible situation. You keep hoping that it will be so obviously bad that will finally be addressed.

Some of that happened in California. The workman’s comp system in California had immense fraud in it, particularly egregious fraud by lots of doctors and lots of lawyers and lots of claimants. And it was so awful that it affected the whole employment prospects in California. And with the Schwarzenegger revolution, that was partly corrected. I would say maybe 15% corrected. And, but…

Warren Buffett [02:50:33] 500 push-ups, Charlie.

Charlie Munger [02:50:34] 500 push-ups, unless it’s 100. So I think that if it gets bad enough, there is some possibility there will be more correction. In a sense, it’s totally crazy for a court system to be paying tons of money to people that have smoked two packs of cigarettes all their life and have one little spot on a lung that no honest doctor would know what the hell it caused, and they aren’t yet sick, and they’re nearly dead anyway from their other behaviors and longevity. And it’s just… it never should have been allowed. But once you get a powerful political force, even judges fear consequences, and it’s very easy just to drift along with an evil system.

Luckily, we aren’t using this particular… There are two kinds of asbestos, one of which is virtually harmless, and the other, which caused all this damage. And we stopped using the damaging asbestos, and eventually the asbestos problem will go away. But how many people it will leave in some kind of financial wreckage before the storm is over, I can’t tell. I don’t think the last Indian is with the dust. Do you want… No, I think that… but the behavior is so terrible. It’s that kind of behavior that makes me talk about apexes of the civilization.

Warren Buffett [02:52:15] Number 12.

[02:52:16] Shareholder (Marc Rabinov, Melbourne, Australia): Mr. Buffett and Mr. Munger, my name is Marc Rabinov from Melbourne, Australia. I think it’s rare for diverse collections of businesses to be successful, and I believe an important part of Berkshire’s success has been your skillful oversight of the wholly owned subsidiaries. My question is, what advice would you give to your successor in managing our diverse portfolio of businesses?

Warren Buffett [02:52:52] Yeah, well, it’s a very good point, that Charlie and I have been known to rail a bit about companies that go and buy this business and that business, and of course that’s exactly what we’ve done ourselves over the years. I think the motivations have been somewhat different perhaps than in many of the cases. And then I think the way we’ve approached it has been different. We have been reasonably successful, although we’ve had some notable failures, but we’ve been reasonably successful in creating a climate where the people who built the businesses continue to run them with the same energy after they sell to us that they possessed early on.

And I think that you can find all kinds of illustrations in the histories of businesses that are diversified. I mean, Gillette bought 20-some businesses, I remember, back in the ’60s. Coke bought all kinds of businesses. And certainly the cigarette companies did, all kinds of people. The oil companies for a while were doing it. And generally the experiences were not very good when they got outside of their own fields. But I think when those companies bought businesses, they really thought they were going to take them over and run them themselves. And Charlie and I are under no illusions that we can run the businesses that we buy as well as, or nearly as well as, the people that have been running them over time.

And we don’t have group vice presidents at… in Omaha. We don’t have a whole bunch of directives going out. We don’t have companies that were run one way and then we’re going to run them entirely differently and have them reporting in all kinds of special ways to us, and have a human relations department and a public relations department and the legal department, all kinds of things in Omaha telling them how to run their businesses. We think that destroys… can destroy many good businesses. Certainly can destroy the incentive of the people that have already gotten rich to stay around and make us rich in turn. So I think that has been an important difference.

I think it’s been demonstrated well enough to all of those around Berkshire that it’s been a very good place, generally, I think, for people in terms of how they feel about working there, and I think they recognize it works. So the successor to me will come from within Berkshire. They will have seen how it worked. They will believe in it. They will be surrounded by people who have worked in this manner. And I don’t think it will be the most difficult job in the world to keep that engine going down the tracks at 90 miles an hour. I mean, it isn’t like they have to create the system. They will inherit a system. And I would be amazed if any of the three successors that we will talk about with the directors on Monday, if any of them would not recognize the inherent special values in the system as it now works, and take up one of these other models that clearly has been disasters for one company after another that’s diversified. Charlie?

Charlie Munger [02:56:26] Yeah, I don’t agree with you that the success at Berkshire has come from our oversight of the subsidiary companies. That’s come from our lack of oversight of the subsidiary companies. And I think our successors will be able to provide the same wonderful lack of oversight that we have provided. And if you’re not going to use a lot of oversight, you’ve got to be very careful and in what you bring into your corporate family, and you got to be very careful and treating honorably and well the people who are running the business… businesses over which you’re not giving any oversight to speak of. And I think our system is… it’s very different from a General Electric system. And I think their system works very well for them, but I don’t think it’s the only system in the world that works in corporate capitalism. And I think the Berkshire system will work very well after we’re gone. It’s a very simple system.

Warren Buffett [02:57:34] I mean, GE works exceptionally well. But when I go back to some of the conglomerates, and that’s not a term that I shrink from, but most people do because they think it brings down their PE or something, but we are a conglomerate, and I hope we can become more of a conglomerate. The… we don’t… we haven’t succeeded because we had great complicated systems or some magic formulas we applied. We’ve succeeded because we don’t have… we have simplicity itself. We take people that know how to play their game very well, and we let them play the game. And it’s just worked in one field after another. And every now and then we make a mistake, and we’ll, you know, there’ll be more mistakes made, but overwhelmingly it works.

And it doesn’t require some great business insight or anything like that in terms of whoever’s running this place to keep that kind of machine in motion. I mean, it is not… it is not complicated. The big… the bigger worry would be that the culture would get with in some way, and people would try to oversteer, basically. But that won’t happen. Our board won’t let it happen, and the ownership won’t let it happen. And I think we’ve got something that’ll work for a very, very, very long time. And that’s why I’m comfortable with the fact that every share I have will go to a foundation that I care about having getting good financial results in the future, and I’m quite happy to have them have 100% of their money in Berkshire. Number 1.

[02:59:17] Shareholder (Jonathan Mills, London, England): Jonathan Mills from London, England. What has been the single best investment of your careers, and why do you consider it to be the best, excluding Berkshire Hathaway itself?

Warren Buffett [02:59:31] Yeah, well, probably the best investment, if you’re talking about business, was getting Charlie’s a partner. He works cheap too. The… we’ve had… you can’t measure it by dollar terms, because obviously we’re doing bigger things now than early on. I mean, See’s was an enormously important part of our success. It doesn’t contribute a huge percentage of our net income now, but it provided income that led us by other things in the past. It taught us a lot of lessons about business, all kinds of things. So we’ve probably, in terms of what it’s done already and where it’s going to go over time, probably the single best investment was the first half of GEICO, which we purchased for $40 million. Now, the second half cost us $2 billion. I’m glad I didn’t buy it in thirds.

But, you know, that $40 million will, for half the company, will turn out very well. But GEICO… some of our businesses have growth potential, some don’t, and we don’t require growth potential as part of a business. If a business makes good money and we can use it to buy other businesses, one of the advantages of the Berkshire system is we have a tax-efficient and kind of frictionless way of moving money to the best opportunities. And GEICO internally has still enormous possibilities for growth.

Incidentally, we’ve… you know, I watched that movie, and I kept touting the American Express card, but here is our GEICO card, which I’m sure all of you are eligible for. And I don’t advise people using credit cards to revolve, but the truth is that people do. So use a GEICO card if you’re going to behave in… if you’re going to charge anything. I still advise you to pay off your account before it starts revolving. And I think it’s a terrible mistake for people to get hooked on revolving credit at high interest rates. And I… that’s the first thing I tell students, is that they don’t remember anything else I say, just, you know, don’t fool around with charge cards and run up balances that keep getting larger and larger.

But GEICO has well over 6 million customers now. As was mentioned, we entered New Jersey last year. We’re adding very rapidly there. It’s a great, great business model, and it’s run by a superb human being and businessman, Tony Nicely. And I think it’s got a huge potential. But I love them all.

Charlie Munger [03:02:31] Well, but GEICO, after all, cost $2 billion for the second half and a significant number of tens of millions for the first half. Now, the search expenses that brought us Ajit Jain, now there was an investment that really paid a dividend. I can think of no higher return investment that we’ve ever made. It was better than that one. And I think that’s a good life lesson. In other words, getting the right people into your system can frequently be more important than anything else.

Warren Buffett [03:03:13] Okay, let’s try number 2.

[03:03:14] Shareholder (Maggie Gilliam, New York City): I’m Maggie Gilliam from New York City. As someone who visited the New York Stock Exchange at a very early age and have been touting its merits over the years, could you comment a little bit about what you think of the shenanigans going on currently?

Warren Buffett [03:03:35] Well, where?

[03:03:36] Shareholder (Maggie Gilliam, New York City): At this exchange.

Warren Buffett [03:03:38] Oh, you’re so good at this. Shenanigans or they… I personally think it would be better if the New York Stock Exchange remained as a neutral… and it’s not strictly a non-profit, earn some money, but as a not-for-big-profit, we’ll put, an institution. I mean, the exchange has done a very good job over centuries. It’s one of the most important institutions in the world. And the enemy of investment performance is activity, and the creator of profit in a profit-minded exchange is activity. So I personally would rather not have an exchange which is trying to increase its earnings per share annually, and thereby wanting to encourage people to trade more actively and create more income for itself. That will not be, in my view, good for the American investor.

So I think that the exchange of yesterday may be better for the American investor than what looks like it may be in the exchange of tomorrow. Now, there may be all kinds of reasons that people find compelling why they want to turn it into a for-profit exchange. But I know the American investor will not be better off if volume doubles on the New York Stock Exchange. And I know that the New York Stock Exchange is a for-profit institution would be trying to figure out ways to have that volume increase, and to perhaps even charge more money one way or the other. I mean, you know, it… the profit of an exchange, the profit of people working on… in a sense, that’s the frictional cost of capitalism. That’s coming out of the earnings of the businesses. And, you know, IBM or General Motors or General Electric will not earn more money because their stock turns over more frequently. But any…

Charlie Munger [03:06:01] Well, I feel as on this one the same as you do, but much more strongly. I think we have lost our way when people, when people like the governors of the stock exchange and the CEO failed to realize that they had a duty to the rest of us to act as his exemplar, exemplars, there was a… of the right behaviors. Once your activity is that freighted with public significance, I think you’ve got a duty to create the right appearances. You have a duty as an exemplar. I mean, you do not want your first grade school teacher to be fornicating on the floor or drinking booze in the classroom, or… And similarly, you… I don’t think you want your stock exchange to be all over the headlines with wretched excess. And I certainly don’t think you want to turn the stock… the major stock exchange of the country into even more of a casino than it is already. I think we have totally lost our way on this stuff, and I agree with Warren that it ought to be a public institution that cares deeply about its duties as exemplar.

Warren Buffett [03:07:39] I wish I’d gone to first grade where he did.

Charlie Munger [03:07:43] I didn’t hear that.

Warren Buffett [03:07:45] I wish I’d gone to first grade where you didn’t know. Number 3.

[03:07:51] Shareholder (Glenn Strong, Canton, Ohio): Good afternoon, gentlemen. My name is Glenn Strong. I’m from Canton, Ohio. I want to extend a warm thank you to Warren’s daughter Susan for the fine introduction that she provided for this gathering. Thank you. Also a special thank you to your wife Susan. I thank her for the contributions that she made to the company and for the outstanding example that she obviously set for her husband and the many people that she must have come into contact with. (Applause)

Today I’m asking for your opinion on Social Security. Shall we call it the government-sponsored Ponzi scheme for retirees? I am interested in your views on private accounts, age adjustments for retirees, and tax adjustments for the employees. What would you promote if you were in the Oval Office? Thank you.

Warren Buffett [03:09:00] Yeah, the Social Security was introduced in the, what, ’36 or ’37. My grandfather used to have Charlie bring two pennies to work at the Buffett and Son grocery store on Saturday in order to pay his share of Social Security. He didn’t want Charlie any false ideas that there was a free lunch in this world, and he gave him a half-hour lecture on the evils of socialism. So we’ve had a lot of exposure to Social Security and the various arguments on it.

It was proposed, of course, as insurance, because basically that was the only way Roosevelt could get it passed. The idea of transfer payments did not… would not have washed in the ’30s, certainly. You know, and I think the first woman that received a Social Security check paid in a total of $22 or something and got $2,400. So it wasn’t insurance. It wasn’t insurance at all. Been transfer payment by the people who are in their productive years to the people who are past their productive years. And we’ll get into definitional requirement terms as to whether it’s 65 or 67 now, your past productive years. But essentially it’s a transfer payment.

I basically believe that anything that would take Social Security payments below their present guaranteed level is a mistake. I think that in this country, extraordinarily rich country, that the people in their productive years can take care of those outside, in both areas, even though the ratio of productive and unproductive has changed and is changing. But we take care of our young, and a rich country takes care of its young, and it takes care of its old. And incidentally, taking care of its young, when we educate five children in the family, we don’t expect that family to pay, you know, five times the tax or something like that. We recognize that in taking care of the young, that it should not be based on a per capita basis, or based on… wired in a way that enables us to get very, very, very rich, rich far beyond any possible needs we could have.

And not everybody’s wired the same way. Now, if you come into this world wired with an IQ of 85 or something of the sort, or disabled, or whatever it may be, you know, you are not going to do as well in a market economy, remotely as well as we do. But you still provide much of what makes Charlie and I very rich. And, you know, when it comes to fighting in Iraq or something of the sort and all that, that becomes an equal opportunity type thing. But when it comes to making a lot of money, it’s not equal opportunity in this country.

So I believe that a rich country like ours should not give lower benefits than what takes place now. And I certainly don’t think that… we’ve got all kinds of mechanisms for saving that are extremely good. We have 401(k)s in this country. We have taxes on dividends and capital gains at 15%. So the money I earn gets taxed at a lower rate than the money that a receptionist in our office may earn. And I would not be doing so well if I were stuck over in Bangladesh or someplace. So this society is providing huge benefits to me that other societies would not. And I think that the obligation for the people who do well in the society is to provide a reasonable level of sustenance for those beyond their productive years. We’ve got the capability to do it.

You know, right now we quit taxing for Social Security at $90,000. But… and that means that everybody in my office is paying, or most of them are paying, 12.4%, 12.2% or 12.4%, counting what the company contributes toward this. People talk about double taxation of dividends. They’re getting taxed for Social Security, and they get… getting taxed for income on their income, and they’re paying a higher rate or an equal rate overall in many cases, to the same rate, compared to the rate that I pay. And I think that’s sort of nonsense in the society.

So I don’t want to do anything that hurts the level of the bottom 20% or 30% in terms of their income. I see people living with fear about health care, living with fear about running out of money their old age. And I think a society should try to minimize the fear that they’re… that their inhabitants experience. And that doesn’t mean just fear of getting mugged or something. It means fear that the last 25 years of their life they’re not going to have much income. So I would… and they did… the degree to which the administration or other people are worrying about the deficit in Social Security 25 years out, when they have a $500 billion deficit, excluding the Social Security surplus, now, I mean, it strikes me as nonsense. Here we are deploring something that’s going to happen in 20 years that’s a fraction of what is happening right now, while they’re cheering, you know, basically, and talking about further favoritism in the tax law.

So I have great trouble with people that say, you know, that this system can’t sustain. Right now, 4 and a fraction percent of our GDP goes to Social Security. Fifty years from now, 6%, no, 6 and a fraction percent. Well, believe me, our GDP will be far larger 50 years from now, and going from 4% to 6% does not strike me as a terrible prospect. If you ask me what I would do to change it now, I would means test it. I would lift the $90,000 way up. In fact, then I might apply it, you know, on all income. Then you’d really get people’s attention. But… and I would gradually, and we’re in the process of doing this, but I would certainly increase the retirement age. I mean, the world in 2005 is much different than the world in 1937 in terms of longevity prospects and the ability to function productively. Charlie, what do you say?

Charlie Munger [03:15:19] Well, that’s the view from Berkshire’s Democratic chairman. And the odd part of Berkshire on this issue is that the right-wing Republican who is speaking feels more strongly than Warren that the Republicans are out of their cotton-picking minds to be taking on this issue right now. I do not… if the country is going to get richer at 1% or 2% per annum for a long time ahead and it’s going to have more old people who are living longer and spending money on medical care, the idea that eventually a higher share of GDP would be going through Social Security to retirees and so on that we now have is not an athlete to me. It’s exactly… it’s an exactly logical way to be spending money under different circumstances. And if the government runs out a little short of money as it gets more Social Security obligations, I see nothing wrong with having some consumption taxes or whatever to pay in a reasonable way for what is a very reasonable expenditure.

Social Security is very successful. Apart from the disability element, which is relatively small, is practically no fraud. It’s hard to fake being dead. And furthermore, it’s a reward for work. All kinds of people are working in this country because they want to eventually qualify for Social Security, just as many people are doing dangerous military service because they want the pension that will come eventually. So Social Security is a very capitalistic institution with profoundly good effects. It’s one of the most successful things the government has ever done in terms of efficiency and good effects. And in a Republican administration that may shortly have to do something really unpleasant, like face down North Korea or Iran over atom bombs, is wasting its goodwill over some twaddle that a bunch of economists that haven’t thought it through properly devoutly believe. It’s a very sad occurrence.

Warren Buffett [03:17:33] Number 4.

[03:17:33] Shareholder (Bill Ackman, New York, New York): Thank you. Bill Ackman from New York, New York. For the handful of AAA-rated companies, AIG, Fannie Mae, Freddie Mac and MBIA are under formal investigation for accounting shenanigans and are in the process of restating their financials. Like Charlie said before, I think of a triple-A-rated company as an exemplar, a company that should behave in the… with the highest accounting and ethical standards. My questions this leads me to are, how can investors comfortably invest in any financial service company when even… when a decent percentage of the AAA-rated companies have false and misleading financials? And I guess the follow-up question is, why don’t the rating agencies do some independent due diligence from an accounting standpoint, so that they can help serve as a watch on this issue?

Warren Buffett [03:18:34] Well, financial companies are more difficult to analyze than many companies. I mean, the… it is more… if you take the insurance business, you know, the biggest single element that is very difficult evaluate, even if you own the company, is the loss and loss adjustment expense reserve. And that has a huge impact on reported earnings of any given period, and the shorter the period, the more the impact can be from just small changes and assumptions. You know, we carry, we’ll say, $45 billion of lost reserves. But, you know, if I had to bet my life on whether $45 billion turned out to be a little over, a little under, I mean, it’s… it’d be a… I think a long time. And you could just as easily have a figure of $45.5 billion or $44.5 billion. And if you were concerned about reporting given earnings in a given period, that would be an easy game to play.

In a bank, you know, it basically is what… whether the loans are any good. And I’ve been on the boards of banks, and that’s, you know… I’ve gotten surprises. It’s tough to tell. It’s financial companies… If you’re analyzing something like WD-40, you know, or See’s Candy, or our brick business, whatever, you know, they may have good or bad prospects, but you’re not likely to be fooling yourself much about what’s going on currently. But with financial institutions, it’s much tougher. Then you get ad throwing derivatives on top of it. And, you know, it’s… no one probably knows, you know, perfectly what some of the… or even within a reasonable range, the exact condition of some of the biggest, you know, banks in the world.

And… but that brings you back to the due diligence question of the agencies. You had very high grade, very smart, financially smart people on the boards of both Freddie and Fannie, and yet, you know, one was $5 billion and one was apparently $9 billion. Those are big numbers. And I don’t think those people were negligent. And it’s just… it’s very, very tough to know precisely what’s going on in a financial institution. Charlie and I were directors of Salomon, and Charlie was on the audit committee, and I forget the size of a few of those things that you found, but, you know, what… what wasn’t found. And that isn’t… that doesn’t mean the people below are crooks or anything like that. It just means that it’s very tough with thousands and thousands and thousands of complicated transactions, sometimes involving the computations involving multiple variables. It can be very hard to figure out where things stand at any given moment.

And of course, when the numbers get huge on both sides, and you get small changes in these huge numbers, they have this incredible effect on quarterly or yearly figures, because it all comes lumped in… those adjustments come lumped in a short period of time. So I just think you have to accept the fact that insurance, banking, finance companies, we’ve seen all kinds of finance company, both frauds and just big, big mistakes over time, just one after another over the years. And it’s just a more dangerous field to analyze. That doesn’t mean you can’t make money on it. We’ve made a lot of money on it. But it’s difficult.

Now, obviously, a GEICO, where you’re ensuring pretty much the same thing, auto drivers, and you get… your statistics are much more valid in something like that than they will be if you’re taking something that… like asbestos liability. You’re subject to far greater errors in estimation. Doesn’t mean the people aren’t operating in good faith. But, you know, I would take… just take the asbestos estimates of the 20 largest insurance companies. I will bet you they’re way off, but I don’t know in which direction. And that’s sort of the nature of financial companies.

I wouldn’t fault the rating agencies in terms of not being able to dig into the financials and find things that, you know… All of the companies that you’ve talked about have had big-name auditors. And our auditors at Berkshire, how many hours did they spend last year? You know, I don’t know whether… what it would be, probably 60,000, 70,000 hours. And I’m sure another… you know, if you take major banks, they’re spending more than that. But, you know, can they be certain of the numbers? I doubt it. Charlie?

Charlie Munger [03:23:39] Yeah, Warren is obviously correct that where you’ve got complexity, which by its very nature provides better opportunities to be mistaken and not have it come to notice, or to be fraudulent and have it not be found out, you’re going to get more fraud and mistakes than you are if you’re selling a business where you shovel sand out of the river and sell it by the truckload. And just as a business that sells natural gas is going to have more explosions than a business that sells sand, a business like these major financial institutions, by its nature, is going to have way more problems. And that will always be true. And it’s true when the financial institutions are owned by governments. In fact, some of the worst financial reporting in the world is done by governments and governments’ institutions, like government banks in China, etc. So if you don’t like the lack of perfect accounting and financial institutions, you’re in the wrong world.

Warren Buffett [03:24:42] Number 5.

[03:24:43] Shareholder (Adrian Chair, Hong Kong): Good afternoon, Mr. Buffett, Mr. Munger. Thank you very much for your wisdom and all your investment advice. I’m Adrian Chair, and I’m from Hong Kong. Back in the old days in Hong Kong, when somebody turned 100, they got to have tea at Buckingham Palace with the Queen. I don’t know what you have here in America, but I hope that in 2030 we come back to watch you do 50 push-ups at the White House.

Charlie Munger [03:25:17] It’s not the way to bet.

[03:25:19] Shareholder (Adrian Chair, Hong Kong): Well, you settle for 10. My question comes in two parts. Firstly, in 1968, ’69, you liquidated all your partnerships, and I guess, aside from your holdings in Berkshire Hathaway, you got completely out of the market and stayed out. In 2000, 2001, you mentioned to us that in the coming decade the markets would go at best nowhere. However, despite $50 billion in cash, you, and therefore us, remain substantially invested in the market. So my first question was, how and why is the investment climate different today than in 1968, ’69, that makes you comfortable remaining substantially invested?

Warren Buffett [03:26:01] Yeah, well, we do own certain securities which we wouldn’t… we probably wouldn’t buy at these prices. Some of them we would, some of them we wouldn’t. We’re not unhappy with anything we own. We’re not happy with putting more money in. So we’re in a zone in some of those securities where we wouldn’t buy and we wouldn’t sell. Now, part of it, that decision relates to the kind of quantities that we deal in. I mean, if we owned a hundred shares of each one of the stocks that we own, you know, many billions of dollars’ worth, it would be an easier decision to go in and out. But we would face significant costs, including taxes, but in top of taxes, and going… trying to go in and out of the big positions we have. And basically we like the businesses. So we are not unhappy. We may feel like we wouldn’t want to buy more here, but we are not unhappy about being in the businesses in which we have big equity holdings.

Now, notwithstanding all of that, a lower percentage of our intrinsic value is represented by the common stocks we own than just about at any time of our history, with the exception of a couple… well, the period right there at the end of 1969 when we liquidated the partnership. So we have not made any big statement by purchases of stocks or the ownership of stocks that says we in any way… says that we think that this is a particularly attractive time to own them. But we are not unhappy with Coca-Cola. We are not unhappy with American Express. We are not happy with… we’re not unhappy with Wells Fargo or Moody’s. Those are very, very good businesses that we own. Would we be buying them at today’s prices? If we… you know, well, the answer is we’re not. You know, we’ve got money, and we may buy more later on. We’re more likely to buy more later on than to sell those sort of investments. But there is a zone which, because of size, because of taxes, where we would neither be a buyer nor a seller. And we do not see lots of attractive stocks, but we also don’t think that there’s as much silliness in the market by far as there was five years ago, roughly. Charlie?

Charlie Munger [03:28:30] Yeah, one of the things that’s interesting about Berkshire lately is that if you take the last four or five things we did in the stock market with a goodly number of millions, but billions really, but small in relation to Berkshire’s overall size, our record is much like it used to be in some of the best days where we were able to move around with small amounts of money. The results were quite respectable. But where we were facing the problems of being enormously rich, way we were… we were prevented from the nimble money-making record of the past. I don’t think that’s a permanent state of affairs, but it’s never going away either.

Warren Buffett [03:29:23] But explain that one.

Charlie Munger [03:29:24] Well, what I mean is that I think we may be able to deploy large amounts of money eventually at very satisfactory rates, whereas in recent times we have deployed small amounts of money at very satisfactory rates, and better small and nil, and smaller still billions.

Warren Buffett [03:29:51] Number 6.

[03:29:51] Shareholder (Mike McGowan, Pasadena, California): Good afternoon. My name is Mike McGowan. I’m from Pasadena, California. I had a pretty good question on Prop 13, but after watching the movie, I don’t think I’ll ask it.

Warren Buffett [03:30:05] Good.

[03:30:06] Shareholder (Mike McGowan, Pasadena, California): What I’d like to ask about, I guess, is one quibble and then a question. The question being about financial education or study of financial history that might help people in handling these markets, or in just dealing with investing at or near the apex of Western civilization. When you mentioned your dad’s lectures about buy gold back in the 1930s, and then saying, well, 60 years later it hasn’t done very well, gold was pretty much pegged at a set price back in the ’30s for years, and they didn’t really let it loose until 1971, and then it caught up, and then it’s kind of bounced around. If you looked at gold maybe now, in derivatives and real estate bubbles and lots of other things, maybe gold wouldn’t be such a bad investment, looked at in current terms. So my question would be, do you consider that you have some sort of an obligation or duty as financial exemplars to maybe pay a little attention to that classical kind of gold as the benchmark or the bedrock of a financial system to some extent, and that it might be nice to talk about it in your, at least your annual letter, to your stockholders, about how people might protect themselves in what’s a fairly bubbleus kind of environment from really the decline in purchasing power or problems caused by the financial domination that we have today? Thanks.

Warren Buffett [03:31:40] Yeah, I would say that gold would be weighed out on my list as a store of value. I mean, I would much prefer owning 100 acres of land near here in Nebraska, or an apartment house, or an index fund. Gold, we’ll say, was freed up 30-odd years ago. But it adjusted to a market that still… if you go back to 1900, you know, you were talking $20 gold. Well, you take $20 to $400 in a hundred years. The Dow went from 60 to, what, 12 or 13,000, in the 12,000 or whatever it might have been, in that same period, and paid you dividends during the time you own it. It was 66, I think, at the start of the century, and I forget what it ended, but it’s 11 or 12,000. And, like I say, was paying you something every quarter during that period. And if you own gold, you You paid $20, in 1900 or thereabouts, and then you will say you had $400, hundred years later. And in the meantime you paid insurance and perhaps some storage cost. It really is not a… it’s not a store of value. And it’s… I’m not arguing for paper money, but if you’re worried about paper money, and I think, you know, makes a lot of sense to worry about paper money over long periods of time, but it’s just about, you know, it’s just about the last thing I would want to own under those circumstances. You know, it has a… a farm has utility, an apartment house has utility, a business, you know, will produce earnings, and some businesses will produce them in real terms as they go along.

You know, I’d rather have the ability to sell people a pound of candy 20 years from now, and if they’re dealing in seashells, I’ll get an appropriate number of seashells instead of paper money for it. But I, it, I just don’t… I don’t see, I don’t see gold as a store of value. And it’s… the truth is it hasn’t worked very well, but forget about whether it’s worked well the last 100 years or the last 50 years or the last 10 years. I see no reason, you know, why it would, why would work well in the future. I forget whether we’re turning out about 3,000 or 4,000 tons of gold a year, and you know, we take it out of the ground in South Africa and we put it in the ground at Fort Knox or someplace, and, you know, in New York Fed. And I mean, and it doesn’t do much along the way for anybody. So I know… Charlie, how do you feel about gold?

Charlie Munger [03:34:50] Well, I think gold was a… and similar items, that was a great thing to have if you were a well-to-do Jewish family in Vienna in 1935, because you had hazards where that gold had enormous utility to you. But for Berkshire Hathaway sitting here in 2005, it just doesn’t interest us at all.

Warren Buffett [03:35:16] Number 7.

[03:35:16] Shareholder (Al Henderson, Minnesota): My name, my name is Al Henderson from Minnesota. I’d like to thank both of you for being yourselves and doing so much for all of us and to help enrich ourselves and everyone else. My question I have is, actually you have already referred to it, that you devote very little time to looking at the total market and look for individual opportunities most. But I was wondering, in the past he made some excellent presentation on points to consider in projecting reasonable 10-year returns for the stock market and had it advised reduced expectations. Where do we stand now on your stock market and economic measurements and expected 10-year returns?

Warren Buffett [03:36:20] Yeah, every now and then, I mean, and I really very infrequently, you probably can say something intelligent about markets as a whole. I mean, that you do see circumstances that are extreme enough that you can make a statement that is likely to look reasonably intelligent five or 10 years later. And I’ve seen a few of those times in my lifetime. I mean, I, and I’ve spoken on a couple of times, and I did in ’69 and ’74 and a few times. Most of the time, you know, you’re in some in-between zone.

Obviously you get more for your money in equities now than you got, say, in the summer of 1999, which is when I delivered a talk out of Sun Valley that later got turned into an article for Fortune. But that was an ex… I spoke out then because it was extreme. I mean, I knew in a general way that I was going to be right, particularly in certain aspects of the market, but I didn’t know when, and then I didn’t know how right or anything of the sort. And you could have done the same thing in the other direction back in the mid-’70s.

I think that if you had to make a choice between owning long-term bonds, which are now yielding, the Treasury only a little over 4.5%, or owning equities for the next 20 years, and you couldn’t make it change that decision, I would certainly prefer equities. But I think people that have expectations that they can earn more than 6% or 7% in equities, and certainly when they start expecting double digits, I think the degree that they have expectations they can do that, or that they can find somebody else to do it for them, I think they’re making a big mistake. But 6% or 7% is not the end of the world at all. In fact, and it gets treated better tax-wise right now than it has almost any, well, really any time in my lifetime.

So I don’t think we’re in bubble type at all valuations inequities, and I don’t think we’re anywhere close, to remotely close, to the bargain valuations. And I don’t think it’s an extreme enough period that you can speak out in some very definitive way about the outlook. But if you told me I had to go away for 20 years and choose between what’s obtainable in an index fund of equities or be committed to long-term bonds, I would rather take equities. But I think you will get a chance to do something that is more screamingly intelligent, not too many years and maybe a lot shorter, than the alternatives that you’re offered now. Charlie?

Charlie Munger [03:39:39] Well, I can’t improve on that at all.

Warren Buffett [03:39:43] And then we’ll go to number 8.

[03:39:47] Shareholder (Hamid Rezapour, Orinda, California): Oh, hello. My name is Hamid Rezapour. I’m from Orinda, California. I had a question about real estate, and I know this question was asked in previous shareholder meetings about how come Berkshire doesn’t invest in real estate, and I believe the answer was that we like operating business. So I want to make my question a little more specific towards commercial real estate. So considering the characteristics of larger size commercial real estate investments like REITs that can have the behavior and financial returns of an operating business, why not invest in real estate? Is it because you just don’t like the returns or the business is just not attractive?

Warren Buffett [03:40:38] Yeah, well, Charlie got a start in real estate, right, Charlie?

Charlie Munger [03:40:44] Yeah. I would say, number one, that in a corporation like Berkshire that’s taxable under Subchapter C of the Internal Revenue Code, owning real estate is grossly disadvantaged compared to owning it directly by individuals such as yourself. That’s number one. And number two, real estate investment… real estate is having bubble valuation problems of its own right now. All my rich friends who own real estate are selling their worst properties, and they’re getting bids that come in higher than their highest expectations, and people are competing to take these things off their hands. I do not find it exciting, and it certainly doesn’t fit Berkshire. Named me a lot of C corporations that have been passive holders in real estate and have done well over a whole lot of years. It’s almost a null class.

Warren Buffett [03:41:39] Yeah, Charlie and I, I mean, both, more Charlie than I am, we’ve had certain personal real estate investments over time, and it, you know, it’s a field that in general we understand. We don’t bring that much special to the game, but we understand it, we’ve made money in it. And actually, at the time that the NASDAQ about hit its high, REITs were quite cheap in my view. And I would, I have a less than 1% of my net worth outside of Berkshire, but basically I had that portion all in REITs. They’re all small ones at that time. And but they were selling at discounts at that time, they were selling at discounts to the value of the properties, and those values of properties were much more conservatively figured than today. Today you have very fancy prices on real estate, and on top of that you have the REITs often selling at a premium, though. So I regard REITs as quite unattractive now, certainly compared to five or six years ago.

Charlie Munger [03:42:44] But that’s an ass… that’s a group of individuals. Unattractive, yeah. And for a corporation, that much more so.

Warren Buffett [03:42:53] Yeah, right, right. The situation’s changed dramatically from five or six years ago. I mean, the stock market in many respects from the 1999, 2000 period is down significantly, rates are up significantly. REITs were very unpopular five or six years ago, now they’re popular. And it’s better to pay attention to something that is being scorned than something that’s being championed. And there’s really been a big change in the REIT situation in the last five or six years.

Charlie Munger [03:43:25] And the REITs have phony accounting. Otherwise we love them.

Warren Buffett [03:43:29] You don’t want to bring up anything in these meetings. Number 9.

[03:43:34] Shareholder (Carlos Lockham, Lawrence, Kansas): Good afternoon. My name is Carlos Lockham from Lawrence, Kansas. The U.S. has set a dominant role in the world economy for about a hundred years. His dominance resembles that of an economic monopoly. Would you say that the U.S. is, quote-unquote, a castle with a moat, and if so, how can we make the moat any bigger? Thank you.

Warren Buffett [03:44:02] Yeah, well, the U.S. has been pretty remarkable. As I indicated in my earlier comment, I mean, you know, essentially the same population pool pretty much, and they’ve garnered over this 215-year period a remarkable share of the world’s wealth. And it’s an interesting question as to just why this group of people here have been able to do so much better than the rest of the world, considering we’re not a smarter or anything of the sort. It’s not an economic castle anymore. I wouldn’t, I wouldn’t call it that. What we do is no secret.

And I think that the relative importance of America, I mean, when, you know, we have been a dominant factor in the world in post-World War II, and I think it will decline somewhat, although I’m not an alarmist on that. But I think to some extent the rest of the world, or much of the rest of, some of the rest of the world is catching on and adopting some, you know, sort of best practices, as they say in industry. And our castle will grow in size, but there will be more castles around it. And I basically think that’s a very good thing for the world. I think the more prosperous generally the rest of the world is, you know, the better generally it will be for us.

And, you know, I’ve talked about our trade problems. The more trade we have the better. We had $1.1 trillion of real trade last year in the country, we would have, with the world, and then we had another $600 billion, six-tenths of a trillion, that unilaterally we bought. Well, I would love to see the $1.1 trillion grow and grow and grow. It’d be good for us and good for the rest of the world. But I don’t think that our prosperity will come in the future, will come at the expense of the rest of the world at all. And I do think that there were parts of the world that will grow economically from a lower base, but much faster than the U.S., and basically I think that’s a good thing. I mean, there’s 6 billion people in this world, and a lot of them don’t live very well, and I would hope that 20 or 50 years from now that it’s a higher percentage of them would live well. And that… but I don’t think it comes out of our height at all. Charlie?

Charlie Munger [03:46:31] Well, I think it comes out of our hide in that sense, but if we are now the richest and most powerful nation in the world, and 50 or 100 years from now we’re a poor third, some country in Asia, sure, we’re richer, but it’s a peculiar type of richness where you’ve lost your relative position in the world. It’s not all… I think if I had to bet, I would bet that the part of the world that does best is Asia, in terms of percentage gains per annum. And I think it might do amazingly well if it doesn’t blow up in some way, and if it does amazingly well, it will eventually be a much richer place than ours.

Warren Buffett [03:47:36] Number 10.

[03:47:36] Shareholder (Thorsten Kramer, Cologne, Germany): Good afternoon, gentlemen. I’m Thorsten Kramer from Cologne, Germany. You’ve criticized the extraordinary large stake that the financial sector in the United States is currently representing in relation to GDP, which is also reflected in a total credit volume exceeding GDP by roughly 250%, significantly up from the level we’ve seen a decade ago. A current account deficit and budget deficit running at 6% of GDP, in combination with a still accommodating easy money policy and high asset prices, will have to be consolidated sooner or later. How do you think the adjustment will take place? What are your two most likely scenarios how these huge imbalances might be consolidated, and is the dollar devaluation scenario your most favorite one?

Warren Buffett [03:48:41] As I said earlier, I don’t see how the situation resolves itself with the stronger dollar. Most people still seem fairly sanguine about the fact that there won’t be anything terribly bumpy about it, that they’ll be the so-called soft landing. And I don’t know whether that’ll be the case or not. But I would say that we’re running the risk of having markets that could get chaotic if certain events converged, superimposed upon those factors that you just, that you just listed. But I don’t… I’m not an Armageddon type at all on the economy.

I mean, the things you named are important factors. I think that, absent something happening in the terrorism field, I think that, you know, the citizens of the United States on balance will be living better 10 years from now than now, and 20 years from now than now. But I do think that we’re following policies that are unwise. But we’ve done that plenty of times over history. I mean, Peter Lynch has always said, you know, buy a business that’s so good that an idiot can run it, because sooner or later one will. We’ve got a country that’s so good that we can have policies that are counterproductive, and we’ll still come out okay. Just think of what we’ve had over the years. I mean, you know, Warren Harding, Chester Arthur. We’ve had a lot of, a lot of things in this country. We had a Civil War, we had thing, all kinds of things over the years. But the society has marched forward with some fits and starts, but still at a very significant clip.

The real GDP per capita is seven times in the U.S. what it was a hundred years ago. Just think of that. One century in the human pageant and a sevenfold increase in GDP per cap, but it’s remarkable. So I acknowledge, you know, consume… I acknowledge, you know, consumer debt doing what it’s done and the trade deficit being what it is, and I think that those things, particularly the trade deficit, should be addressed and promptly. But I don’t think they pull down the whole place. They may create very severe dislocations in financial markets from time to time, but that’s been the history of this country. I mean, we have had very dramatic things happen in financial markets over the years, and the country, the country survives despite that. And sometimes there’s great opportunity in those dislocations. There’s likely to be. So I’m not pessimistic about the U.S. at all.

You know, I can’t imagine any place that I would rather be. But whether… when you say the two most likely outcomes, I think the eventual outcome is that the country does fine. But I think a… there’s a significant possibility, and that you do have some chaotic financial markets at one time or another, but we’ve had them historically. Charlie?

Charlie Munger [03:52:08] We don’t have any great record as macroeconomic predictors, and I don’t see any reason why we should really start now. Obviously there are more chances for convulsion now. I mean, everybody from Paul Volcker uranus has looked at the current figures and said we could have some kind of convulsion as a consequence of horses now, and being apart from knowing that, we have no contribution to make.

Warren Buffett [03:52:56] Yeah, I do think, as I mentioned earlier, that far greater sums relatively, in almost, in one asset class after another, are held by people who were really on a hair-trigger type mechanism. So the creation of lots of new financial instruments, the piling up of huge amounts by intermediaries or agency activities in terms of money management, I think they lend themselves to more explosive outcomes on any given day than might have been the case some years back when I was selling utility stocks to people 100 shares at a time. And almost, I mean, those… that money was not on a hair-trigger basis.

But as you turn it over to fund managers who think their job is to beat the S&P in on a short-term basis, you are getting very short time horizons on huge amounts of money, and those people may think they are operating independently in one sense, but they’re responding to the same stimuli, and they can, as they did in the fall of 1998, they can all head for the exits, or try to head for the exits, at one time. And the thing about financial instruments is there is no exit. I mean, the only way that you get rid of a financial… and the only way you leave your seat in a burning theater, either in financial markets, is to find somebody else to take the seat, and that is not always easy. Go ahead.

Charlie Munger [03:54:49] I think it’s also true that the amount of credit being used, not only by hedge funds but by ordinary investors, is way heavier than most people realize. It wasn’t even controversial in this country when we came to introduce single-stock futures and what, you know, commonly traded puts and calls, and ordinary people got in trouble. If I’d been running the country, I never would have allowed that. I don’t know what good it does for the country to have a wonderful… a lot of trading and puts and calls.

One of my children knew a nice man who had a $2.5 million house and $5 million worth of wonderful securities, but he couldn’t live as comfortably, he never worked, as he liked to live on the income from his $5 million of securities. And he got in the habit of picking up easy money with the credit systems of the world. He kept selling naked puts secured by his account, including puts on a whole lot of internet stocks. And in due time he didn’t have the $5 million of securities, and he didn’t have the house, and he now works in a restaurant. That kind of self-destruction wasn’t possible before we created all these wonderful trading opportunities involving credit. It was not a smart thing for this country to do, to legalize gambling everywhere and to bring it in a more facile form into our investment practices.

Warren Buffett [03:56:26] Is there anyone we’ve forgotten to offend? We… yeah, we don’t want to miss anyone. Number 11, please.

[03:56:33] Shareholder (Andy Peake, Weston, Connecticut): Good afternoon, Mr. Chairman, Mr. Vice Chairman. My name is Andy Peake. I’m from Weston, Connecticut. Recently we have seen a number of corporate boards take forceful action, Hewlett-Packard and Boeing, for example. We have also seen board members from WorldCom pay large amounts to personally settle lawsuits. Today we see Morgan Stanley embroiled in a bitter battle largely based on divergent views of how to govern the firm. What responsibilities do directors have in this new environment, and what do you look for in your directors?

Warren Buffett [03:57:14] Charlie, why don’t you take that one first?

Charlie Munger [03:57:17] Well, we are completely out of step with modern practices with directors. The modern practice is to have one from each diversity care category and to have a whole lot of people who need, more or less, the $100,000 or $200,000 per year that they’re paid for being a director. And people think this makes the system better. At Berkshire, all the directors are rich, and they own a lot of stock in Berkshire, and they’re all very smart, and they don’t get any liability insurance provided by Berkshire. So we’ve been waiting for our system to spread, but we seem to be losing.

Warren Buffett [03:58:05] Yeah, it’s, it’s a tough job at times to be a director. The real problem that you can face, and often and may often face, is when you’re dealing with mediocrity. I mean, if you have a baseball team and you have a .240 hitter in the majors, .240 here, and the majors are still a pretty good baseball player, but if your job is to have a winning team, you get rid of them and you find somebody that can bet .280 or .290 in field just as well. In business, the tough part is to get, is to get rid of something a notch or two above mediocrity, but not the best one that could be found.

And, a, when people meet every couple of months, they come from different parts of the country, and they have the normal social instincts. They don’t like to have rump meetings or to sort of talk being behind people’s backs. It’s very difficult for a group, and particularly if it’s a group like Charlie described, where a significant number of them, the director’s fees they earn are important to their well-being, and they like, they’d love to be recommended for another board and add another $100,000 a year to their income. It’s very difficult for somebody to leave a charge and all of a sudden start at the meeting, or trying to arrange a rump meeting of some sort, to say, you know, we really think this guy at the head of the table is no good.

And changing, dealing with mediocrity is, or like I say a notch above it, is it difficult, as a difficult problem if you’re a board member. And we believe that, you know, independence is a… it’s a state of mind. I mean, it, and it’s the willingness, but not the eagerness, to challenge the ideas of others. And to… if you see a merger that doesn’t make sense, and Charlie and I have seen a lot of them, and we’ve been on the boards, and sometimes we’ve spoken up and sometimes we haven’t spoken up. If you feel that, you know, you can… the group around you, in terms of social behavior, can only tolerate a certain amount of obnoxiousness on the part of you yourself, that you have to sort of ration it out, and so you save yourself for big ones. And then it’s not necessarily an easy equation.

And certainly I would say of the things I’ve seen proposed in the way of major acquisitions, and a significant percentage of them I wouldn’t do myself. But would I overrule somebody else? I wouldn’t get the votes, probably, anyway. And it’s a very difficult thing to do. You could occasionally fire a bullet if you think it’s important enough, and usually it doesn’t do any good. So I… we have a group that has, every one of them has significant money invested in Berkshire. They all bought it in the market, just like you did. I mean, nobody… I mean, I’ve been on all these boards, and they keep handing me things, and, you know, I had shares of this one and that one were given to me, or options or whatever, matching charitable contributions, all kinds of things.

But we have real owners on our board, and what they make for being board members is really inconsequential, as I get reminded occasionally, compared to their investment. And they’re friends of mine. They’re smart, they’re very smart. I mean, they are hand-picked in terms of a business brainpower and quality of human being. And I really think that, you know, we have the best board in the country. But the people that want to make their evaluations by checklists, you know, whether either in terms of diversity or in terms of supposed independence, although I don’t know how anybody that’s getting half their income from board memberships can be independent, you know, we don’t, we may not stack up so well.

But it’s the kind of board that I want to have, knowing that if I die tonight, that virtually everything I have goes to a foundation. I wanted that foundation to have as much money over the years to spend as possible, and there’s no group of people I’d rather have in charge of the decision subsequent to my death than the people that we’ve got now.

The answer is that Charlie and I, and managing Berkshire, try to do things, put money in things that we understand. And when I mean understand, I mean that we, where we think we know in a reasonable way what the economics will look like in five or 10 or 20 years. And Bill is a lot smarter about a whole lot of things than I am, but it’s still Charlie and I that have the responsibility for managing the money, and we’ll stick within what we consider to be our circle of competence. And the fact that somebody else’s circle is wider or different, you know, that’s the way the world is. I’ll listen, any idea Bill has, believe me, I will listen to him. I mean, he is a… he’s not only a smart manager, but he’s a smart investor. And I think actually our ideas on investment overlap to quite an extent. But I still wish I had bought a little Microsoft when I first met him. Charlie?

Charlie Munger [04:04:20] I think what has happened at Berkshire is just wonderfully for the good, and I do think we have a perfectly marvelous board. What makes me sad, as I said earlier, is I don’t see more of the same practice followed elsewhere. A director getting $150,000 a year from a company who needs it is not an independent director. That director, it automatically becomes an inside director. And so it’s a typical government intervention. It’s just, it says it’s doing one thing, and it does another.

Warren Buffett [04:05:00] Yeah, I have never… I’ve been on 19 boards. I’ve never seen a director where the director’s fees were important to them object to an acquisition proposal, object to a compensation arrangement of the CEO. It’s just never happened, you know, and in my experience. And, you know, they do not, they frequently do not behave as they would if they own the place. And basically we want people that behave as if they own the place.

Charlie Munger [04:05:36] The correct system is the Elihu Root system. Elihu Root, who had three different cabinet appointments, if I remember right, said no man was fit to hold public office who wasn’t perfectly willing to leave it at any time. And a fellow who wrote… didn’t approve of something the government asked him to do, he could always go back and be the most sought-after lawyer in the world. He had an identity to go back to, and he didn’t need the government’s salary. And I think that ought to be more the test in corporate directorships. Is a man really fit to make tough calls who isn’t perfectly willing to leave the office at any time? My answer is no.

Warren Buffett [04:06:20] Yeah, we will have one of our directors who was, who’s been removed twice from compensation committees of other corporations because he had the temerity to actually question whether the compensation arrangement being suggested was the appropriate one. I mean, it… it’s not, it’s being put on the comp committee of American corporations. As I’ve said, they’re not… they’re looking for Chihuahuas and not Great Danes and Dobermans. And yeah, and I hope I’m not insulting any of my friends that are on comp committees.

Charlie Munger [04:07:08] You’re insulting the dogs. (Applause)

Warren Buffett [04:07:11] Okay, number 1.

[04:07:12] Shareholder (Rory Johnson, Suffolk, UK): Hello. I’m Rory Johnson, and I’m from Suffolk in the UK. Do you have, or are there any appropriate criteria beyond purely financial returns in a success, in assessing the success or otherwise of your investments?

Warren Buffett [04:07:36] Well, I would say that, I would say that the financial returns achieved in a way that we want them to be achieved are they determined of whether we’ve made an intelligent commitment. Now, we don’t get rid of companies that don’t meet our original expectations. There’s a section in the back of our annual report on the economic principles, and I forget which one it is, it’s toward the… or the end, but we say that Charlie and I have this quirk, which business schools would teach is a mistake, in that if we have a business that’s underperforming and we could sell it and put, and achieve greater returns someplace else, we don’t do it.

We say that if business is going to permanently lose money, we’ll get rid of it. If it has major labor problems over a period of time, we might get rid of it. But we are not going to engage in what we call gin rummy time management, where we pick up one card and discard another. And so we will not… if a business has been disappointing to us, but we like the people there, and we’re not having… not because of labor problems, and we’re not going to have to put money in incessantly, we will stay with it when business school theory and management theory would say get rid of it and do something else.

We don’t disagree with the people that do it that way. It’s just that we don’t want to live our lives that way. And if we owned 100% of Berkshire, we wouldn’t do it that way. And we don’t… we just, we want the shareholders to know that we have this mindset that may produce slightly sub-optimal returns because of our attitude, but that’s the way we’re going to play it. And we tell people ahead of time that that’s the way we’re going to play it. We like being associated with the managers that we are, even the ones that are in, facing headwinds. I mean, but in a sense you almost identify more with the ones that are facing headwinds, because they’re doing a hell of a job under very tough conditions.

And every business decision, an investment decision, is going to work out perfectly, and some businesses are going to run into unexpected surprises. But the people that have gone in with us have stuck with us in times like that, and our attitude is we’ll stick with them. So to the… I would say that how the people behave with us after we buy the business is an important part of how we feel about, you know, the whole relationship, as well as the returns achieved. Charlie?

Charlie Munger [04:10:27] Yeah, I think he’s actually asking, in part, are there some businesses we won’t have as subsidiaries in Berkshire, even though they’re wonderful businesses? Are we rejecting some business opportunities on moral grounds?

Warren Buffett [04:10:43] Yeah, well, we…

I’ve referred in past meetings to one we did on that basis. We will own stocks of companies where we wouldn’t want to own the whole business. I mean, I, you know, you can… I’m not sure that the logic is perfect on that, but we would not have trouble owning stock in a cigarette company. We wouldn’t want to manufacture cigarettes. You know, we might own a retail company that sells cigarettes. I mean, there’s all kinds of great asians. But we do not… there are things we don’t want to own and be responsible for, their businesses where we have no problem owning their stocks or bonds.

And some years back, Charlie and I went down to water Memphis? Yeah, yeah. We looked at a… we were invited down, and we looked at a company that made a product that, perfectly legal, probably one of the best businesses I’ve ever seen in terms of the economics of it, absolutely, still doing very well. And we met in the room with… we went to a hotel, we met in the room with the people that had the business, and people were perfectly decent people, and they described the business to us. And we went down in the lobby, and as I remember, we said on the lobby, and we just decided we didn’t want to be in that business.

And, you know, the lines are not perfect on this sort of thing. I mean, it… I’m sure that there may be ads in the Buffalo News that are selling some investment service or something that I would cringe at if I knew the people involved or what they were selling. And that, if you own a big retail establishment, a retailer, general merchandise, you know, you’re probably going to be selling cigarettes when you don’t think that you should smoke yourself or that your children should smoke. And it’s… they’re not perfect, but we have turned down some, the most dramatic being that one, because we went… it took us a trip of a thousand miles or so to finally face up to the fact that we didn’t want to own it. Charlie, you have anything to add on it?

Charlie Munger [04:12:51] No, but that was interesting, because we were young and poor then by modern standards, and, you know, we’re very human, and we could see it was just like putting $100 million in a bushel basket and setting it on fire as we walked away. And it makes me feel bad. We made the decision all right, and with no difficulty, but there was a certain twinge.

Warren Buffett [04:13:19] Number 2.

[04:13:20] Shareholder (Jade White, Wilton, Maine): My name is Jade White. I’m from a small town in Maine called Wilton, Maine. My question comes more of a request, and could Charlie Munger create a curriculum, or a list of reading and experiences, which he believes would lead to his concept of worldly wisdom? This would serve two great, three great purposes. One, it would pass on the most valuable possession, that is your knowledge and experience, to us and to others in the future. Two, it would preserve and enhance that wealth beyond the material riches endowed on future generations. And three, it would begin to remedy the stunted educations of those like Mr. Munger are plunging along with ordinary will with time to improve ourselves. Thank you.

Charlie Munger [04:14:19] Well, of course, Peter Kaufman has tried to do that, and that book that he stitched together out of my old speeches was a lot else. And I didn’t want to do it, and he went and saw Warren, and Warren got enthusiastic, and Warren suggested this ridiculous name, Poor Charlie’s Almanack, and me to do it. But the whole idea of doing it is with just the motivation you’re talking about thinking about. I think if you assimilate everything in that simple book, you will know a lot more than about 95% of your compatriots. And it’s not that hard to do. So Peter Kaufman has made it easy for you.

Warren Buffett [04:15:08] Yeah, I couldn’t be more enthusiastic about what you suggested, and it’s been done, and it’s a sensational book. And anybody that reads it is going to learn a whole lot, and about life, and you’ll learn, even, get you to read it, I’ll tell you, you’ll even learn something about making money. The… and it’s right next door here. They haven’t sold out. Number 3, please.

[04:15:37] Shareholder (Scott Jeffords, Davidson, North Carolina): Good afternoon. Scott Jeffords from Davidson, North Carolina. The major pharmaceutical companies have faced a myriad of fundamental and legal challenges in recent years. With that in mind, and given the apparent ongoing nature of those obstacles, how should investors be thinking about the long-term prospects for this very important industry?

Warren Buffett [04:16:01] Well, my answer is I don’t know, but maybe Charlie will. And it’s a, you know, it’s a terrific question. It’s just that that industry is in a state of flux now. It does very important things for mankind. It’s historically earned good returns, very good returns on invested capital. But it’s going… it could well be that the world will unfold differently for those companies in the future than the past. It may… that may not be the case. And I don’t think I’m really qualified to give you a good answer on that, because much of it is in the political realm, and my judgment about the what politicians will do is probably not better than yours. Charlie?

Charlie Munger [04:16:57] I share Warren’s agnosticism on the subject. We just throw some decisions into the too-hard pile and go on to others.

Warren Buffett [04:17:05] Incidentally, there’s a lot of wisdom in that remark. I mean, there are things, there are things in life that you don’t have to make a decision on, and that are too hard. And many years ago, on one of the reports, I said one of the interesting things about investment is that there’s no degree-of-difficulty factor. I mean, if you, if you’re gonna go diving in the Olympics and try and win a gold medal, you get paid more, in effect, for certain kinds of dives than others, because they’re more difficult, and they properly adjust for that factor. But in terms of investing, there is no degree of difficulty. If something is staring you right in the face and the easiest decision in the world, the payoff can be huge.

And we get paid not for jumping over seven-foot bars but for stepping over one-foot bars. And the biggest thing we have to do is decide which ones are the one-foot bars and which ones are the seven-foot bars, so when we go to step, we don’t bump into the bar. And that is something that I think we’re reasonably good at. Now, maybe we cast out too many things as being too hard and thereby narrow our universe. But I’d rather have the narrow, the universe be a little too, interpreted as being a little too, a little smaller than it really is, than being interpreted as larger than it is. Obviously. 4. (Laughter)

[04:18:36] Shareholder (Whitney Tilson, New York City): Good afternoon. I’m Whitney Tilson, a shareholder from New York City. One of the things I find most refreshing and admirable about you as corporate leaders is that you’re very candid about making mistakes, and, as you put it last year, Mr. Munger, rubbing your noses in it. Last year, Mr. Buffett, you talked about the $10 billion mistake of starting to buy Walmart and then stopping after it had ticked up a little bit. Today you seem to allude to a somewhat similar mistake. You bought a stake in PetroChina, then after it was disclosed that you owned it, it popped up a bit, and obviously in hindsight you could have made a lot of money had you continued buying it.

If these emotional traps, I think you called it anchoring at last year’s annual meeting, are the traps that even people as experienced as you gentlemen are occasionally fall into, I sort of wonder what hope do the rest of us have. So my question is, you know, how do you… what are the mental tricks you have, or how do you overcome these behavioral and emotional traps like anchoring, and what advice do you have for us?

Warren Buffett [04:19:41] Well, that’s a good question. And of course, at first, in recognition of the fact that they can be trapped, and that you will be affected by them, and you will make some mistakes because of them. But Charlie, in his, in Poor Charlie’s Almanack, which I probably do take credit for the name of, and the… he talks about the various psychological traps that people fall into, and simply reading that section, you will come away wiser than before you started on it.

We will… our personalities are such that Charlie and I probably are a little less prone to some of those mistakes than other people are. But as our record clearly indicates, we still are prone to them, and we make them, and we’ll make them again. We’re probably a little less inclined to make some of them than we were 30 or 40 years ago. But, you know, the nice thing about it is, though, is that if you make fewer of those mistakes than others, you know, they will continue making their share, and you’ll get very rich. Charlie?

Charlie Munger [04:20:57] Yeah, you don’t have to have perfect wisdom to get very rich. All you’ve got to do is have slightly more than other people, on average, over a long time. You know, it’s the old story about the guy out running the bear. I mean, I don’t have the… outrun the bear, I just have to outrun that other fellow.

Warren Buffett [04:21:23] And number 5.

[04:21:23] Shareholder (Steve Casbell, Atlanta): I am Steve Casbell from Atlanta. With signs of inflation, you know, in commodities and oil, why do you think the 10-year is still, you know, the yield is 4.2%, and, you know, is it that the market sees signs of deflation coming in the future? And in addition, that if you thought rates would stay at this level for an extended period, would you have a more favorable view of the market?

Warren Buffett [04:21:51] Well, the answer to the second part is yes. I mean, if somebody guaranteed me that the 10-year rate would never go above 4.2% for the next 50 years, we would have to readjust, recalibrate every decision we make around Berkshire. I think it was Alan Greenspan, I don’t know whether he’s talking about the 10-year or what is the closest thing now to the 30, or we don’t issue 30 years anymore, but he referred to it as a conundrum. And after I looked it up, I decided I agreed with him. I don’t understand it. And but that’s okay. There’s a lot of things in financial markets I don’t understand, and that doesn’t mean I have to make a decision. I don’t have to either go long or go short the 10-year.

Although by keeping as much money as we do short, we are in effect at least making the decision that we don’t want to be long, long bonds. That doesn’t mean we think it necessarily would be smart to be short ’em, but we do not want to be long longer bonds. And I… if you told me two years ago that every move that the Fed would make in the last two years, and you told me all the other variables that would take place, and you’d ask me what the 10-year rate would have, would be at this time, I would have been very wrong. So it’s… and, you know, it’s not a game I’ve excelled at so far. I’m puzzled by it, and we’ll see where it is next year when we meet. Charlie?

Charlie Munger [04:23:24] Yeah, I think the one thing you can confidently predict is there won’t be some automatic and rational correlation between inflation and interest rates. There will be weird diversions.

Warren Buffett [04:23:35] Do you want to elaborate on how these weird things will manifest in them?

Charlie Munger [04:23:41] No, no. I know… all I know is it happens, yeah, frequently. Very surprising.

Warren Buffett [04:23:46] Well, it surprised us on this so far, haven’t it? Sure. Yeah. Number 6.

[04:23:51] Shareholder (Glenn Tongue, New York City): Hi. Glenn Tongue from New York City. I hope this does not overstate your ground rules. I’ve read what you have written about finance reinsurance in the annual report. There’s been much erroneous stuff written recently about finance, finite reinsurance. Can you simply explain the product and it’s important in its importance to Berkshire?

Warren Buffett [04:24:12] Yeah, well, it’s a good question, because the term has been used, finite reinsurance, and, you know, basically almost all insurance is finite. I mean, if you have a $200,000 home owners policy, or if you have 100/300 auto liability, that’s a finite policy. The insurance company will pay you that much and pay you no more. And with the exception of workers comp, and maybe there’s a something else I’m forgetting about, but basically all insurances is denied with a limit. At $500 million we wrote on that airport, I mean, we can lose $500 million, but I don’t think we can lose $501 million. And so the… I think the term finite has gotten, it’s gotten to be convenient to use without anybody totally describing it.

Well, I actually, when the SEC sent out its first request for information, I think they called it non-traditional insurance, and I think that may be a better term to use in terms of what’s being looked at. And there’s nothing wrong, I mean, there’s nothing wrong at all with finite insurance. We’re issuing finite insurance policies every day at our, on our auto policies and everything else. And there’s nothing wrong, in my view, at all with retroactive contracts. For example, we wrote a few years back, we wrote a… and this is very rough, but it’s been in the press, so that I’m not violating any confidences of clients. We wrote a contract, as I remember, and I may be just a little off on this, that to pay, when INA was being sold to ACE, we, to pay $2.5 billion of claims from the past, and I think we got a premium around $1.25 billion on it.

Now, we were making a, an estimate or a guess as to whether the whole $2.5 billion would be paid, how fast it would be paid, in a lot of things. And ACE, on the other hand, was getting rid of $2.5 billion of potential liabilities, and they did not have the capital strength of Berkshire. And that contract went before the Pennsylvania Insurance Department. It was approved. I mean, it had value to both parties. It had, you can argue, to add value to the public, and that Berkshire was a stronger insurer.

Actually, in the first quarter of last year, in our 10-Q, you will see that we recorded a loss of $100 million because the payment pattern on that contract turned out to be faster than we anticipated. I mean, there was risk involved, but it was all retroactive, and a perfectly proper contract in my view, or I think anybody’s view. And we would do more of that business. In fact, we looked at a very, very big one here recently.

What I think the… and understandably, the authorities are looking for is that, contracts that had no purpose and that were possibly misused by some party in accounting, and the facts on that remain to be seen. But I think calling it finite, it just isn’t the right descriptive, right descriptive word. I think that, like I say, non-traditional, we can have a lot of knowledge, we issue non-traditional products all the time. I mean, I talked last year about the billion-dollar thing for PepsiCo. It certainly isn’t traditional, but it’s real insurance. And the question is whether risk is transferred.

But the risk on the ACE contract, for example, was several. One is we had a risk as to whether the whole $2.5 billion would be paid. Second was how fast it would be paid. And the third risk is what you can do with the money in between, and money hasn’t been worth very much to us lately. So there was risk in that, and that’s what insurance is all about. Charlie?

Charlie Munger [04:28:32] Well, I certainly agree with you about the word final, about the word finite reinsurance. It’s, it absolutely… you could hardly not invent a worse word to use to describe a new class of insurance. It’s just a meaningless rubric. And of course non-traditional is imperfect too, because we have traditionally issued non-traditional insurance. And but we have to use some words to describe what’s happening. There’s no question about the fact that the corporate world has gotten more and more interested over the last 10 years in having regularity and earnings reports, and they’ve turned to a huge variety of ways to try and do that, and reinsurance is a very minor part of the whole picture. But there has been more more reinsurance sought because people were more anti-volatility in terms of reported results.

Warren Buffett [04:29:36] But of course insurance is a way to reduce volatility in a perfectly proper way. I mean, if you pay $1,000 a year on your auto and premiums for the next 30 years, it isn’t… you are going to have a income stream then if you wait and have one $125,000 accident one year and don’t pay the premiums in the other, means in the other years. I mean, people have bought insurance to reduce the volatility in their own personal results, in their own business results. So reducing volatility per se is not… it’s not bad at all. It’s the reason they’re $400 billion worth of insurance premiums paid in this country every year. But that doesn’t… you know, you can also get into abuses of that, and that’s what the people are looking to find and see what the real situation is. Number 7.

[04:30:35] Shareholder (Aki Progakis, Montreal, Canada): Well, it’s more, it’s more nerve-wracking than I thought it would be. Hello, Warren, Charlie. My name is Aki Progakis. I’m from Montreal, Canada. Warren, I wrote a letter back in January, I wrote a letter to you recommending a beautiful Canadian retail company, in which I described my analysis to you. I’d like to thank you for taking the time to respond to me. You said some nice kind words that meant a lot to me, and I think you’re an amazing individual. My question, simple: what is the single most difficult decision you’ve had to make in your lifetime, whether it be business or personal?

Warren Buffett [04:31:20] I think I’m going to let Charlie answer that one first.

Charlie Munger [04:31:25] Yeah, I would argue that that may be one that you shouldn’t ask. (Laughter) (Applause) Or let’s put it this way: I think you should answer it with several interesting examples before you ask us to answer.

Warren Buffett [04:31:43] That’s a little dirty. It’s interesting, as Charlie was talking, I haven’t… I can’t think of a lot of difficult… I think of a lot of wrong decisions I’ve made, but I certainly can’t think of, I can’t think of anything I agonized over making for any long period of time. Like I say, that isn’t, you know, you… I mean, it’s calling balls and strikes. I mean, you gotta, you got a second there, and that if you don’t do it, that, you know, you’re no longer an umpire. So I, I made, I made plenty of wrong decisions. I’m gonna make plenty more. That, that’s just part of living. But I don’t think in terms of being difficult as measured by the time it took me to do it, or the… not a lot of them popped to mind, and if they do, I’ll probably give you the same answer. Surely. Charlie, have you thought of any more there while we’re talking?

Charlie Munger [04:32:49] Let’s go on to another.

Warren Buffett [04:32:52] Okay. That was not a bad decision. Number 8. But thank you.

[04:32:57] Shareholder (Frank Lindgren, Philadelphia): Good afternoon. My name is Frank Lindgren. I’m from Philadelphia, and I’m interested in real estate. You’ve already covered many different areas today about real estate, such as the real estate bubble, the long-run performance most people have obtained in their personal holdings of real estate, the GSEs, the REITs. But one of the things that appears in today’s newspaper is quoting Mr. Buffett about building a brokerage powerhouse, and that seems to say that you envision changes in the way in which people buy and sell their houses and other kinds of related things. So I was wondering if you could tell me a little bit more about that area of where you envisioned Berkshire Hathaway going.

Warren Buffett [04:33:48] Yeah, I’ll be glad to. But the… we are hoping to build a powerhouse that built very much on the model of today. In other words, we do not envision big changes in residential real estate brokerage, which is what we’re in. We, as we put in… they talk about sides in real estate, the buy side and the south side. We participated in sides the total $50-odd billion last year, and we are the second largest residential real estate brokerage firm in the country. But we expect that business really to be conducted quite similarly in the future to how it has been in the past.

Now, there are people who disagree with that and think way more will happen by the internet. But, you know, the purchase of a home, as a single most important transaction for most people in their lifetimes, it’s… it can be partly emotional, it’s partly something that they appreciate people guiding them through. It’s something where I think one-on-one will be very important in the future, as it has been so far. And in this country there are going to be millions and millions and millions of homes that get sold every year, just in terms of people moving and dying and moving up in their economic potential. So there will… the real estate brokerage business is going to be a very, very big business, and I think it will tend to be a very local business.

And we have bought leading local firms in a number of markets, and they have retained their individual identity. We have not gone for a Century 21 or something approach, where we put them all under the umbrella of a single brand. Rather, we have these individual brands in given communities, and they’re usually very strong brands in each community. But we’ve only scratched the surface, and I would expect… it has nothing to do with the potential for real estate or anything. It just relates to the fact that tens and tens and tens of millions of people own their own homes, and some are going to move around every year, and there’s… I think that they’re going to continue to have a real estate broker involved in most of the transactions.

And we would like to be very big in that business. We already are big, but we’re going to… I would think it’s almost certain that we will be a lot bigger in that business five or 10 years from now. I mean, a lot bigger than we are now. And it’s a question of acquiring these firms. Generally they’re, you know, they’re proprietorships, they’re owned by a single individual or a family, and they come up periodically because of the family circumstances, at the individual circumstances of somebody. But there’s a lot of them out there, and we’re a logical buyer, and we’ve been found to be a good owner. So I think it’s going to be a good size field for us over time. Charlie?

Charlie Munger [04:36:56] Yeah, we’ve voted by buying the brokerage operation instead of the real estate. Obviously, we regard it as having better economics than the underlying real estate, which Berkshire could buy.

Warren Buffett [04:37:11] Number 9.

[04:37:11] Shareholder (Martin White, London): Hello. My name is Martin White. I’m in the insurance business in London, and quite separately, together with other volunteers, I also helped to run the only independent lobby group for private shareholders in the UK. I would like to ask you your thoughts on two aspects of worldwide solvency and how assets and liabilities are recognized in everyone’s accounts. I suppose both are about whether the regulators have the bottle to do the right thing in spite of possible complaints from companies. One aspect is about how insurance liabilities and assets are valued for solvency purposes and the discussions that are going on to develop new accounting standards worldwide. The other aspect is about derivatives, the potential weapons of financial mass destruction.

For those derivatives which don’t have quotes, I suspect we could find out how big a black hole there might be if the regulators around the world required everyone to report at the same date, for each derivative they have, their current recognized asset or negative asset, and most importantly, who the counterparty was. So the regulators, sharing information collected from both sides, could see what the worldwide aggregate misstatement was. On insurance solvency, if we started with a fair attempt at mean discounted liabilities and then added a large chunk for safety, and for reinsurance assets did the same, discounted, but this time the safety chunk was deducted, life would be a lot simpler, and there will be a lot more consistency, and I suspect safety, than under the current undiscounted regime. I think both problems need regulatory attention. What are your thoughts?

Warren Buffett [04:39:12] Well, on the subject of discounting reserves, which essentially means taking what you expect to pay in the future and then taking in the appropriate interest rate and carrying it some lower figure now, because you don’t have to pay now but later, I can certainly make the purest argument, the argument of the purest, for the fact that that might be the most accurate way, and certainly, of course, in the life insurance field that is prevalent. But I would say there has been such a tendency of managements to understate reserves worldwide, and in some cases by extraordinary amounts, that I think anything that pushes in the direction of carrying those reserves at even lower amounts, and I realize you stuck in that part about the healthy bumping of them too, but I think anything that, the any accounting that lets, gives people a rationale we’re making reserves even lower than they have been, unbalanced, is dangerous.

That, there is such a tendency on what they call long-tail business, or business where you don’t expect to actually make the payments for a few years or more, I think there’s such a tendency to view those with optimism, particularly when somebody’s going to retire in a couple years, or their options are about to run out, or whatever it may be, that I don’t like giving them the ac extra leeway of discounting on top of that. The derivatives question you raise is really interesting, but it would be mind-boggling in to implement.

I mean, it’s always fascinating to me how people can write a derivative contract, you know, and both sides of it, the trader will be perhaps at least showing a profit on it, you know, by the end of the month or something of the sort. That, now usually the contracts aren’t that precisely matched, because they, you have all kinds of other contracts that bear on the one you’re doing. But I would say that the trader’s estimate, and maybe the auditor’s estimate, of the value of all derivatives contracts outstanding in the world would end up with a quite a large positive sum for something that essentially will wash out as a zero sum.

And I can tell you, from the fact that I inherited a book of 23,000 contracts, that’s far, far, far from the largest or the second largest or the third largest in the world, and the complexity of those contracts and the complexity of unwinding them now, where we’re three years into it, and we’ve done an awful lot of it, but we’ve been operating in a benign environment. I don’t think, I don’t think any regulator, and I’m not sure any auditor, when you get up to really extensive derivative books, in effect can get their minds around evaluation.

I know that, you know, as I pointed out in our report, ours were supposedly marked to market, and people think of that as something that you just go out and hit bids, and, you know, within a few days wind up something. And if you’re trading government bonds, you know, you can do that, and if you’re trading actually active equities, you can do it. But when you start trading derivatives, it’s unbelievable what you can find, and I’ve had a couple of experiences with them. Charlie, what are your thoughts?

Charlie Munger [04:43:08] Well, my thoughts are that stupid and dishonorable accountants allowed the genie of totally improper accounting to come out of the bottle and descend in the derivative books of the world. Once that has happened, and people have used it to create masses of assets and masses of earnings reports and bonuses and status, and so on and so on and so on, getting the genie back in the bottle is no small tasked, because you have these huge vested interests who are fighting you. And what ordinary housewife is, she puts the toast in in the morning, is thinking, my God, I’ve got to do something about derivatives? You know, so the people that are, have vested interests in the current system are powerful, and the rest of the people don’t care, and so this evil genie stays out of the bottle and does more and more mischief with each passing day. If you’re trying to fix this, you are going to have a very interesting life.

Warren Buffett [04:44:24] It’s three o’clock now. If you haven’t had enough, Charlie Rose has a show on Channel 12 tonight, on, at eight o’clock, where there’s another hour and a half of interviews he did with me and with Bill Gates and various people. So with that, I thank you all for coming. We’ll have the business meeting in 15 minutes, and I hope I see you next year. Thank you.