1990 年伯克希尔完整年报

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BERKSHIRE HATHAWAY INC. 1990 ANNUAL REPORT

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business activities. The most important of these is the property and casualty insurance BERKSHIRE HATHAWAY INC. and its subsidiaries engage in a number of diverse and reinsurance business conducted nationwide through a number of subsidiaries. Investment portfolios of insurance subsidiaries include meaningful ownership percentages of other publicly traded companies. newspaper circulated in upstate New York, and a number of Berkshire subsidiaries conduct Additionally. Berkshire Hathaway publishes the Buffalo News, a daily and Sunday substantial business activities unrelated to the insurance business. These include: the and of See's fine chocolate candy; also, manufacture and distribution of Fechheimer Bros. uniforms, of Kirby home cleaning systems encyclopedias and other reference materials; the retailing of home furnishings and the the publication and distribution of World Book retailing of fine jewelry. A savings and loan business is conducted in Pasadena, California subsidiary of Berkshire. The Scott Fetzer Financial Group, 100% owned by Berkshire, by a subsidiary of Wesco Financial Corporation, a publicly traded and 80.1% owned provides financing for buyers of World Book and Kirby products. Investment decisions and all other capital allocation decisions are made for Berkshire and Operating decisions for the various Berkshire business units are made by unit managers. its subsidiaries by Warren E. Buffett, in consultation with Charles T. Munger. Mr. Buffett is Chairman and Mr. Munger is Vice Chairman of Berkshire's Board of Directors.

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BERKSHIRE HATHAWAY INC. 1990 ANNUAL REPORT TABLE OF CONTENTS Business Activities Of The Company .................Inside Front Cover Owner-Related Business Principles... ...2 Selected Financial Data At Five Year Intervals. 4 Chairman's Letter* Appendix A: Accounting satire authored in 1936 by Ben Graham. ..22 Appendix B: later hon es ren F: Bu lur Business: .26 .28 Business Segment Data.. .39 Management's Discussion 40 ombined Financia. Statements — Unaudited - or Berkshire Business Groun • 47 Shareholder-Designated Contributions .54 Annual Report Letter - Wesco Financial Corporation... .56 Selected Financial Data For The Past Five Years .72 Common Stock Data .72 Directors and Officers of the Company Inside Back Cover copyright © 1991 By Warren E. Buffe Il Rights Reserve

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Shareholders of Berkshire Hathaway Inc. in the 1983 Annual Report. Because the material remains topical, Certain OWNER-RELATED BUSINESS PRINCIPLES were included in the Chairman's letter* to it is reproduced on this and the following page. that pertain to the manager-owner relationship: With so many new shareholders, it's appropriate to summarize the major business principles we follow shareholders as owner-partners, and of ourselves as managing partners. (Because of the size of our • Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholdings we also, are, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but, instead, view the company as a conduit through which our shareholders own the assets. the case of at least four, over 50% of family net worth is represented by holdings of Berkshire. We eat our • In line with this owner-orientation, our directors are major shareholders of Berkshire Hathaway. In own cooking. average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic • Our long-term economic goal (subject to some qualifications mentioned later) is to maximize the significance or performance of Berkshire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future - a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation. generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of • Our preference would be to reach this goal by directly owning a diversified group of businesses that similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year's capital allocation. conventional accounting, consolidated reported earnings may reveal relatively little about our true economic • Because of this two-pronged approach to business ownership and because of the limitations of performance. Charlie and 1, both as owners and managers, virtually ignore such consolidated numbers. of great importance. These figures, along with other information we will supply about the individual However, we will also report to you the earnings of each major business we control, numbers we consider businesses, should generally aid you in making judgments about them. acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under • Accounting consequences do not influence our operating or capital-allocation decisions. When that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has • We rarely use much debt and, when we do, we attempt to structure it on a long-term fixed-rate basis. penalized obligations to policyholders, depositors, lenders and the many equity holders who have committed unusually our results but it is the only behavior that leaves us comfortable, considering our fiduciary large portions of their net worth to our care. (As one of the Indianapolis "500" winners said: "To finish first, you must first finish.")

• Copyright © 1984 by Warren E. Buffett

All Rights Reserved 2

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entire businesses at control prices that ignore long-term economic consequences to our shareholders. We • A managerial "wish list" will not be filled at shareholder expense. We will not diversify by purchasing will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market. earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each • We feel noble intentions should be checked periodically against results. We test the wisdom of retaining net worth grows, it is more difficult to use retained earnings wisely. $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our applies to all forms of issuance - not only mergers or public stock offerings, but stock-for-debt swaps, stock • We will issue common stock only when we receive as much in business value as we give. This rule options, and convertible securities as well. We will not sell small portions of your company - and that is what the issuance of shares amounts to - on a basis inconsistent with the value of the entire enterprise. regardless of price, we have no interest at all in selling any good businesses that Berkshire owns, and are • You should be fully aware of one attitude Charlie and I share that hurts our financial performance: long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our will be dazzling - the advocates will be sincere - but, in the end, major additional investment in a terrible behavior (discard your least promising business at each turn) is not our style. We would rather have our industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial overall results penalized a bit than engage in it. appraising business value. Our guideline is to tell you the business facts that we would want to know if • We will be candid in our reporting to you, emphasizing the pluses and minuses important in business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when our positions were reversed. We owe you no less. Moreover, as a company with a major communications reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as • Despite our policy of candor, we will discuss our activities in marketable securities only to the extent good product or business acquisition ideas are. Therefore, we normally will not talk about our investment ideas. This ban extends even to securities we have sold (because we may purchase them again) and to stocks we are incorrectly rumored to be buying. If we deny those reports but say "no comment" on other occasions,

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BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: one of the next three years." During much of 1990's second half, we were on the road to quickly proving Last year we made a prediction: "A reduction [in Berkshire's net worth] is almost certain in at least that forecast accurate. But some strengthening in stock prices late in the year enabled us to close 1990 with net worth up by $362 million, or 73%. Over the last 26 years (that is, since present management took over) our per-share book value has grown from $19.46 to $4,612.06, or at a rate of 23.2% compounded showed little change in market value. Last year I told you that though these companies - Capital Our growth rate was lackluster in 1990 because our four major common stock holdings, in aggregate, widespread recognition of these attributes had pushed the stock prices of the four to lofty levels. The market Cities/ABC, Coca-Cola, GEICO, and Washington Post - had fine businesses and superb managements, industry developments that I will discuss later — and the price of Coca-Cola stock has increased significantly prices of the two media companies have since fallen significantly - for good reasons relating to evolutionary from enticing, were a bit more appealing than they were a year earlier. for what I also believe are good reasons. Overall, year-end 1990 prices of our "permanent four," though far record. We continue to aim for a 15% average annual gain in intrinsic value. But, as we never tire of telling Berkshire's 26-year record is meaningless in forecasting future results; so also, we hope, is the one-year you, this goal becomes ever more difficult to reach as our equity base, now $5.3 billion, increases. gains will produce an identical gain for a specific shareholder only if he eventually sells his shares at the If we do attain that 15% average, our shareholders should fare well. However, Berkshire's corporate premium to intrinsic value; if intrinsic value subsequently grows at 15% a year; and if you then sell at a same relationship to intrinsic value that existed when he bought them. For example, if you buy at a 10% no dividends are paid.) If, however, you buy at a premium and sell at a smaller premium, your results will 10% premium, your own return will correspondingly be 15% compounded. (The calculation assumes that be somewhat inferior to those achieved by the company. his period of ownership. That is why Charlie Munger, Berkshire's Vice Chairman and my partner, and I Ideally, the results of every Berkshire shareholder would closely mirror those of the company during ignoring volatility of the past two years: In 1989 intrinsic value grew less than did book value, which was hope for Berkshire to sell consistently at about intrinsic value. We prefer such steadiness to the value- amount, while the market price fell 23%. up 44%, while the market price rose 85%; in 1990 book value and intrinsic value increased by a small Berkshire's intrinsic value continues to exceed book value by a substantial margin. We can't tell you the exact differential because intrinsic value is necessarily an estimate; Charlie and I might, in fact, differ considerably more than the values at which they are carried on our books. by 10% in our appraisals. We do know, however, that we own some exceptional businesses that are worth them. Charlie and I feel free to brag about this group because we had nothing to do with developing the Much of the extra value that exists in our businesses has been created by the managers now running and provide an environment in which they can do their stuff. Having done it, they send their cash to skills they possess: These superstars just came that way. Our job is merely to identify talented managers headquarters and we face our only other task: the intelligent deployment of these funds. and her fourth birthday party last fall. Attending were other children, adoring relatives, and Beemer the My own role in operations may best be illustrated by a small tale concerning my granddaughter, Emily, Clown, a local entertainer who includes magic tricks in his act.

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wonders." Green handkerchiefs went into the box, Emily waved the wand, and Beemer removed blue ones. Beginning these, Beemer asked Emily to help him by waving a "magic wand" over "the box of transformations, each more amazing than its predecessor, Emily was unable to contain herself. Her face Loose handkerchiefs went in and, upon a magisterial wave by Emily, emerged knotted. After four such aglow, she exulted: "Gee, I'm really good at this." And that sums up my contribution to the performance of Berkshire's business magicians - the Blumkins, the Friedman family, Mike Goldberg, the Heldmans, Chuck Huggins, Stan Lipsey and Ralph Schey. They deserve your applause. Sources of Reported Earnings amortization of Goodwill and other major purchase-price accounting adjustments are not charged against The table below shows the major sources of Berkshire's reported earnings. In this presentation, the specific businesses to which they apply, but are instead aggregated and shown separately. This procedure lets you view the earnings of our businesses as they would have been reported had we not purchased them. managers than one utilizing generally accepted accounting principles (GAAP), which require purchase-price I've explained in past reports why this form of presentation seems to us to be more useful to investors and adjustments to be made on a business-by-business basis. The total net earnings we show in the table are, of course, identical to the GAAP total in our audited financial statements. our segment earnings reported on a GAAP basis. For information on Wesco's businesses, I urge you to read Much additional information about these businesses is given on pages 39 - 46, where you also will find Charlie Munger's letter, which starts on page 56. His letter also contains the clearest and most insightful discussion of the banking industry that I have seen. (000s omitted) Berkshire's Share (after taxes and of Net Earnings Pre-Tax Earnings 1990 1989 1990 minority interests) 1989 Operating Earnings: Insurance Group: Underwriting. Buffalo News. Net Investment Income $ (26,647) $ (24,400) $ 243,599 (14,936) $ (12,259) 327,047 Fechheimer. ...• 43,954 46,047 282,613 25,981 213,642 Kirby.... ... Nebraska Furniture Mart .... 27,445 12,450 26,114 12,621 6,605 27,771 6,789 17,613 16,803 See's Candies Scott Fetzer Manufacturing Group ..•• ..•• 17,248 17,070 8,485 8,441 30,378 39,580 33,165 23,892 18,458 19,996 Wesco - other than Insurance. .•.• 12,441 34,235 20,626 World Book •••• 31,896 13,008 20,420 9,676 16,372 9,810 Amortization of Goodwill •••• Other Purchase-Price Accounting Charges.. • ... (3,476) 25,583 (76,374) (5,951) (3,387) (3,461) (3,372) (5,740) (49,726) (6,856) (27,098) (6,668) Shareholder-Designated Contributions Interest Expense*... ..•. (5,824) (42,389) Other... 482,477 58,310 23,755 (5,867) 35,782 (3,801) 12,863 (3,814) Operating Earnings. Sales of Securities. $ 516,466 33,989 393,414 370,745 299,902 $ 617,224 223,810 $ 394,093 23,348 $ 447,477 147,575 Total Earnings - All Entities *Excludes interest expense of Scott Fetzer Financial Group and Mutual Savings & Loan. 6

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These correspond to the way Charlie and I think about the business and should help you more in estimating We refer you also to pages 47 - 53, where we have rearranged Berkshire's financial data into four segments. Berkshire's intrinsic balance sheets and earnings statements for: (1) our insurance operations, with their major investment value than consolidated figures would do. Shown on these pages are positions itemized; (2) our manufacturing, publishing and retailing businesses, leaving aside certain non- operations, which are Mutual Savings and Scott Fetzer Financial; and (4) an all-other category that includes operating assets and purchase-price accounting adjustments; (3) our subsidiaries engaged in finance-type the non-operating assets (primarily marketable securities) held by the companies in segment (2), all purchase- price accounting adjustments, and various assets and debts of the Wesco and Berkshire parent companies. those shown on our GAAP statements. However, I want to emphasize that this four-category presentation If you combine the earnings and net worths of these four segments, you will derive totals matching does not fall within the purview of our auditors, who in no way bless it. "Look-Through" Earnings unqualified auditor's certificate, a naive reader might think it comparable in certitude to pi, calculated to The term "earnings" has a precise ring to it. And when an earnings figure is accompanied by an dozens of decimal places. them. Eventually truth will surface, but in the meantime a lot of money can change hands. Indeed, some In reality, however, earnings can be as pliable as putty when a charlatan heads the company reporting important American fortunes have been created by the monetization of accounting mirages. A on page 22 a previously unpublished satire on accounting practices written by Ben Graham in 1936. Alas, Funny business in accounting is not new. For connoisseurs of chicanery, I have attached as Appendix excesses similar to those he then lampooned have many times since found their way into the financial must always keep their guard up and use accounting numbers as a beginning, not an end, in their attempts statements of major American corporations and been duly certified by big-name auditors. Clearly, investors to calculate true "economic earnings" accruing to them. investments in companies ("investees") whose earnings far exceed their dividends and in which we record Berkshire's own reported earnings are misleading in a different, but important, way: We have huge our share of earnings only to the extent of the dividends we Cities/ABC, Inc. Our 17% share of the company's earnings amounted to more than $83 million last year. receive. The extreme case is Capital Yet only about $530,000 ($600,000 of dividends it paid us less some $70,000 of tax) is counted in Berkshire's our benefit but go unrecorded on our books. GAAP earnings. The residual $82 million-plus stayed with Cap Cities as retained earnings, which work for is of no importance, but their ownership and subsequent utilization is all-important. We care not whether Our perspective on such "forgotten-but-not-gone" earnings is simple: The way they are accounted for the auditors hear a tree fall in the forest; we do care who owns the tree and what's next done with it. ownership in what I regard to be the most valuable franchise in the world. (Coke also, of course, uses When Coca-Cola uses retained earnings to repurchase its shares, the company increases our percentage those funds to us in dividends, which we could then use to purchase more Coke shares. That would be retained earnings in many other value-enhancing ways.) Instead of repurchasing stock, Coca-Cola could pay a less efficient scenario: Because of taxes we would pay on dividend income, we would not be able to increase our proportionate procedure were followed, however, Berkshire would report far greater "earnings." ownership to the degree that Coke can, acting for us. If this less efficient I believe the best way to think about our earnings is in terms of "look-through" results, calculated as investees; subtract $30 million, for the incremental taxes we would have owed had that $250 million been follows: Take $250 million, which is roughly our share of the 1990 operating earnings retained by our paid to us in dividends; and add the remainder, $220 million, to our reported operating earnings of $371 million. Thus our 1990 "look-through earnings" were about $590 million. 7

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we substantially exceeded that rate but in 1991 we will fall far short of it. Our Gillette preferred has been As 1 mentioned last year; we hope to have look-through earnings grow about 15% annually. In 1990 called and we will convert it into common stock on April 1. This will reduce reported earnings by about our media earnings $35 million annually and look-through earnings by a much smaller, but still significant, amount. Additionally,

• both direct and look-through — appear sure to decline. Whatever the results, we

will post you annually on how we are doing on a look-through basis. Non-Insurance Operations Take another look at the figures on page 51, which aggregate the earnings and balance sheets of our non-insurance operations. After-tax earnings on average equity in 1990 were 51%, a result that would have placed the group about 20th on the 1989 Fortune 500. our major facilities are owned, not leased, and such small debt as these operations have is basically offset Two factors make this return even more remarkable. First, leverage did not produce it: Almost all by cash they hold. In fact, if the measurement was return on assets — a calculation that eliminates the effect of debt upon returns - our group would rank in Fortune's top ten. stations, possessing spectacular economics for all participating in them. Instead it came from a group of Equally important, our return was not earned from industries, such as cigarettes or network television businesses operating in such prosaic fields as furniture retailing, candy, vacuum cleaners, and even steel warehousing. The explanation is clear: Our extraordinary returns flow from outstanding operating managers, not fortuitous industry economics. Let's look at the larger operations: Friedman at Borsheim's. Sales were up 18%. That's both a same-stores and all-stores percentage, since • It was a poor year for retailing - particularly for big-ticket items — but someone forgot to tell Ike Borsheim's operates but one establishment. But, oh, what an establishment! We can't be sure about the fact (because most fine-jewelry retailers except for Tiffany's New York store. are privately owned) but we believe that this jewelry store does more volume than any other in the U.S., area, whose population is about 600,000. We have long had a huge percentage of greater Omaha's jewelry Borsheim's could not do nearly that well if our customers came only from the Omaha metropolitan grows dramatically. Many visit the store in person. A large number of others, however, buy through the mail business, so growth in that market is necessarily limited. But every year business from non-Midwest customers in a manner you will find interesting $20,000 range — and we then send them five to ten items meeting their specifications and from which they These customers request a jewelry selection of a certain type and value — say, emeralds in the $10,000- $1,000 to hundreds of thousands of dollars. can pick. Last year we mailed about 1,500 assortments of all kinds, carrying values ranging from under must always have been well recommended, however.) While the number of mailings in 1990 was a record, The selections are sent all over the country, some to people no one at Borsheim's has ever met. (They well our "honor-system" works: We have yet to experience a loss from customer dishonesty. Ike has been sending merchandise far and wide for decades. Misanthropes will be crushed to learn how most important item in the equation is our operating costs, which run about 18% of sales compared to 40% We attract business nationwide because we have several advantages that competitors can't match. The or so at the typical competitor. (Included in the 18% are occupancy and buying costs, which some public companies include in "cost of goods sold!") Just as Wal-Mart, with its 15% operating costs, sells at prices What works with diapers works with diamonds. that high-cost competitors can't touch and thereby constantly increases its market share, so does Borsheim's. Our low prices create huge volume that in turn allows us to carry an extraordinarily broad inventory of goods, running ten or more times the size of that at the typical fine-jewelry store. Couple our breadth a national jewelry phenomenon from an Omaha location. of selection and low prices with superb service and you can understand how Ike and his family have built 8

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And family it is. Ike's crew always includes son Alan and sons-in-law Marvin Cohn and Donald Yale. and Susie. In addition, Fran Blumkin, wife of Louie (Chairman of Nebraska Furniture Mart and Ike's And when things are busy - that's often - they are joined by Ike's wife, Roz, and his daughters, Janis afternoons, Wall Street Journal in hand. Given a family commitment like this, is it any surprise that cousin), regularly pitches in. Finally, you'll find Ike's 89-year-old mother, Rebecca, in the store most Borsheim's runs rings around competitors whose managers are thinking about how soon 5 o'clock will arrive? Ron, along with husband Louie, were setting records at The Nebraska Furniture Mart. Sales at our one-and- • While Fran Blumkin was helping the Friedman family set records at Borsheim's, her sons, Irv and believe NFM does close to double the volume of any other home furnishings store in the country. only location were $159 million, up 4% from 1989. Though again the fact can't be conclusively proved, we 15% in 1990 against about 40% for Levitz, the country's largest furniture retailer, and 25% for Circuit City The NFM formula for success parallels that of Borsheim's. First, operating costs are rock-bottom - to price well below all competitors. Indeed, major chains, knowing what they will face, steer clear of Omaha. Stores, the leading discount retailer of electronics and appliances. Second, NFM's low costs allow the business Third, the huge volume generated by our bargain prices allows us to carry the broadest selection of merchandise available anywhere. in Des Moines, which showed that NFM was Number 3 in popularity among 20 furniture retailers serving Some idea of NFM's merchandising power can be gleaned from a recent report of consumer behavior Moines, whereas our store is 130 miles away. This leaves customers driving a distance equal to that between that city. That may sound like no big deal until you consider that 19 of those retailers are located in Des Washington and Philadelphia in order to shop with us, even though they have a multitude of alternatives traditional method of opening new stores but rather by creating an irresistible magnet that employs price next door: In effect, NFM, like Borsheim's, has dramatically expanded the territory it serves — not by the and selection to pull in the crowds. Last year at the Mart there occurred an historic event: I experienced a counterrevelation. Regular readers of this report know that I have long scorned the boasts of corporate executives about synergy, In Berkshire's first synergistic explosion, NFM put a See's candy cart in the store late last year and sold deriding such claims as the last refuge of scoundrels defending foolish acquisitions. But now I know better: more candy than that moved by some of the full-fledged stores See's operates in California. This success contradicts all tenets of retailing. With the Blumkins, though, the impossible is routine. in the year. After the invasion of Kuwait, mall traffic in the West fell. Our poundage volume at Christmas • At See's, physical volume set a record in 1990 — but only barely and only because of good sales early dropped slightly, though our dollar sales were up because of a 5% price increase. retailing environment, Chuck Huggins delivered outstanding results, as he has in each of the nineteen years That increase, and better control of expenses, improved profit margins. Against the backdrop of a weak we have owned See's. Chuck's imprint on the business - a virtual fanaticism about quality and service - is visible at all of our 225 stores. operation, our store in Albuquerque was endangered: The landlord would not renew our lease, wanting us One happening in 1990 illustrates the close bond between See's and its customers. After 15 years of would have wiped out the store's profit. After extended negotiations got us nowhere, we set a date for instead to move to an inferior location in the mall and even so to pay a much higher rent. These changes closing the store. (He, too, proved susceptible to a counterrevelation.) He repeated his thanks in a newspaper ad that listed the names of all 263. The sequel: Christmas sales Chuck subsequently wrote personal letters of thanks to every loyalist and sent each a gift certificate. in Albuquerque were up substantially. 9

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• Charlie and1 were surprised at developments this past vear in the media industry, including newspapers such as our Buffalo News. The business showed far more vulnerability to the early stages of aberrational cycle — to be fully made up in the next upturn — or whether the business has slipped in a a recession than has been the case in the past. The question is whether this erosion is just part of an way that permanently reduces intrinsic business values. wil Spend deverphedes, l prote a pened, you may estion the blus of me wed retion about what I, the industry, or lenders thought would be the case only a few years ago. marvels in comparison with American industry generally, they will prove considerably less marvelous than The reason media businesses have been so outstanding in the past was not physical growth, but rather slowly. In addition, retailers that do little or no media advertising (though they sometimes use the Postal the unusual pricing power that most participants wielded. Now, however, advertising dollars are growing number of both print and electronic advertising channels has substantially increased. As a consequence, Service) have gradually taken market share in certain merchandise categories. Most important of all, the advertising dollars are more widely dispersed and the pricing power of ad vendors has diminished. These circumstances materially reduce the intrinsic value of our major media investments and also the value of our operating unit, Buffalo News - though all remain fine businesses. 1990, our earnings held up much better than those of most metropolitan papers, falling only 5%. In the Notwithstanding the problems, Stan Lipsey's management of the News continues to be superb. During last few months of the year, however, the rate of decrease was far greater. newspaper publishers; and (2) earnings will fall substantially. Despite a slowdown in the demand for I can safely make two promises about the News in 1991: (1) Stan will again rank at the top among be considerably higher. Since revenues may meanwhile be down, we face a real squeeze. newsprint, the price per ton will average significantly more in 1991 and the paper's labor costs will also from a gain in news pages. Regardless of earnings pressures, we will maintain at least a 50% news hole. Cutting product quality is not a proper response to adversity. George Heldman, at 69, has decided to retire. I tried to talk him out of it but he had one irrefutable • The news at Fechheimer, our manufacturer and retailer of uniforms, is all good with one exception: argument: With four other Heldmans - Bob, Fred, Gary and Roger - to carry on, he was leaving us with an abundance of managerial talent. encountered in integrating the large acquisition we made in 1988 were moderated or solved. However, rechheimer's operating performance improved considerably in 1990, as many of the problems we several unusual items caused the earnings reported in the "Sources" table to be flat. In the retail operation, we continue to add stores and now have 42 in 22 states. Overall, prospects appear excellent for Fechheimer. to overseeing three entities listed on page 6 — World Book, Kirby, and Scott Fetzer Manufacturing - Ralph • At Scott Fetzer, Ralph Schey runs 19 businesses with a mastery few bring to running one. In addition directs a finance operation that earned a record $12.2 million pre-tax in 1990. terms of return on equity, although it is not in businesses that one would expect to be economic champs. Were Scott Fetzer an independent company, it would rank close to the top of the Fortune 500 in The superior results are directly attributable to Ralph. ization move were considerably less in 1990 than 1989 and the benefits of decentralization are being At World Book, earnings improved on a small decrease in unit volume. The costs of our decentral- realized. World Book remains far and away the leader in United States encyclopedia sales and we are growing internationally, though from a small base. 3, which was an unqualified success. Earnings did not grow as fast as sales because of both start-up Kirby unit volume grew substantially in 1990 with the help of our new vacuum cleaner, The Generation expenditures and "learning-curve' problems we encountered in manufacturing the new product. International 10

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business, whose dramatic growth I described last year, had a further 20% sales gain in 1990. With the aid of a recent price increase, we expect excellent earnings at Kirby in 1991. fine year. This company, the country's leading producer of small and medium-sized air compressors, achieved Within the Scott Fetzer Manufacturing Group, Campbell Hausfeld, its largest unit, had a particularly record sales of $109 million, more than 30% of which came from products introduced during the last five years.

only $47 million in 1990 although earnings were $133 million. This does not mean that our managers are In looking at the figures for our non-insurance operations, you will see that net worth increased by in any way skimping on investments that strengthen their business franchises or that promote growth. Indeed, they diligently pursue both goals. funneled well over 80% of their earnings to Charlie and me for use in new business and investment But they also never deploy capital without good reason. The result: In the past five years they have opportunities. Insurance Operations insurance industry: Shown below is an updated version of our usual table presenting key figures for the property-casualty early Change in Premiums Combined Ratio Written (%) After Policyholder Yearly Change Dividends in Incurred Inflation Rate Losses (%) GNP Deflator (%) Measured by 1982 1981. 3.8 3.7 106.0 8.5 5.0 109.6 6.5 9.6 1983 112.0 16.1 16.9 6.8 8.4 6.5 1984 3.8 1985. 22.2 22.1 118.0 3.8 1986 116.3 13.5 3.0 1987 4.4 9.4 108.0 5.5 7.8 2.6 1988. 104.6 3.1 1989 (Revised)........ 4.5 3.2 109.2 105.4 5.0 7.7 3.3 1990 (Est.).............. 109.8 4.1 4.1 Source: A.M. Best Co. revenue from premiums: A ratio below 100 indicates an underwriting profit, and one above 100 indicates The combined ratio represents total insurance costs (losses incurred plus expenses) compared to a loss. The higher the ratio, the worse the year. When the investment income that an insurer earns from holding policyholders' funds ("the float") is taken into account, a combined ratio in the 107 - 111 range typically produces an overall breakeven result, exclusive of earnings on the funds provided by shareholders. average of 10% annually, even in periods when general inflation runs considerably lower. (Over the last 25 For the reasons laid out in previous reports, we expect the industry's incurred losses to grow at an years, incurred losses have in reality grown at a still faster rate, 11%.) If premium growth meanwhile reserve when business turns bad may obscure their size for a time. materially lags that 10% rate, underwriting losses will mount, though the industry's tendency to under- worsened. (In our table, however, the severity of the deterioration in 1990 is masked because the industry's Last year premium growth fell far short of the required 10% and underwriting results therefore 1989 losses from Hurricane Hugo caused the ratio for that year to be somewhat above trendline.) The combined ratio will again increase in 1991, probably by about two points. 11

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Results will improve only when most insurance managements become so fearful that they run from business, even though it can be done at much higher prices than now exist. At some point these managements will indeed get the message: The most important thing to do when you find yourself in a hole is to stop digging. But so far that point hasn't gotten across: Insurance managers continue to dig - sullenly but vigorously. such a shock, one to two years will likely pass before underwriting losses become large enough to raise The picture would change quickly if a major physical or financial catastrophe were to occur. Absent management fear to a level that would spur major price increases. When that moment arrives, Berkshire will be ready - both financially and psychologically - to write huge amounts of business. In the meantime, our insurance volume continues to be small but satisfactory. In the next section of this report we will give you a framework for evaluating insurance results. From that discussion, you will gain an understanding of why I am so enthusiastic about the performance of our insurance manager, Mike Goldberg, and his cadre of stars, Rod Eldred, Dinos lordanou, Ajit Jain, and Don Wurster. we are pursuing that could cause them to be unusually volatile. If this line of business expands, as it may, In assessing our insurance results over the next few years, you should be aware of one type of business our underwriting experience will deviate from the trendline you might expect: In most years we will somewhat exceed expectations and in an occasional year we will fall far below them. The volatility I predict reflects the fact that we have become a large seller of insurance against truly major catastrophes ("super-cats"), which could for example be hurricanes, windstorms or earthquakes. The buyers of these policies are reinsurance companies that themselves are in the business of writing catastrophe catastrophes of special severity. Because the need for these buyers to collect on such a policy will only arise coverage for primary insurers and that wish to "lay off," or rid themselves, of part of their exposure to sellers. And here we have a major competitive advantage: In the industry, our strength is unmatched. at times of extreme stress — perhaps even chaos - in the insurance business, they seek financially strong $10 million policy providing that the buyer, a reinsurer, would be paid that sum only if a catastrophe caused A typical super-cat contract is complicated. But in a plain-vanilla instance we might write a one-year, two results: (1) specific losses for the reinsurer above a threshold amount; and (2) aggregate losses for the insurance industry of, say, more than $5 billion. Under virtually all circumstances, loss levels that satisfy the second condition will also have caused the first to be met. in annual premiums of $100 million from super-cat policies of all kinds. In that case we are very likely in For this $10 million policy, we might receive a premium of, say, $3 million. Say, also, that we take that we are not spreading risk as insurers typically do; we are concentrating it. Therefore, our yearly any given year to report either a profit of close to $100 million or a loss of well over $200 million. Note combined ratio on this business will almost never fall in the industry range of 100 - 120, but will instead be close to either zero or 300%. Most insurers are financially unable to tolerate such swings. And if they have the ability to do so, they insurance that would deliver them dismal results at the very time they would be experiencing major losses often lack the desire. They may back away, for example, because they write gobs of primary property on super-cat reinsurance. In addition, most corporate managements believe that their shareholders dislike volatility in results. that Berkshire shareholders, if properly informed, can handle unusual volatility in profits so long as the We can take a different tack: Our business in primary property insurance is small and we believe swings carry with them the prospect of superior long-term results. (Charlie and I always have preferred a lumpy 15% return to a smooth 12%.) results over, say, a decade, we're sure it will produce absolutely terrible results in at least an occasional year; We want to emphasize three points: (1) While we expect our super-cat business to produce satisfactory (2) Our expectations can be based on little more than subjective judgments - for this kind of insurance, historical loss data are of very limited value to us as we decide what rates to charge today; and (3) Though we expect to write significant quantities of super-cat business, we will do so only at prices we believe to be commensurate with risk. If competitors become optimistic, our volume will fall. This insurance has, in fact, tended in recent years to be woefully underpriced; most sellers have left the field on stretchers. 12

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major quake occurs in an urban area or a winter storm rages across Europe, light a candle for us. At the moment, we believe Berkshire to be the largest U.S. writer of super-cat business. So when a Measuring Insurance Performance business, temporarily hold. Because these funds are available to be invested, the typical property-casualty In the previous section I mentioned "float," the funds of others that insurers, in the conduct of their insurer can absorb losses and expenses that exceed premiums by 7% to 11% and still be able to break even on its business. Again, this calculation excludes the earnings the insurer realizes on net worth - that is, on the funds provided by shareholders. crops from hail damage produces virtually no float at all. Premiums on this kind of business are paid to However, many exceptions to this 7% to 11% range exist. For example, insurance covering losses to almost immediately. Thus, a combined ratio of 100 for crop hail insurance produces no profit for the insurer. the insurer just prior to the time hailstorms are a threat, and if a farmer sustains a loss he will be paid accountants produces a very high amount of float compared to annual premium volume. The float At the other extreme, malpractice insurance covering the potential liabilities of doctors, lawyers and materializes because claims are often brought long after the alleged wrongdoing takes place and because other kinds of liability insurance "long-tail" business, in recognition of the extended period during which their payment may be still further delayed by lengthy litigation. The industry calls malpractice and certain lawyers as well). insurers get to hold large sums that in the end will go to claimants and their lawyers (and to the insurer's produced by the float will exceed the 15% by which claims and expenses overrun premiums. The catch, In long-tail situations a combined ratio of 115 (or even more) can prove profitable, since earnings though, is that "long-tail" means exactly that: Liability business written in a given year and presumed at when the years have rolled by and all claims have finally been settled. first to have produced a combined ratio of 115 may eventually smack the insurer with 200, 300 or worse long-tail lines may prove profitable at combined ratios of 110 or 115, insurers will invariably find it The pitfalls of this business mandate an operating principle that too often is ignored: Though certain against the societal trends that are forever springing expensive surprises on the insurance industry. Setting unprofitable to price using those ratios as targets. Instead, prices must provide a healthy margin of safety a target of 100 can itself result in heavy losses; aiming for 110 - 115 is business suicide. where a company ranks in profitability. We believe a better measure, however, to be a comparison of underwriting loss to float developed. time periods: Quarterly underwriting figures and even annual ones are too heavily based on estimates to This loss/float ratio, like any statistic used in evaluating insurance results, is meaningless over short generated by insurance operations. A low cost of funds signifies a good business; a high cost translates into be much good. But when the ratio takes in a period of years, it gives a rough indication of the cost of funds a poor business. we entered the business and relate that bottom line to the average float we have held during the year. On the next page we show the underwriting loss, if any, of our insurance group in each year since From this data we have computed a "cost of funds developed from insurance." 13

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(1) (2) Yearend Yield Underwriting (Ratio of 1 to 2) Cost of Funds Approximate LosS (In $ Millions) Average Float on Long-Term Govt. Bonds 1967.. 1969 1968. profit profit $17.3 23.4 19.9 less than zero less than zero 5.50% 1971 1970 profit less than zero 5.90% $0.37 52.5 32.4 less than zero 1.14% 6.79% 1973 1972 profit profit 6.25% 73.3 69.5 less than zero 5.81% 1974. profit less than zero 5.82% 1976.. 1975 11.35 7.36 79.1 12.96% 9.30% 7.27% profit profit 102.6 87.6 8.13% less than zero less than zero 8.03% 1977.. 1979 1978. 139.0 10.08% 8.93% 7.97% 7.30% profit profit 227.3 190.4 less than zero 1981 1980 profit profit 237.0 less than zero less than zero 1983. 1982 21.56 228.4 less than zero 11.94% 33.87 220.6 14.64% 9.77% 10.64% 13.61% 1985 1984 48.06 231.3 55.84 44.23 253.2 18.98% 11.84% 1986 390.2 11.34% 11.58% 1988 1987 55.43 797.5 7.00% 9.34% 24.40 11.08 1,266.7 4.38% 8.95% 7.60% 1989 1,497.7 1990 26.65 1,615.9 1,541.3 0.74% 1.65% 1.58% 9.00% 7.97% 8.24% unearned premium reserves minus agents' balances, prepaid acquisition costs and deferred charges applicable The float figures are derived from the total of loss reserves, loss adjustment expense reserves and to assumed reinsurance. At some insurers other items should enter into the calculation, but in our case these are unimportant and have been ignored. others. The underwriting loss we sustained during the year was $27 million and thus our insurance operation During 1990 we held about $1.6 billion of float slated eventually to find its way into the hands of produced funds for us at a cost of about 16%. As the table shows, we managed in some years to 1984, we paid a very high price for float. In 19 years out of the 24 we have been in insurance, though, we underwrite at a profit and in those instances our cost of funds was less than zero. In other years, such as have developed funds at a cost below that paid by the government. ing, and we won't know our true 1967 - 1990 cost of tunds until all losses from this period have beel 'here are two important qualifications to this calculation. First, the fat ladv has vet to gargle, let alon settled many decades from now. Second, the value of the float to shareholders is somewhat undercut by the fact that they must put up their own funds to support the insurance operation and are subject to double taxation on the investment income these funds earn. Direct investments would be more tax-efficient. calculation is necessarily imprecise, I would estimate that the owners of the average insurance company The tax penalty that indirect investments impose on shareholders is in fact substantial. Though the approximates the correct figure for Berkshire. would find the tax penalty adds about one percentage point to their cost of float. I also think that operation has a positive or negative value for shareholders. If this cost (including the tax penalty) is higher Figuring a cost of funds for an insurance business allows anyone analyzing it to determine whether the 14

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than that applying to alternative sources of funds, the value is negative. If the cost is lower, the value is positive — and if the cost is significantly lower, the insurance business qualifies as a very valuable asset. GEICO, in which our ownership interest is now 48% and which customarily operates at an underwriting So far Berkshire has fallen into the significantly-lower camp. Even more dramatic are the numbers at profit. GEICO's growth has generated an ever-larger amount of funds for investment that have an effective cost of considerably less than zero. Essentially, GEICO's policyholders, in aggregate, pay the company interest on the float rather than the other way around. (But handsome is as handsome does: GEICO's unusual that in turn allows rock-bottom prices for policyholders.) profitability results from its extraordinary operating efficiency and its careful classification of risks, a package combined with the tax penalty, produces negative results for owners. In addition, these companies, like all Many well-known insurance companies, on the other hand, incur an underwriting loss/float cost that, others in the industry, are vulnerable to catastrophe losses that could exceed their reinsurance protection and take their cost of float right off the chart. Unless these companies can materially improve their underwriting performance - and history indicates that is an almost impossible task - their shareholders on deposits than it receives on loans. will experience results similar to those borne by the owners of a bank that pays a higher rate of interest on the average is reasonable, and we have further prospered because we have earned good returns on these All in all, the insurance business has treated us very well. We have expanded our float at a cost that low-cost funds. Our shareholders, true, have incurred extra taxes, but they have been more than compensated mistakes made by your Chairman prior to Mike Goldberg's arrival. Insurance offers a host of opportunities A particularly encouraging point about our record is that it was achieved despite some colossal for error, and when opportunity knocked, too often I answered. Many years later, the bills keep arriving for these mistakes: In the insurance business, there is no statute of limitations on stupidity. value of, say, our candy or newspaper companies. By any measure, however, the business is worth far more The intrinsic value of our insurance business will always be far more difficult to calculate than the than its carrying value. Furthermore, despite the problems this operation periodically hands us, it is the one - among all the fine businesses we own - that has the greatest potential. Marketable Securities these investments belongs to subsidiaries of which Berkshire owns less than 100%. Below we list our common stock holdings having a value of over $100 million. A small portion of Shares Company Cost 12/31/90 Market 46,700,000 3,000,000 The Coca-Cola Co. Capital Cities/ABC, Inc... $ 517,500 (000s omitted) $1,377,375 2,400,000 6,850,000 Federal Home Loan Mortgage Corp. 1,023,920 2,171,550 5,000,000 1,727,765 The Washington Post Company GEICO Corp. ....... 45,713 71,729 1,110,556 117,000 9,731 Wells Fargo & Company • 289,431 342,097 289,375 Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither in 1989, the rest in 1990. in this industry - mistakes that involve only a small portion of assets can destroy a major portion of equity. The banking business is no favorite of ours. When assets are twenty times equity — a common ratio 15

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a managerial failing that we described last year when discussing the "institutional imperative:" the tendency And mistakes have been the rule rather than the exception at many major banks. Most have resulted from of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. a lemming-like fate. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing Because leverage of 20:1 interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in magnifies the effects of managerial strengths and weaknesses, we have no buying into well-managed banks at fair prices. Paul Hazen. In many ways the combination of Carl and Paul reminds me of another - Tom Murphy and With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas ). Watson Sr. of IBM followed the same rule: "I'm no genius," he said. "I'm smart in spots - but I stay around those spots!") was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided public display. As one huge loss after another was unveiled - often on the heels of managerial assurances five times after-tax earnings, and less than three times pre-tax earnings. by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than and 1.25% on assets. Our purchase of one-tenth of the bank may be thought of as roughly equivalent to Wells Fargo is big — it has $56 billion in assets - and has been earning more than 20% on equity a purchase, we would have to pay about twice the $290 million we paid for Wells Fargo. Moreover, that $5 our buying 100% of a $5 billion bank with identical financial characteristics. But were we to make such to find a Carl Reichardt to run it. In recent years, Wells Fargo executives have been more avidly recruited billion bank, commanding a premium price, would present us with another problem: We would not be able than any others in the banking business; no one, however, has been able to hire the dean. face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn Of course, ownership of a bank — or about any other business - is far from riskless. California banks or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable. low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed None of these eventualities can be ruled out. The probability of the first two occurring, however, is institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans — not interest) averaging 30% of principal, the company would roughly break even. distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that A year like that — which we consider only a low-level possibility, not a likelihood - would not Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused produced no return for a year, but that could then be expected to earn 20% on growing equity. the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices. similar attitude toward market fluctuations; instead many illogically become euphoric when stock prices Investors who expect to be ongoing buyers of investments throughout their lifetimes should adopt a 16

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they are forever going to be buyers of food, they welcome falling prices and deplore price increases. (It's rise and unhappy when they fall. They show no such confusion in their reaction to food prices: Knowing the seller of food who doesn't like declining prices.) Similarly, at the Buffalo News we would cheer lower we always keep on hand - because we know we are going to be perpetually buying the product. prices for newsprint - even though it would mean marking down the value of the large inventory of newsprint or small parts of businesses, called stocks — year in, year out as long as I live (and longer, if Berkshire's Identical reasoning guides our thinking about Berkshire's investments. We will be buying businesses — directors attend the seances I have scheduled). Given these intentions, declining prices for businesses benefit us, and rising prices hurt us. a company or industry. We want to do business in such an environment, not because we like pessimism The most common cause of low prices is pessimism - some times pervasive, some times specific to but because we like the prices it produces. It's optimism that is the enemy of the rational buyer. unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy. What's required is thinking None of this means, however, that a business or stock is an intelligent purchase simply because it is rather than polling. Unfortunately, Bertrand Russell's observation about life in general applies with unusual force in the financial world: "Most men would rather die than think. Many do."

securities that we first bought in late 1989. At yearend 1990 we had $440 million invested in these securities, Our other major portfolio change last year was large additions to our holdings of RJR Nabisco bonds, than $150 million.) an amount that approximated market value. (As I write this, however, their market value has risen by more bonds. But opportunities that interest us and that are also large enough to have a worthwhile impact on Just as buying into the banking business is unusual for us, so is the purchase of below-investment-grade the business we're buying into and believe that price and value may differ significantly. (Woody Allen, in Berkshire's results are rare. Therefore, we will look at any category of investment, so long as we understand bi-sexual because it doubles your chances for a date on Saturday night.") another context, pointed out the advantage of open-mindedness: "I can't understand why more people aren't old-fashioned "fallen angels" - bonds that were initially of investment grade but that were downgraded In the past we have bought a few below-investment-grade bonds with success, though these were all when the issuers fell on bad times. In the 1984 annual report we described our rationale for buying one fallen angel, the Washington Public Power Supply System. were far below investment-grade when issued. As the decade progressed, new offerings of manufactured A kind of bastardized fallen angel burst onto the investment scene in the 1980s - "junk bonds' that name. In 1990 — even before the recession dealt its blows - the financial sky became dark with the bodies junk became ever junkier and ultimately the predictable outcome occurred: Junk bonds lived up to their of failing corporations. cause operating managers to focus their efforts as never before, much as a dagger mounted on the steering The disciples of debt assured us that this collapse wouldn't happen: Huge debt, we were told, would such an attention-getter would produce a very alert driver. But another certain consequence would be a wheel of a car could be expected to make its driver proceed with intensified care. We'll acknowledge that deadly - and unnecessary - accident if the car hit even the tiniest pothole or sliver of ice. The roads of business are riddled with potholes; a plan that requires dodging them all is a plan for disaster. "Confronted with a challenge to distill the secret of sound investment into three words, we venture the In the final chapter of The Intelligent Investor Ben Graham forcefully rejected the dagger thesis: The failure of investors to heed this simple message caused them staggering losses as the 1990s began. motto, Margin of Safety." Forty-two years after reading that, I still think those are the right three words. cases, so much debt was issued that even highly favorable business results could not produce the funds At the height of the debt mania, capital structures were concocted that guaranteed failure: In some to service it. One particularly egregious "kill-'em-at-birth" case a few years back involved the purchase of 17

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a mature television station in Tampa, bought with so much debt that the interest on it exceeded the station's gross revenues. Even if you assume that all labor, programs and services were donated rather than purchased, this capital structure required revenues to explode — or else the station was doomed to go broke. (Many of the bonds that financed the purchase were sold to now-failed savings and loan associations; as a taxpayer, you are picking up the tab for this folly.) bankers pointed to the "scholarly" research of academics, which reported that over the years the higher All of this seems impossible now. When these misdeeds were done, however, dagger-selling investment interest rates received from low-grade bonds had more than compensated for their higher rate of default. than would a portfolio of high-grade bonds. (Beware of past-performance "proofs" in finance: If history books Thus, said the friendly salesmen, a diversified portfolio of junk bonds would produce greater net returns were the key to riches, the Forbes 400 would consist of librarians.) recognize. An assumption was being made that the universe of newly-minted junk bonds was identical to There was a flaw in the salesmen's logic - one that a first-year student in statistics is taught to the universe of low-grade fallen angels and that, therefore, the default experience of the latter group was the historical death rate from Kool-Aid before drinking the version served at jonestown.) meaningful in predicting the default experience of the new issues. (That was an error similar to checking angel almost invariably yearned to regain investment-grade status and worked toward that goal. The junk- The universes were of course dissimilar in several vital respects. For openers, the manager of a fallen bond operator was usually an entirely different breed. Behaving much as a heroin user might, he devoted his energies not to finding a cure for his debt-ridden condition, but rather to finding another fix. not always, more finely developed than were those of the junk-bond-issuing financiopath. Additionally, the fiduciary sensitivities of the executives managing the typical fallen angel were often, though proportional not to its merit, but rather to the revenue it would produce. Mountains of junk bonds were Wall Street cared little for such distinctions. As usual, the Street's enthusiasm for an idea was sold by those who didn't care to those who didn't think - and there was no shortage of either. As we said last year, we have never bought a new issue of a junk bond. (The only time to buy these is Junk bonds remain a mine field, even at prices that today are often a small fraction of issue price. on a day with no "y" in it.) We are, however, willing to look at the field, now that it is in disarray. In the case of RJR Nabisco, we feel the Company's credit is considerably better than was generally compensates for the risk we incur (though that is far from nil). RJR has made asset sales at favorable perceived for a while and that the yield we receive, as well as the potential for capital gain, more than prices, has added major amounts of equity, and in general is being run well. Wall Street of the 1980s is even worse than we had thought: Many important businesses have been However, as we survey the field, most low-grade bonds still look unattractive. The handiwork of the mortally wounded. We will, though, keep looking for opportunities as the junk market continues to unravel. Convertible Preferred Stocks Salomon Inc, $600 million of The Gillette Company, $358 million of USAir Group, Inc. and $300 million We continue to hold the convertible preferred stocks described in earlier reports: $700 million of of Champion International Corp. Our Gillette holdings will be converted into 12 million shares of common assess our holdings in Salomon and Champion at yearend 1990 as worth about what we paid, Gillette as stock on April 1. Weighing interest rates, credit quality and prices of the related common stocks, we can worth somewhat more, and USAir as worth substantially less. at almost the exact moment that it ran into severe problems. (No one pushed me; in tennis parlance, I In making the USAir purchase, your Chairman displayed exquisite timing: I plunged into the business by the post-merger difficulties it encountered in integrating Piedmont, an affliction I should have expected committed an "unforced error") The company's troubles were brought on both by industry conditions and since almost all airline mergers have been followed by operational turmoil. 18

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excellent marks for service. Industry-wide problems have proved to be far more serious. Since our purchase, In short order, Ed Colodny and Seth Schofield resolved the second problem: The airline now gets the economics of the airline industry have deteriorated at an alarming pace, accelerated by the kamikaze pricing tactics of certain carriers. The trouble this pricing has produced for all carriers illustrates an important truth: In a business selling a commodity-type product, it's impossible to be a lot smarter than your dumbest competitor. work out all right. Ed and Seth have decisively addressed the current turbulence by making major changes However, unless the industry is decimated during the next few years, our USAir investment should in operations. Even so, our investment is now less secure than at the time I made it. is any guide, you may from time to time read inaccurate or misleading statements about them. Last year, Our convertible preferred stocks are relatively simple securities, yet I should warn you that, if the past for example, several members of the press calculated the value of all our preferreds as equal to that of the common stock into which they are convertible. By their logic, that is, our Salomon preferred, convertible there is a small problem with this line of reasoning: Using it, one must conclude that all of the value of into common at $38, would be worth 60% of face value if Salomon common were selling at $22.80. But a convertible preferred resides in the conversion privilege and that the value of a non-convertible preferred of Salomon would be zero, no matter what its coupon or terms for redemption. from their fixed-income characteristics. That means the securities cannot be worth less than the value they The point you should keep in mind is that most of the value of our convertible preferreds is derived would possess as non-convertible preferreds and may be worth more because of their conversion options. *** * * * *

]r., CEO of Gillette, who died in January. No description better fitted Colman than "gentleman" — a word I deeply regret having to end this section of the report with a note about my friend, Colman Mockler, signifying integrity, courage and modesty. Couple these qualities with the humor and exceptional business him and why I, and all others who knew him, will miss Colman so much. ability that Colman possessed and you can understand why I thought it an undiluted pleasure to work with simple: The company's success in shaving products has come not from marketing savvy (though it exhibits A few days before Colman died, Gillette was richly praised in a Forbes cover story. Its theme was that talent repeatedly) but has instead resulted from its devotion to quality. This mind-set has caused it to ranked as the class of the field. In so depicting Gillette, Forbes in fact painted a portrait of Colman. consistently focus its energies on coming up with something better, even though its existing products already Help! Help! for Berkshire. And, as we constantly preach at the Buffalo News, advertising does work: Several businesses Regular readers know that I shamelessly utilize the annual letter in an attempt to acquire businesses have knocked on our door because someone has read in these pages of our interest in making acquisitions. (Any good ad salesman will tell you that trying to sell something without advertising is like winking at a girl in the dark.) the owner/manager of a desirable business. If you have no personal connection with a business that might In Appendix B (on pages 26 - 27) I've reproduced the essence of a letter I wrote a few years back to be of interest to us but have a friend who does, perhaps you can pass this report along to him. Here's the sort of business we are looking for: (1) Large purchases (at least $10 million of after-tax earnings), "turnaround" situations), Demonstrated consistent earning power (future projections are of little interest to us, nor are (3) Businesses earning good returns on equity while employing little or no debt, 19

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(4) Management in place (we can't supply it), (5). Simple businesses (if there's lots of technology, we won't understand it, 16) preliminarily, about a transaction when price is unknown). An offering price (we don't want to waste our time or that of the seller by talking, even answer — customarily within five minutes — as to whether we're interested. We preter to buy for cash, but We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast Will consider issuing stock when we receive as much in intrinsic business value as we give. the company's owner-managers wish to generate significant amounts of cash, sometimes for themselves, Our favorite form of purchase is one fitting the Blumkin-Friedman-Heldman mold. In cases like these, but often for their families or inactive shareholders. significant owners who continue to run their companies just as they have in the past. We think we offer At the same time, these managers wish to remain contacting people with whom we have done business in the past. a particularly good fit for owners with such objectives. We invite potential sellers to check us out by We've found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you Charlie and I frequently get approached about acquisitions that don't come close to meeting our tests: their cocker spaniels. A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: "When the phone don't ring, you'll know it's me." Besides being interested in the purchase of businesses as described above, we the negotiated purchase of large, but not controlling, blocks of stock comparable to those we hold in Capital are also interested in Cities, Salomon, Gillette, USAir, and Champion. We are not interested, however, in receiving suggestions about purchases we might make in the general stock market. Miscellaneous have no mandatory retirement age for directors at Berkshire (and won't!), but Ken, at 75 and living in Ken Chace has decided not to stand for reelection as a director at our upcoming annual meeting. We Maine, simply decided to cut back his activities. control of Berkshire early in 1965. Although I made an economic mistake in sticking with the textile Ken was my immediate choice to run the textile operation after Buffett Partnership, Ltd. assumed business, I made no mistake in choosing Ken: He ran the operation well, he was always 100% straight with me about its problems, and he generated the funds that allowed us to diversify into insurance. Berkshire and if she outlives me will inherit all of my stock and, effectively, control the company. She knows, My wife, Susan, will be nominated to succeed Ken. She is now the second largest shareholder of and agrees, with my thoughts on successor management and also shares my view that neither Berkshire is received for one or all. nor its subsidiary businesses and important investments should be sold simply because some very high bid which, it should be added, is excellent - and I have planned accordingly. Neither my estate plan nor that I feel strongly that the fate of our businesses and their managers should not depend on my health - of my wife is designed to preserve the family fortune; instead, both are aimed at preserving the character of Berkshire and returning the fortune to society. sold; (2) Both a controlling shareholder and a manager with philosophies similar to mine would follow Were I to die tomorrow, you could be sure of three things: (1) None of my stock would have to be sell our corporate jet, The Indefensible (ignoring my wish that it be buried with me). me; and (3) Berkshire's earnings would increase by $1 million annually, since Charlie would immediately

program. Contributions made through the program were $5.8 million, and 2,600 charities were recipients. About 97.3% of all eligible shares participated in Berkshire's 1990 shareholder-designated contributions 20

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program that appears on pages 54 - 55. To participate in future programs, you must make sure your We suggest that new shareholders read the description of our shareholder-designated contributions shares are registered in the name of the actual owner, not in the nominee name of a broker, bank or depository. Shares not so registered on August 31, 1991 will be ineligible for the 1991 program. operating businesses make contributions, including merchandise, averaging about $1.5 million annually. In addition to the shareholder-designated contributions that Berkshire distributes, managers of our These contributions support local charities, such as The United Way, and produce roughly commensurate benefits for our businesses. make contributions to broad national programs or charitable activities of special personal interest to them, However, neither our operating managers nor officers of the parent company use Berkshire funds to their alma maters or other institutions to which they feel a personal attachment, we believe they should except to the extent they do so as shareholders. If your employees, including your CEO, wish to give to use their own money, not yours. *****+* on Monday, April 29, 1991. Attendance last year grew to a record 1,300, about a 100-fold increase from The annual meeting this year will be held at the Orpheum Theater in downtown Omaha at 9:30 a.m. ten years ago. Tower, a small (88 rooms) but nice hotel across the street from the Orpheum; (2) the much larger Red We recommend getting your hotel reservations early at one of these hotels: (1) The Radisson-Redick Omaha about 100 yards from Borsheim's and a twenty minute drive from downtown. We will have buses Lion Hotel, located about a five-minute walk from the Orpheum; or (3) the Marriott, located in West at the Marriott that will leave at 8:30 and 8:45 for the meeting, and return after it ends. is reflected in the quality of the questions we get: We have never attended an annual meeting anywhere Charlie and I always enjoy the meeting, and we hope you can make it. The quality of our shareholders that features such a consistently high level of intelligent, owner-related questions. to the meeting. Because weekday parking can be tight around the Orpheum, we have lined up a number An attachment to our proxy material explains how you can obtain the card you will need for admission of nearby lots for our shareholders to use. The attachment also contains information about them. and to take you to downtown hotels or to the airport later. I hope that you will allow plenty of time to As usual, we will have buses to take you to Nebraska Furniture Mart and Borsheim's after the meeting fully explore the attractions of both stores. Those of you arriving early can visit the Furniture Mart any Sundays. While there, stop at the See's Candy cart and see for yourself the dawn of synergism at Berkshire. day of the week; it is open from 10 a.m. to 5:30 p.m. on Saturdays, and from noon to 5:30 p.m. on Borsheim's normally is closed on Sunday, but we will open for shareholders and their guests from noon the day's volume, he suggested to me that we start holding annual meetings quarterly. Join us at Borsheim's to 6 p.m. on Sunday, April 28. At our Sunday opening last year you made Ike very happy: After totaling even if you just come to watch; it's a show you shouldn't miss. generation shareholder from New York City. Nicholas plays rough: "How come the stock is down?" he Last year the first question at the annual meeting was asked by 11-year-old Nicholas Kenner, a third- fired at me. My answer was not memorable. attends, he will be offered the chance to again ask the first question; Charlie and I want to tackle him while We hope that other business engagements won't keep Nicholas away from this year's meeting. If he we're fresh. This year, however, it's Charlie's turn to answer. Warren E. Buffett March 1, 1991 Chairman of the Board 21

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APPENDIX A U.S. STEEL ANNOUNCES SWEEPING MODERNIZATION SCHEME* completely modernizing the world's largest industrial enterprise. Contrary to expectations, no changes will Myron C. Taylor, Chairman of U.S. Steel Corporation, today announced the long awaited plan for entirely revamped. By adopting and further improving a number of modern accounting and financial be made in the company's manufacturing or selling policies. Instead, the bookkeeping system is to be conditions of 1935, it is estimated that the new bookkeeping methods would have yielded a reported devices the corporation's earning power will be amazingly transformed. Even under the subnormal comprehensive survey made by Messrs. Price, Bacon, Guthrie & Colpitts; it includes the following six profit of close to $50 per share on the common stock. The scheme of improvement is the result of a points:

1. Writing down of Plant Account to Minus $1,000,000,000.
2. Par value of common stock to be reduced to 14.
3. Payment of all wages and salaries in option warrants.
4. Inventories to be carried at $1.
5. Preferred Stock to be replaced by non-interest bearing bonds redeemable at 50% discount.
6. A $1,000,000,000 Contingency Reserve to be established.

The official statement of this extraordinary Modernization Plan follows in full: of the problems arising from changed conditions in the industry, it has approved a comprehensive plan The Board of Directors of U.S. Steel Corporation is pleased to announce that after intensive study for remodeling the Corporation's accounting methods. A survey by a Special Committee, aided and behind other American business enterprises in utilizing certain advanced bookkeeping methods, by means abetted by Messrs. Price, Bacon, Guthrie & Colpitts, revealed that our company has lagged somewhat of which the earning power may be phenomenally enhanced without requiring any cash outlay or any but to develop them to a still higher stage of perfection. The changes adopted by the Board may be changes in operating or sales conditions. It has been decided not only to adopt these newer methods, summarized under six heads, as follows: 1. Fixed Assets to be written down to Minus $1,000,000,000. by writing down their plant account to $1. The Special Committee points out that if their plants are Many representative companies have relieved their income accounts of all charges for depreciation worth only $1, the fixed assets of U.S. Steel Corporation are worth a good deal less than that sum. It is now a well-recognized tact that many plants are in reality a liability rather than an asset, entailing not decided to extend the write-down policy initiated in the 1935 report, and to mark down the Fixed Assets only depreciation cars but manne, and other expenditures. Accordingly, the Board has from $1,338,522,858.96 to a round Minus $1,000,000,000. correspondingly reduced. Hence, instead of the present depreciation charge of some $47,000,000 yearly The advantages of this move should be evident. As the plant wears out, the liability becomes there will be an annual appreciation credit of 5%, or $50,000,000. This will increase earnings by no less than $97,000,000 per annum.

2. Reduction of Par Value of Common Stock to 14, and
3. Payment of Salaries and Wages in Option Warrants.

• An unpublished satire by Ben Graham, written in 1936 and given by the author to Warren Buffett

in 1954. 22

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Board of Directors have adopted the following advanced form of this idea: to buy common stock at $50 per share, at the rate of one purchase right for each $50 of salary and/or The entire personnel of the Corporation are to receive their compensation in the form of rights wages in their present amounts. The par value of the common stock is to be reduced to 14. The almost incredible advantages of this new plan are evident from the following: based on 1935 operations. A. The payroll of the Corporation will be entirely eliminated, a saving of $250,000,000 per annum, B. At the same time, the effective compensation of all our employees will be increased severalfold. Because of the large earnings per share to be shown on our common stock under the new methods, it share, making the readily realizable value of these option warrants greatly in excess of the present cash is certain that the shares will command a price in the market far above the option level of $50 per wages that they will replace. C. The Corporation will realize an additional large annual profit through the exercise of these warrants. Since the par value of the common stock will be fixed at 14, there will be a gain of $49.99 on each share subscribed for. In the interest of conservative accounting, however, this profit will not be included in the income account, but will be shown separately as a credit to Capital Surplus. D. The Corporation's cash position will be enormously strengthened. In place of the present annual through exercise of the subscription warrants for 5,000,000 shares of common stock. The Company's large cash outgo of $250,000,000 for wages (1935 basis), there will be annual cash inflow of $250,000,000 earnings and strong cash position will permit the payment of a liberal dividend which, in turn, will result in the exercise of these option warrants immediately after issuance which, in turn, will further improve the cash position which, in turn, will permit a higher dividend rate — and so on, indefinitely. 4. Inventories to be carried at $1. value to market. Various enterprises — notably in the metal and cotton-textile fields - have successfully Serious losses have been taken during the depression due to the necessity of adjusting inventory U.S. Steel Corporation has decided to adopt a still more progressive policy, and to carry its entire inventory dealt with this problem by carrying all or part of their inventories at extremely low unit prices. The at $1. This will be effected by an appropriate write-down at the end of each year, the amount of said write-down to be charged to the Contingency Reserve hereinafter referred to. The benefits to be derived from this new method are very great. Not only will it obviate all possibility of inventory depreciation, but it will substantially enhance the annual earnings of the year at an excellent profit. It is estimated that our income will be increased by means of this method Corporation. The inventory on hand at the beginning of the year, valued at $1, will be sold during the to the extent of at least $150,000,000 per annum which, by a coincidence, will about equal the amount of the write-down to be made each year against Contingency Reserve. be written down to $1, in the interest of consistency and to gain additional advantages similar to those A minority report of the Special Committee recommends that Accounts Receivable and Cash also just discussed. This proposal has been rejected for the time being because our auditors still require that income. It is expected, however, that this auditing rule - which is rather reminiscent of the horse-and- any recoveries of receivables and cash buggy days — will soon be changed in line with modern tendencies. Should this occur, the minority report will be given further and favorable consideration. 5. Replacement of Preferred Stock by Non-Interest Bearing Bonds Redeemable at 50% Discount. including in income profits arising from repurchases of their own bonds at a substantial discount from the recent depression many companies have been able to offset their operating losses by par. Unfortunately the credit of U.S. Steel Corporation has always stood so high that this lucrative source of revenue has not hitherto been available to it. The Modernization Scheme will remedy this condition. 23

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bearing sinking-fund notes, redeemable by lot at 50% of face value in 10 equal annual installments. This It is proposed that each share of preferred stock be exchanged for $300 face value of non-interest at a cost to the Corporation of only $54,000,000, thus creating an annual profit of the same amount. will require the issuance of $1,080,000,000 of new notes, of which $108,000,000 will be retired each year Corporation and its preferred stockholders. The latter are assured payment for their present shares at Like the wage-and/or-salary plan described under 3. above, this arrangement will benefit both the 150 % of par value over an average period of five years. Since short-term securities yield practically no its present annual charge of $25,000,000 for preferred dividends into an annual bond-retirement profit return at present, the non-interest-bearing feature is of no real importance. The Corporation will convert of $54,000,000 - an aggregate yearly gain of $79,000,000. 6. Establishment of a Contingency Reserve of $1,000,000,000. The Directors are confident that the improvements hereinbefore described will assure the Corporation of a satisfactory earning power under all conditions in the future. Under modern accounting methods, any sort, since all these may be provided for in advance by means of a Contingency Reserve. however, it is unnecessary to incur the slightest risk of loss through adverse business developments of in the fairly substantial amount of $1,000,000,000. As previously set forth, the annual write-down of The Special Committee has recommended that the Corporation create such a Contingency Reserve inventory to $1 will be absorbed by this reserve. To prevent eventual exhaustion of the Contingency from Capital Surplus. Since the latter is expected to increase each year by not less than $250,000,000 Reserve, it has been further decided that it be replenished each year by transfer of an appropriate sum through the exercise of the Stock Option Warrants (see 3. above), it will readily make good any drains on the Contingency Reserve. unable to improve upon the devices already employed by important corporations in transferring large In setting up this arrangement, the Board of Directors must confess regretfully that they have been sums between Capital, Capital Surplus, Contingency Reserves and other Balance Sheet Accounts. In fact, mystification that characterizes the most advanced procedure in this field. The Board of Directors, it must be admitted that our entries will be somewhat too simple, and will lack that element of extreme however, have insisted upon clarity and simplicity in framing their Modernization Plan, even at the sacrifice of possible advantage to the Corporation's earning power. we submit herewith a condensed Income Account for 1935 on two bases, viz: In order to show the combined effect of the new proposals upon the Corporation's earning power, B. Pro-Forma Changes Proposed Giving Bitect to A. As Reported Herewith Salaries and Wages. Gross Receipts from all Sources (Including Inter-Company)...... $765,000,000 $765,000,000 Other Operating Expenses and Taxes 251,000,000 Interest..... Depreciation. 461,000,000 311,000,000 47,000,000 (50,000,000) Preferred Dividends Discount on Bonds Retired 5,000,000 5,000,000 - (54,000,000) Average Shares Outstanding Balance for Common (24,000,000) 25,000,000 553,000,000 Earned Per Share.. 8,703,252 ($2.76) 11,203,252 $49.80 Balance Sheet of the U.S. Steel Corporation as of December 31, 1935, after giving effect to proposed In accordance with a somewhat antiquated custom there is appended herewith a condensed pro-forma changes in asset and liability accounts. 24

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ASSETS Cash Assets Fixed Assets, net ($1,000,000,000) 142,000,000 Inventory.. Receivables. 56,000,000 1 Miscellaneous Assets 27,000,000 Total ($774,999,999) LIABILITIES Common Stock Par 14 (Par Value $87,032.52) Stated Value* ($3,500,000,000) Subsidiaries' Bonds and Stocks... 113,000,000 New Sinking Fund Notes 1,080,000.000 Current Liabilities .... 69,000,000 Contingency Reserve. 1,000,000,000 Initial Surplus Other Reserves .... 389,000,001 74,000,000 Total.. ($774,999,999) *Given a Stated Value differing from Par Value, in accordance with the laws of the State of Virginia, where the company will be re-incorporated. rise to balance sheets differing somewhat in appearance from those of a less advanced period. In view It is perhaps unnecessary to point out to our stockholders that modern accounting methods give it is not expected that undue attention will be paid to the details of assets and liabilities. of the very large earning power that will result from these changes in the Corporation's Balance Sheet, arried at a minus figure, our wage bill will be eliminated, and inventory will stand on our books a n conclusion, the Board desires to point out that the combined procedure, v virtually nothing, will give U. S. Steel Corporation an enormous competitive advantage in the industry. profit. It is the considered view of the Board of Directors that under the Modernization Scheme we shall We shall be able to sell our products at exceedingly low prices and still show a handsome margin of be able to undersell all competitors to such a point that the anti-trust laws will constitute the only barrier to 100% domination of the industry. may seek to offset our new advantages by adopting similar accounting improvements. We are confident, In making this statement, the Board is not unmindful of the possibility that some of our competitors however, that U. S. Steel will be able to retain the loyalty of its customers, old and new, through the user of steel. Should necessity arise, moreover, we believe we shall be able to maintain our deserved unique prestige that will accrue to it as the originator and pioneer in these new fields of service to the uperiority by introducing still more advanced bookkeeping methods, which are even now unde levelopment in our Experimental Accounting Laborator! 25

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APPENDIX B Some Thoughts on Selling Your Business* Dear Here are a few thoughts pursuant to our conversation of the other day. built upon endless repetition, they sharpen their skills in merchandising, purchasing, personnel selection, Most business owners spend the better part of their lifetimes building their businesses. By experience etc. It's a learning process, and mistakes made in one year often contribute to competence and success in succeeding years. atmosphere with a multitude of pressures coming from different directions. Often, much of the pressure In contrast, owner-managers sell their business only once - frequently in an emotionally-charged consequences for both buyer and seller. The fact that the decision is so important, both financially and comes from brokers whose compensation is contingent upon consummation of a sale, regardless of its personally, to the owner can make the process more, rather than less, prone to error. And, mistakes made o the once-ina teme sale of a busines are not reversible. Price is very important, but often is not the most critical aspect of the sale. You and your family have an extraordinary business

• one of a kind in your field - and any buyer is going to recognize that. It's

also a business that is going to get more valuable as the years go by. So if you decide not to sell now, you are very likely to realize more money later on. With that knowledge you can deal from strength and take the time required to select the buyer you want. If you should decide to sell, I think Berkshire Hathaway offers some advantages that most other buyers do not. Practically all of these buyers will fall into one of two categories: (1) A company located elsewhere but operating in your business or in a business somewhat akin to yours. Such a buyer — no matter what promises are made - will usually have managers who feel they know how to run your business operations and, sooner or later, will want to apply some hands-on "help." part by promises that they will get to run future acquisitions. They will have their own way of doing things If the acquiring company is much larger, it often will have squads of managers, recruited over the years in point cause them to believe that their methods of operating are superior. You and your family probably and, even though your business record undoubtedly will be far better than theirs, human nature will at some have friends who have sold their businesses to larger companies, and I suspect that their experiences will confirm the tendency of parent companies to take over the running of their subsidiaries, particularly when the parent knows the industry, or thinks it does. to resell either to the public or to another corporation as soon as the time is favorable. Frequently, this (2) A financial maneuverer, invariably operating with large amounts of borrowed money, who plans buyer's major contribution will be to change accounting methods so that earnings can be presented in the most favorable light just prior to his bailing out. I'm enclosing a recent article that describes this sort of transaction, which is becoming much more frequent because of a rising stock market and the great supply of funds available for such transactions. and plenty of sellers fall in this category - either type of buyer that I've just described is satisfactory. But If the sole motive of the present owners is to cash their chips and put the business behind them - if the sellers' business represents the creative work of a lifetime and forms an integral part of their personality and sense of being, buyers of either type have serious flaws. don't expect to have, operating people in our parent organization. All of the businesses we own are run Berkshire is another kind of buyer — a rather unusual one. We buy to keep, but we don't have, and

• This is an edited version of a letter I sent some years ago to a man who had indicated that he might want to sell his

family business. I present it here because it is a message I would like to convey to other prospective sellers. - W.E.B. 26

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autonomously to an extraordinary degree. In most cases, the managers of important businesses we have owned for many years have not been to Omaha or even met each other. When we buy a business, the sellers go on running it just as they did before the sale; we adapt to their methods rather than vice versa. We have no run businesses we have bought from owner-managers. And we won't have. one - family, recently recruited MBAs, etc. - to whom we have promised a chance to bought a business, and I invite you to check with them as to our performance versus our promises. You You know of some of our past purchases. I'm enclosing a list of everyone from whom we have ever ascertain how we behaved under difficult conditions. should be particularly interested in checking with the few whose businesses did not do well in order to does need you. But a great many buyers, for the reasons mentioned above, don't match their subsequent Any buyer will tell you that he needs you personally - and if he has any brains, he most certainly because we need to in order to achieve the best business results. actions to their earlier words. We will behave exactly as promised, both because we have so promised, and in the business. We need 80% to consolidate earnings for tax purposes, which is a step important to us. This need explains why we would want the operating members of your family to retain a 20% interest It is equally important to us that the family members who run the business remain as owners. Very simply, partners. Contracts cannot guarantee your continued interest; we would simply rely on your word. we would not want to buy unless we felt key members of present management would stay on as our Other personnel decisions, operating strategies, etc. are his bailiwick. Some Berkshire managers talk over The areas I get involved in are capital allocation and selection and compensation of the top man. some of their decisions with me; some don't. It depends upon their personalities and, to an extent, upon their own personal relationship with me. If you should not be used as collateral for any loan by Berkshire. There would be no brokers involved. decide to do business with Berkshire, we would pay in cash. Your business would then back off or start suggesting adjustments (with apologies, of course, and with an explanation that banks, Furthermore, there would be no chance that a deal would be announced and that the buyer would lawyers, boards of directors, etc. were to be blamed). And finally, you would know exactly with whom you few years later, or have the president regretfully tell you that his board of directors required this change are dealing. You would not have one executive negotiate the deal only to have someone else in charge a or that (or possibly required sale of your business to finance some new interest of the parent's). business already makes you wealthy and soundly invested. A sale would change the form of your wealth, It's only fair to tell you that you would be no richer after the sale than now. The ownership of your but it wouldn't change its amount. If you sell, you will have exchanged a 100%-owned valuable asset that you in busten the you trend of other businesses that you understand less well. There is often a sound reason to sell but, if the you understand for another valuable asset — cash — that will probably be invested in small pieces (stocks) transaction is a fair one, the reason is not so that the seller can become wealthier. business over the next 20 years as you have had during the past 20. Sincerely, /s/ Warren E. Buffett 27

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BERKSHIRE HATHAWAY INC. CONSOLIDATED BALANCE SHEETS and Subsidiaries (dollars in thousands except per share amounts) December 31, Cash and cash equivalents.. ASSETS 1990 1989 Investments: $ 247,024 $ 205,127 Obligations with fixed maturities. Loans and accounts receivable Marketable equity securities 3,061,075 5,685,983 2,795,588 705,649 5,261,598 Properties and equipment 203,795 554,763 Other assets 209,870 195,927 557,027 239,159 207,432 $10,670,423 $9,459,594 Losses and loss adjustment expenses LIABILITIES AND SHAREHOLDERS' EQUITY Unearned premiums. $ 2,050,305 $1,436,311 Accounts payable, accruals and other liabilities Savings accounts .... 286,093 126,381 143,631 1,111,783 475,873 443,602 291,592 Income taxes Term debt and other borrowings. 1,239,358 1,129,038 1,007,516 Minority shareholders' interests. 5,289,793 4,451,690 93,176 82,778 Shareholders' equity: Common stock of $5 par value. Authorized 1,500,000 shares; Capital in excess of par value issued 1,375,202 shares, including shares held in treasury 6,876 Retained earnings Unrealized appreciation of marketable equity securities, net 2,310,433 157,377 157,377 6,876 2,855,061 2,342,198 Less common stock in treasury, at cost (228,761 shares) ....... 5,329,747 2,460,968 Total shareholders' equity. 5,287,454 42,293 4,967,419 4,925,126 42,293 $10,670,423 $9,459,594 See accompanying Notes to Consolidated Financial Statements 28

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BERKSHIRE HATHAWAY INC. CONSOLIDATED STATEMENTS OF EARNINGS and Subsidiaries (dollars in thousands except per share amounts) Year Ended December 31, 1990 1989 1988 Revenues: Insurance premiums earned Sales and service revenues $1,580,074 $1,526,459 $1,407,642 Interest and dividend income... 591,540 394,279 584,235 Realized investment gain .... 450,295 331,452 314,251 Sundry income. 33,989 223,810 131,671 3,574 7,892 27,094 2,659,472 2,483,892 2,464,893 Cost and expenses: Insurance losses and loss adjustment expenses Cost of products and services sold 871,073 844,056 309,391 753,845 534,261 437,695 Insurance underwriting expenses. 83,926 109,288 157,621 Selling, general and administrative expenses... 541,054 526,359 495,331 Interest expense 112,692 77,574 70,280 2,143,006 1,866,668 1,914,772 Earnings before income taxes 516,466 617,224 550,121 Income taxes 112,047 404,419 159,287 457,937 140,791 409,330 Minority interest.. 10,326 10,460 10,060 Net earnings. $ 394,093 $ 447,477 $ 399,270 Net earnings per share.. $344 $390 $348 See accompanying Notes to Consolidated Financial Statements 29

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BERKSHIRE HATHAWAY INC. CONSOLIDATED STATEMENTS OF CASH FLOWS and Subsidiaries (dollars in thousands) 1990 Year Ended December 31, Cash flows from operating activities: 1989 1988 Net income..... Adjustments to reconcile net income to cash flows .. ... $ 394,093 $ 447,477 $ 399,270 from operating activities: Realized investment gain.. Depreciation and amortization (33,989) 34,083 (223,810) 32,107 (131,671) 29,808 Investment purchase price discount Amortization of issue discount on zero coupon notes... accretion less premium amortization (58,648) 5,683 (3,663) Minority interests.. 22,618 272 Increase in liability for losses and loss 10,326 10,460 10,060 Increase in deferred charges adjustment expenses ..... 613,994 29,122 146,767 Decrease in unearned premiums.. re reinsurance assumed (350,787) (Increase) decrease in accounts receivable.. (133,809) (17,250) (98,187) 8,923 (99,526) Increase in accounts payable, accruals and other 8,699 Other. liabilities.. ..... 32,271 9,666 118,088 4,006 (45,224) 45,426 Cash flows from investing activities: Net cash flows from operating activities.. 522,568 330,206 363,881 Purchases of marketable equity securities. Purchases of fixed maturity investments.. (287,700) Proceeds from redemptions and maturities of fixed Proceeds from sales of fixed maturity investments. ..•••. (729,352) (1,468,157) (739,932) (1,708,971) (109,245) 61,035 519,470 345,351 Proceeds from sales of marketable equity securities maturity investments.. (132,313) 261,923 21,457 28,985 821,656 878,228 46,104 Loans originated in finance businesses. Other ... Principal collection on loans 110,415 (133,546) 11,762 (57,174) 109,830 (103,602) 111,745 Net cash flows from investing activities..... 21,144 (682,773) Cash flows from financing activities: (918,868) (519,246) Proceeds from borrowings Other Repayments of borrowings ....... (576,634) 785,818 1,172,356 (7.082) (650,019) 250,000 6,371 (59,877) Net cash flows from financing activities... (1,639) .... 202,102 528,708 188,484 Cash and cash equivalents at beginning of year... Increase (decrease) in cash and cash equivalent.... 41,897 205,127 (59,954) 265,081 231,962 33,119 Cash and cash equivalents at end of year.... Other cash flow information: $ 247.024 $ 205,127 $ 265,081 Income taxes paid Interest paid $ 113,860 79,857 $ 181,468 70,191 $ 137,148 61,798 See accompanying Notes to Consolidated Financial Statements 30

[PAGE 33]

BERKSHIRE HATHAWAY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and Subsidiaries December 31, 1990 (1) Significant accounting policies and practices (a) Basis of consolidation The accompanying Consolidated Financial Statements include the accounts of Berkshire Hathaway Inc. (the 'Company" or "Berkshire") consolidated with accounts of all its subsidiaries. Intercompany accounts an ransactions have been eliminated (c) Investments Investments in obligations with fixed maturities are carried at cost. Marketable equity securities held by members of the Berkshire Hathaway Insurance Group are carried at market value, marketable equity securities held by the Company and by non-insurance subsidiaries are carried at the lower of aggregate cost or market. (d) Cost of investments sold Cost of investments sold is usually identification results in lower applicable income taxes, identified cost is used. determined on a first-in, first-out basis. Occasionally, when specific (e) Goodwill and negative goodwill of acquired businesses The difference between purchase amortized on a straight line basis over forty years. The net unamortized balance is carried in other assets. cost and the fair value of the net assets of acquired businesses is (f) Insurance premium acquisition costs For financial ultimate recoverability, and charged to income as the premiums are earned. With respect to premiums received reporting purposes, certain costs of acquiring insurance premiums are deferred, subject to under major quota-share reinsurance contracts, the computation of ultimate recoverability of the directly to the contracts. Otherwise, ultimate recoverability of premium acquisition costs is determined without regard related acquisition cost takes into account investment income anticipated to be earned on funds held subject to investment income. (g) Deferred charges re reinsurance assumed The excess of estimated liabilities for claims and claim costs ultimately payable by the Insurance Group indemnification of insurance risk, other than structured settlements, is established as a deferred charge at over consideration received with respect to retroactive property/casualty reinsurance contracts that provide for the periods that the liabilities for the claims and claim costs are expected to be outstanding. At December 31, inception of such contracts. The deferred charges are subsequently amortized using the interest method over 1990, deferred charges re reinsurance assumed in the amount of $350,787,000 are included in other assets. (h) Losses and loss adjustment expense Liability for losses and loss adjustment expenses represents the aggregate of such obligations of members (b) retroactive property/casualty reinsurance contracts that provide for indemnification of insurance risk, of the Insurance Group with respect to: (a) prospective property/casualty insurance and reinsurance contracts, claims ("structured settlements"). Except for structured settlement liabilities which are stated at discounted other than structured settlements, and (c) contracts providing for periodic payments with respect to settled payment amounts less amounts recoverable on account of reinsurance. present values, the liability for losses and loss adjustment expenses is at the aggregate of estimated ultimate Ultimate payment amounts with respect to prospective contracts are determined from (i) individual case estimates, (ii) estimates of incurred but not reported losses, based on past experience, and (iti) reports of losses from ceding insurers. 31

[PAGE 34]

Notes to Consolidated Financial Statements (Continued) (1) Significant accounting policies and practices (Continued) (h) Losses and loss adjustment expense (continued) Ultimate payment amounts with respect to retroactive reinsurance contracts that provide for indemnification of insurance risk, other than structured settlements, are established for financial reporting purposes at 31, 1990 of which $350,787,000 was established for financial reporting purposes as deferred charges re maximum limits of indemnification under the contracts. This liability amounted to $737,524,000 at December reinsurance. See also 1(g) above. For statutory reporting purposes, liabilities under these contracts are payable thereunder. These "best estimates" yielded as of December 31, 1990 a liability of $425,595,000. Also established, not at worst-case maximum loss limits, but at best estimates of claims and claim costs ultimately for statutory reporting purposes, a 1990 underwriting loss of approximately $68 million resulted from the contracts. For financial reporting purposes, underwriting gain or loss from the contracts for 1990 was zero. For Federal income tax reporting purposes, the liabilities as established for statutory reporting purposes are subjected to discounting, and 1990 taxable income of approximately $1.3 million, resulted from the contracts. Liabilities under structured settlement contracts are established on a contract-by-contract basis when the discounted at the market interest rate. Thereafter, annual accretions to the liabilities are charged to losses contracts are entered into, at the then present value of the actuarially determined ultimate payment amount incurred. The aggregate of these liabilities for financial reporting purposes at December 31, 1990 was $264,718,000. For statutory and tax reporting purposes, where the liabilities are determined using discount to contracts dated prior to 1987), the aggregate of structured settlement liabilities was $353,613,000. rates mandated by Insurance Regulatory authorities (5% for contracts incepting after 1986 and 7% with respect (i) Insurance premiums Insurance premiums for prospective insurance and reinsurance policies are recognized as revenues ratably over their terms. Related unearned premiums are computed on a monthly or daily pro rata basis and are stated after deduction of unearned premiums ceded to reinsurers. Consideration received for indemnification of risk under retroactive reinsurance contracts, including structured settlements, are accounted for as premiums earned at the inception of the contracts. (k) Income taxes Certain items of income and deductions are recognized in the financial statements in time periods that differ from those in which they are recognized in the Company's consolidated Federal income tax returns, giving rise to recognition in the financial statements to deferred and prepaid income taxes. The liability for income taxes in the Consolidated Balance Sheets includes deferred taxes deemed applicable to unrealized appreciation included in carrying value of marketable equity securities. Such taxes were accrued rate of 28% relative to appreciation that arose in years prior to 1987. at a rate of 34% relative to increases in unrealized appreciation that arose subsequent to 1986 and at the In 1987, the Financial Accounting Standards Board (FASB") issued Statement No. 96 "Accounting for Income Taxes," and implementation of the statement is now required in financial statements for years beginning after December 15, 1991. The statement requires the "liability method" of accounting for income taxes with a balance sheet focus superseding requirements for the "deferred method" with an earnings statement focus. The Company has not yet implemented the statement's provisions. The FASB has announced were to be given effect in Berkshire's consolidated balance sheet as of December 31, 1990, a reduction to its intention to further defer the date required for implementation. If the current provisions of the Statement shareholders' equity of no more than $70 million would result. The precise amount of the reduction is dependent upon Berkshire's selection between alternative means of implementation. (m) Postretirement benefits other than pensions In December, 1990, the FASB issued Statement No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions." This statement alters generally accepted accounting principles with respect to position or results of operations. Company believes that the provisions of this statement will not have a measurable effect on Berkshire's financial 32

[PAGE 35]

(2) Business segment data See page 39. (3) Investments in obligations with fixed maturities maturities are as follows: The amortized cost and estimated market value as of December 31, 1990 of investments in obligations with fixed Amortized Gross Cost Unrealized Unrealized Gross Estimated Market Gains Losses Value Bonds: U.S. Treasury securities and obligations of and agencies.... J.S. government corporations Obligations of states, municipalities ...$ 6,665,000 $ 84,000 $ - $ 6,749,000 Corporate bonds .... and political subdivisions 576,588,000 87,622,000 (551,000) 663,659,000 Redeemable preferred stocks.. 514,547,000 13,787,000 (11,888,000) 516,446,000 1,963,275,000 120,141,000 (143,307,000) 1,940,109,000 $3,061,075,000 $221,634,000 $(155,746,000) $3,126,963,000 by contractual maturity dates. Expected maturities will differ from contractual maturities because issuers of certain of Shown below are the amortized cost and estimated market values of the above obligations at December 31, 1990, the obligations retain early call or prepayment rights. Amortized Estimated Cost Market Due in one year or less Value Due after one year through five years.. $ 46,573,000 $ 56,922,000 Due after five years through ten years 421,598,000 455,559,000 Due after ten years 2,091,645,000 501,259,000 2,097,990,000 516,492,000 $3,061,075,000 $3.126,963.000

• Includes redeemable cumulative convertible preferred stock of The Gillette Company with an amortized cost

of $600,000,000 and an estimated market value of $720,000,000 (see the following Note 4). obligations with fixed maturities. During 1990, gross gains of $3,098,000 and gross losses of $1,468,000 were realized on sales and redemptions of (4) Investment in cumulative convertible preferred stock of The Gillette Company - subsequent event Convertible Preferred Stock of The Gillette Company ("'Gillette"), each preferred share convertible under the terms of On July 20, 1989, insurance subsidiaries of Berkshire purchased an Issue of 600,000 shares of redeemable Cumulative in the aggregate. Dividends with respect to the issue were at the annual rate of $8750 per share. Under the terms of the Issue into 20 shares of Gillette common stock. The cash purchase price and par was $1,000 per share - $600,000,000 to redeem the shares for cash at par if not converted by a date fixed by notice. Gillette gave notice of its exercise of that the Issue, Gillette possessed under certain circumstances the right, exercisable within a two-year period after issuance, shares of Gillette common stock. The shares possess 11% of the voting rights of all Gillette voting shares. right on February 28, 1991, and the date of April 1, 1991 was fixed as the date for conversion of the shares into 12 million 33

[PAGE 36]

Notes to Consolidated Financial Statements (Continued) (5) Investments in redeemable cumulative convertible preferred stocks other than Gillette Subsidiaries of Berkshire own issues of redeemable voting cumulative convertible preferred shares of companies other than Gillette as indicated in the following table: Dividend Date of Issue Price Aggregate Accrual Required redemption Issue Issuer per share Cost Rate Dates 10/1/87 Salomon Inc $1,000 $700,000,000 9.00% * 8/7/89 USAir Group Inc. 1,000 358,000,000 9.25% 8/7/99 12/6/89 Champion International Corp. 1,000 300,000,000 9.25% 12/6/99 *Salomon is required to redeem, at their issue price, 140,000 shares annually on October 31 commencing in 1995. an aste i he sue po, it Beck stire option at any me ito oing ians at Decame o 1he920 and each share f the issue is convertible, at Berkshire's option, a USAir Group Inc.: The issue possessed 12% of Issuer's total outstanding voting rights at December 31, 1990. After August subject to prior conversion, each share may be redeemed, at Issuer's option, at $1,100 per share. 7, 1991, each share of the issue may be converted, at Berkshire's option, into 16 2/3 common shares of the Issuer, and, 31, 1990. At any time each share of the issue is convertible at Berkshire's option into 26.31579 common shares of the Champion International Corporation: The issue possessed 8% of Issuer's total outstanding voting rights at December Issuer, and, subject to prior conversion, each share may be redeemed, at Issuer's option, at $1,150 per share. (6) Investments in marketable equity securities the dates indicated. See Note 1(c) as to methods applied to determine carrying value of these securities. Aggregate data with respect to the consolidated investment in marketable equity securities is shown below as of Unrealized December 31, 1990 Cost Gain (Loss) Market Carrying Common stock of: Value Capital Cities/ABC, Inc. GEICO Corporation ...... The Coca-Cola Company $ 517,500,000 1,023,919,000 $ 859,875,000 The Washington Post Company. 45,713,000 1,147,631,000 $1,377,375,000 2,171,550,000 $1,363,044,000 All other marketable equity securities.. Wells Fargo Company ............ 289,431,000 9,731,000 1,064,843,000 1,110,556,000 2,168,812,000 332,366,000 289,375,000 342,097,000 1,110,556,000 398,386,000 69,882,000 (56,000) 342,097,000 468,268,000 287,341,000 $2,284,680,000 414,133,000 $3,474,541,000 $5,759,221,000 $5,685,983,000 December 31, 1989 Cost Unrealized Common stock of: Gain Market Carrying Value Capital Cities/ABC, Inc.... The Coca-Cola Company $ 517,500,000 GEICO Corporation ...... 1,023,919,000 $1,174,875,000 998,912,000 779,868,000 $1,692,375,000 1,803,787,000 $1,672,794,000 The Washington Post Company 45,713,000 476,635,000 1,044,625,000 1,801,995,000 All other marketable equity securities.. Wells Fargo Company............... 55,124,000 9,731,000 130,572,000 5,436,000 486,366,000 1,044,625,000 60,560,000 486,366,000 162,673,000 $3,566,298,000 293,245,000 195,258,000 60,560,000 $1,814,660,000 $5,380,958,000 (7) Investment in shares of Capital Cities/ABC, Inc. $5,261,598,000 approximately 18% of the voting rights of all Capital Cities shares outstanding at December 31, 1990. The shares are The 3,000,000 common shares of Capital Cities/ABC, Inc. (Capital Cities") owned by Berkshire subsidiaries possessed and otherwise govern until January 3, 1997 the manner by which the shares may be sold or transferred. Also, Berkshire held subject to an Agreement, the terms of which grant to Capital Cities a right of first refusal to purchase the shares and its subsidiaries have delivered to Capital Cities irrevocable proxies with respect to these shares in favor of Thomas at any and all meetings of shareholders of Capital Cities. The proxies expire on January 2, 1997 or at the earlier date S. Murphy or Daniel B. Burke, so long as either shall be the chief executive officer of Capital Cities, to vote the shares when neither of such persons is chief executive officer of Capital Cities. 34

[PAGE 37]

(8) Investment in GEICO Corporation stock of GEICO Corporation. The shares possessed approximately 48% of the voting rights of all GEICO shares outstanding Subsidiaries of Berkshire, at both December 31, 1990 and at December 31, 1989, owned 6,850,000 shares of common by Order of GEICO's domiciliary insurance supervisory authority. The Order, dating from Berkshire subsidiaries' major at December 31, 1990. but Berkshire maintains an independent oroxy arrangement for votine of the shares as reaninod the Order, no officer or director of Berkshire or of any affiliate or subsidiary of Berkshire is permitted to serve as a director purchase of the shares in 1976, prohibits Berkshire from seeking or causing to change the independent proxy. Also, under the equity method of accounting for its investment in GEICO. of GEICO. Because the Order divests Berkshire of its voting rights with respect to the shares, Berkshire does not use (9) Income taxes of liabilities as follows: The liability for income taxes as reflected in the accompanying Consolidated Balance Sheets represent estimates Dec. 31, Deferred, relating to unrealized appreciation Payable currently. $ 49,672,000 1990 Dec. 31, $ 36,906,000 1989 Net prepaid arising from of marketable equity securities 1,085,342,000 1,100,784,000 timing differences. (23,231,000) (8,652,000) $1,111,783,000 $1,129,038,000 The Consolidated Statements of Earnings reflect charges for income taxes as shown below: State... Federal $ 94,713,000 1990 1989 Foreign 16,779,000 $142,996,000 $122,492,000 1988 555,000 15,514,000 777,000 15,871,000 2,428,000 $112,047,000 Increase in prepaid taxes Current provision. $126,626,000 $171,616,000 $159,287,000 $140,791,000 (14,579,000) (12,329,000) $149,835,000 (9,044,000) $112,047,000 $159,287,000 $140,791,000 The increase in net prepaid taxes represent the tax effects of timing differences as follows: Deferred insurance premium acquisition costs Applicable to: $ 1990 Discounting of losses and loss adjustment expense reserves Structured settlement liabilities... 2,796,000 (549,000) $(10,363,000) 1989 1988 (3,588,000) 5,607,000 (7,377,000) (8,515,000) 6,902,000 Delen gross profit on installment receivable .... (9,598,000) (7,752,000) (10,988,000) 1,287.000 3,767,000 (4,610,000) 7,029,000 $(14,579,000) $(12,329,000) $ (9,044,000) Charges for income taxes are reconciled, in the table which follows, to hypothetical amounts computed at the Federal statutory rate: 1990 1989 1988 Net earnings before income taxes $516,466,000 $617,224,000 $550,121,000 Hypothetical amounts applicable to above Decreases, resulting from: computed at the Federal statutory rate .. $175,598,000 $209,856,000 $187,041,000 Dividends received deduction Tax-exempt interest income... (53,901,000) (19,744,000) (26,735,000) State income taxes, less Federal income tax benefit.. 11,073,000 (36,065,000) (33,477,000) Net other differences.. (979,000) 10,240,000 (21,461,000) 1,991,000 10,597,000 (1,909,000) Total income taxes $112,047,000 $159,287,000 $140,791,000 35

[PAGE 38]

Notes to Consolidated Financial Statements (Continued) (10) Term debt and other borrowings December 31, 1990 and 1989. The following table sets forth the term debt and other borrowings of the Company and its subsidiaries at Zero Coupon Convertible Subordinated Notes Due 2004. § 428,301,000 1990 1989 10% Debentures due January 1, 2018, redeemable $ 405,683,000 through operation of a sinking fund which calls for 9 3/4% Debentures due January 15, 2018, redeemable annual repayments of $7,500,000 beginning in 1999 150,000,000 150,000,000 through operation of a sinking fund which calls for Borrowings under obligations of investment agreements annual repayments of $5,000,000 beginning in 1999.. 100,000,000 Other notes, payable through 1993... 324,801,000 100,000,000 1,010,577,000 7,475,000 109,120,000 774,199,000 9,396,000 8.125% Notes, payable in 1996 10% Notes, payable in annual installments of $2,625,000 120,000,000 120,000,000 through 1997 with a final payment of $2,750,000 9 1/2% Notes, payable in annual installments of $2,500,000 on August 31, 1998... 21,125,000 23,750,000 8 7/8% Notes, payable in 1999 20,000,000 22,500,000 Federal Home Loan Bank advance, due August 1994, 30,000,000 30,000,000 Other notes maturing through 2014 bearing interest at 8.73%.. 20,756,000 16,900,000 16,900,000 20,167,000 $1,239,358,000 $1,007,516,000 face value which totaled $902,640,000. The issue price reflected an original issue discount rate and yield to maturity The Zero Coupon Convertible Subordinated Notes Due 2004 were issued on September 28, 1989 at 44.314% of their time prior to redemption into 0.4515 shares of common stock. A holder otherwise entitled upon conversion to a fractional of 5.5% per annum; there are no periodic payments of interest. Each $10,000 face amount note may be converted at any The conversion rate will be adjusted only upon occurrence of certain dilutive events affecting the common stock. The share of common stock shall receive in lieu thereof cash equal to the then current market value of such fractional share. purchase any of its holdings on September 28, 1994 and again on September 28, 1999. The price at which notes will Company may redeem the notes for cash at any time after September 28, 1992. A holder may require the Company to be purchased or redeemed will be issue price plus accrued original discount to the date of purchase or redemption. at various times prior to maturity at the option of the counterparty. Interest rates on such borrowings range from 5.2% Borrowings under obligations of investment agreements are recorded at proceeds received. Obligations may be called No materially restrictive covenants are included in any of the various borrowing agreements. Principal payments on borrowings outstanding at December 31, 1990 are required during the succeeding five year 5) she en i he ble trumediately below. Amounts have been determined vithout regard to optional repayment provisions 1991 1992 $ 30,852,000 1993 108,437,000 1994 52,725,000 99,520,000 1995 5,612,000 36

[PAGE 39]

(11) Shareholders' equity accounts Changes in Shareholders' Equity accounts during the most recent three years were as follows: Net Unrealized Appreciation Earnings Retained Treasury Increase during 1988 in unrealized appreciation Balance at December 31, 1987 $1,104,123,000 $1,614,221,000 $ 40,938,000 Stock included in carrying value of marketable Change during 1988 in deemed applicable equity securities 259,486,000 Increase in minority shareholders' interest .... (88,763,000) Net earnings 1988.. in unrealized appreciation .. (189,000) 399,270,000 Value termination of pension d in comection 1,355,000 Increase during 1989 in unrealized appreciation Balance at December 31, 1988 1,274,657,000 2,013,491,000 42,293,000 equity securities........ included in carrying value of marketable Change during 1989 in deemed income taxes applicable 1,623,462,000 Increase in minority shareholders' interest (552,314,000) Net earnings 1989.. in unrealized appreciation (3,607,000) 447,477.000 Balance Decrease during 1990 in unrealized appreciation December 31, 1989. 2,342,198,000 2,460,968,000 42,293,000 included in carrying value of marketable (45,636,000) Change during 1990 in deemed applicable Increase in minority shareholders' interest 15,441,000 in unrealized appreciation (1,570,000) Net earnings 1990. 394,093.000 Balance December 31, 1990. .. $2,310,433,000 $2,855.061,000 $ 42,293,000 (12) Interest and dividend income Interest and dividend income for each of the past three years was comprised of the following: 1990 1989 1988 Interest earned with respect to: Investment securities. $132,694,000 Dividends fin esed receivables. 53,985,000 $114.928,000 50,904,000 $164,499,000 51,135,000 Fixed maturity preferred stocks Marketable equity securities ...'... 176,742,000 86,874,000 102,181,000 63.439,000 63,652,000 34.965.000 $450,295.000 $331,452,000 $314,251,000 (13) Interest expense Interest expense is comprised of interest on savings accounts of Mutual Savings and Loan Association ("Mutual" plus interest on debt as follows: 1990 1989 1988 Savings accounts of Mutual. $ 21,975,000 Debt of Scott Fetzer Financial Group .. Debt of Mutual. 12,868,000 1,475,000 $ 21,261,000 599,000 $ 20,579,000 Other debt . 76,374,000 42,389,000 13,325,000 35,613,000 14,088,000 $112.692,000 $ 77.574,000 $ 70,280,000 37

[PAGE 40]

Notes to Consolidated Financial Statements (Continued) (14) Dividend Restrictions - Insurance Subsidiaries prior regulatory approval in 1991, Berkshire can receive up to approximately $607,800,000 as dividends from insurance Payments of dividends by Insurance Group members are restricted by insurance statutes and regulations. Without subsidiaries. Surplus as Regards Policyholders) was approximately $6,300,000,000 at December 31, 1990. This amount exceeded by Combined shareholders' equity of insurance subsidiaries determined pursuant to statutory accounting rules (Statutory approximately $900,000,000 the corresponding amounts determined on the basis of generally accepted accounting principles; the difference is principally represented by deferred income tax liabilities recognized for financial reporting purposes but not for statutory reporting purposes. (15) Quarterly data This information is unaudited. Dollars are in thousands, except per share amounts. A summary of revenues and earnings by quarter for each of the last two years is presented in the following table. 19901989 1ST QUARTER 2ND QUARTER 1990 1989 3RD QUARTER 1990 1989 1990 4TH QUARTER Revenues 1989 $590,776 $701,707 $545,310 $564,214 $525.965 $597,143 $997,421 $620,828 Earnings excluding realized investment gain

• per share

$ 84,151 $ 72,241 73.40 63.01 $ 82,917 $ 62,424 $ 81,712 $ 70,932 72.32 54.45 71.27 $121,965 $ 94,305 Realized investment gain $ 325 $ 54,813 61.87 $ 11,041 $ 25,011 106.39 $ 82.49

• per share

0.29 47.81 9.63 21.82 • 8,502 $ 50,723 7.42 44.25 $ 3,480 $ 17,028 Net earnings $ 84,476 $127,054 $ 93,958 $ 87,435 3.03 14.34

• per share

73.69 110.82 81.95 76.27 $ 90,214 $121,655 78.69 106.12 $125,445 $111,333 Revenues and earnings from marketing of World Book products are concentrated in the first quarter. See's Candy 109.42 96.83 sales peak at Easter and more notably so in the fourth quarter when more than one-half of annual revenues for that business are normally recorded. A non-seasonal factor that may influence Berkshire's interim consolidated financial statements can be relatively more significant to results of interim periods than to results for a full year. Variations in amount and is that estimation error, inherent to the process of determining liabilities for unpaid losses of insurance subsidiaries, timing of realized securities gains or losses cause significant variations in periodic net earnings. To the Board of Directors and Shareholders INDEPENDENT AUDITORS' REPORT Berkshire Hathaway Inc. December 31, 1990 and 1989, and the related consolidated statements of earnings and cash flows for each of the three We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries as of years in the period ended December 31, 1990. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material We conducted our audits in accordance with generally accepted auditing standards. Those standards require that financial statements. An audit also includes assessing the accounting principles used and significant estimates made misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. financial position of Berkshire Hathaway Inc. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the their operations and their cash flows for each of the three years in the period ended December 31, 1990, in conformity and subsidiaries as of December 31, 1990 and 1989, and the results of with generally accepted accounting principles. March 8, 1991 DELOITTE & TOUCHE Omaha, Nebraska 38

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BERKSHIRE HATHAWAY INC. Business Segment Data (dollars in thousands) No. 14. The principal activity/product/service of each is described below: Berkshire had seven reportable business segments as defined in Financial Accounting Standards Board Statement Segment Activity/product/service Candy.. Insurance. Property/casualty insurance and reinsurance. Newspaper. Boxed chocolates and other confectionery products. Retailing of home furnishings. Publication of the Buffalo News, a daily and Sunday newspaper. Encyclopedias, other reference materials .... Composition, publication and marketing of World Book Carpet, furniture, appliances, electronics and related products. Home cleaning systems.. Manufacture and distribution of principally Kirby branded home encyclopedias and other educational and reference works. Uniform manufacturing and distribution... Manufacture and distribution of uniforms, trousers, jackets, cleaning systems and products. shirts, and caps. The tables which follow reflect data for those segments for each of the three most recent years. 1990 Revenues 1989 1988 Operating profit before taxes 1990 1989 1988 Candy Insurance Newspaper Encyclopedias, other reference materials Retailing of home furnishings........ Uniform manufacturing and distribution Home cleaning systems........ Other... $2,659,472 $2,483,892 $2,464,893 $516,466 $617.224 $550,121 Insurance Segment Premiums earned: 1990 Revenues 1989 1988 Operating profit before taxes 1990 1989 1988 Primary or direct $154,015 Underwriting (loss)... Reinsurance assumed 437,525 $188,920 205,359 $292,309 291,926 Investment income .... 335,930 Realized investment gain 15,807 220,024 250,723 231,907 $ (26,647) $ (24,400) $ (11,081) 127,731 327,047 15,807 243,599 220,024 127,731 231,250 $943,277 $865,026 $943,873 $316,207 $439,223 $347,900 Deprec. & amort. 1990 of tangible assets Identifiable assets 1990 Capital expenditures 1989 _ 1988 1990 at year-end 1989 1988 1989 1988 • Insurance Newspaper Candy... $ 6,970 601$ 525$ 838 $ 708 $ 918 $ 722 2,229 3,882 971 3,509 988 3,752 3,574 2,909 2,757 2,836 3,392 $ 8,884,393 $7,871,097 $5,421,195 48,286 69,833 48,917 66,278 64,304 50,755 • Retailing of home Encyclopedias, furnishings…. 1,397 2,247 2,037 1,792 1,745 1,612 75,714 71,107 70,660 Home cleaning systems.. other ref. mat.. 3.859 11,191 7,705 3,552 2,370 329 1,124 5,285 3,274 749 2,575 746 107,913 66,388 103,159 60,147 85,675 45,675 Uniform manuf. Other. and distr. 9,832_17,897 1,330 2,272 5,418 2,203 13,236 1,736 13,589 13,421 2,115 1,698 71,572 1,346,324 1,168,292_1,005,575 70,597 73,009 $33.923 $42,537 $17,692 $30,542 528,721 $27,002 810.670.423 $9,459,594 $6,816,848 39

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Financial Condition and Results of Operation Management's Discussion and Analysis of BERKSHIRE HATHAWAY INC. Results of Operations in thousands, and each figure is income tax-effected. Net earnings for each of the past three years are disaggregated in the table that follows. Amounts are Activity or Item 1990 Contribution to Net Earnings Insurance underwriting. 1989** 1988** Insurance segment investment income..... $ (14,936) 282,613 $ (12,259) 213,642 $ (1,045) 267,677 197,779 Manufacturing, merchandising, and services ....... 132,209 201,383 196,734 Interest on debt*.... 124,129 126,260 Unallocated income/expense, net. (49,726) (27,098) (23,212) Earnings before realized investment gain 370,745 20,585 1,488 13,659 Realized investment gain.. 23,348 147,575 299,902 313,441 $ 394,093 $ 447,477 $ 399,270 85,829 *Interest expense with respect to debt of consumer finance subsidiaries as well as interest expense of usuals dings elated service ac is ny refected in interest on deb"but, instead, has been netted **Restated as required for comparability to 1990. this discussion. The Business Segment data on the preceding page of this report should be read in conjunction with Insurance Underwriting The after-tax figures shown above for Insurance underwriting derive from the following: 1990 000s Omitted 1989 Underwriting gain (loss): 1988 Primary or Direct Insurance Operations Reinsurance Assumed .......... $ 546 $ 4,243 $17,466 Underwriting loss - pre-tax. (27,193) (28,643) Applicable income tax credit* (26,647) (28,547) (24,400) After-tax underwriting loss...... Applicable minority interest.. 11,511 (11,081) 200 11,781 9,670 $(14.936) $(12,259) 360 $(1,045) 366 approximately $2.3 million for 1990, $3 million for 1989, and $5 million for 1988 *Income tax credits applicable to underwriting losses include a "fresh start" tax benefit o property/casualty risks. In its "insurance" activities, as distinguished from its "reinsurance" activities, its The Berkshire Hathaway Insurance Group engages in both insurance and reinsurance of activities, the members assume defined portions of similar or dissimilar risks to which other insurers and members assume risks of loss from persons primarily and directly subject to the risks. In its reinsurance 40

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Insurance Underwriting (continued) objective of rejecting underpriced risks. In each of the past four years, market prices (premium rates) have Berkshire Hathaway Insurance Group members employ disciplined underwriting practices with the eroded as industry capital has increased in relation to industry premium volume. As a result the Insurance to the insurance industry increased each year. Statutory surplus as regards policyholders of the Berkshire Group has successively underwritten fewer risks each year. Meanwhile, the amount of Berkshire capital devoted strength creates opportunities for Berkshire Group members to negotiate and enter into contracts of insurance Hathaway Insurance Group increased to approximately $6.3 billion at year-end 1990. This unique capital looking concerns about capital adequacy and solvency of their insurers. specially designed to meet unique needs of sophisticated insurance and reinsurance buyers having forward Primary or Direct Insurance Underwriting accepted accounting principles ("'GAAP"), of the Berkshire Hathaway Insurance Group's primary or direct A summary follows of the combined underwriting results, determined on the basis of generally insurance operations. 1990 (Dollars are in thousands) Premiums written. Amount Premiums earned $139,085 % Amount 1989 % 1988 $154,015 Losses and loss expenses 102,033 100.0 $169,661 $218,838 Amount % Underwriting expenses ... 51,436 66.2 $188,920 100.0 125,873 66.6 $292,309 196,165 100.0 67.1 Total losses and expenses.... 153,469 33.4 Underwriting gain - pre-tax $ 546 99.6 184,677 58,804 31.1 78,678 26.9 $ 4,243 97.7 274,843 94.0 $ 17,466 representing respectively, 11.9%, 10.6% and 10.0% of premiums earned in 1990, 1989 and 1988, were credited Favorable development, discussed on the following page, of beginning-of-the-year loss reserves to losses and expenses of those years. Without those credits (or, stated differently, if only estimated losses and expenses from occurrences of the current year were related to amounts shown in the table for premiums earned for the current year), total losses and expenses as a percentage of premiums earned would equal: 1990 — 111.5%, 1989 — 108.3%, and 1988 - 104.0%. The number of risks accepted in Berkshire's primary or direct insurance operations peaked in 1986 underwriting units that produce the Group's direct business, as reflected in the following table of premiums and has declined significantly each succeeding year. The declines have been shared by each of the earned for the past four years: Traditional motor vehicle/general liability operations .. Underwriting Unit $ 94 1990 (Dollars in millions) 1989 1988 Homestate companies/Cypress Insurance Co. N.Y. commercial casualty/professional liability/specialty risk operations 18 $113 $168 1987 42 20 54 $268 Total premiums earned... $154 $189 56 $292 70 80 93 $441 The "traditional business is written through general agents located nationwide directed from primary group. " Historically from the founding of National Indemnity Company fifty years ago, the volume National Indemnity's Omaha offices. The operations are termed internally as those of the "National Indemnity industry insuring capacity and decreasing when that capacity expanded. When capacity was adequate, much of business written by this group varied significantly from year to year, increasing during periods of limited Indemnity, and (ii) applying less stringent underwriting guidelines than those applied by National Indemnity. of the business was written by competing insurers (i) charging prices lower than those acceptable to National Those Lawer rices continued this the sultes una such point in the cyle, Natoma/ ady arity Compan 41

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Management's Discussion (continued) Insurance Underwriting (continued) and its affiliated Insurance Group members were offered increased opportunities to underwrite the risks at prices they believed to be adequate. In recent years, the group has experienced the down-side of this cycle. The upside, evidenced by increased offerings meeting the Group's acceptance standards, has not yet been observed. commenced operations in 1985. Earned premiums from policies underwritten from these offices peaked at Disciplined underwriting is also practiced by the Group's New York City underwriting units that casualty/professional liability and special risks underwriting units generate "tailored" insurance contracts $93 million in 1987 and then declined each year since, totalling $18 million in 1990. These commercial for insureds presenting unusual and/or unusually large risks. Many standard carriers decline to provide such i.e., in tight markets such as those of 1985 and 1986, but those carriers have increasingly competed for, and coverages when their capacity can be fully employed in providing standard coverages for standard risks, written much of the business in the 1987-1990 period. Nebraska — reduced their premium writings in each of the past two years. Their disciplined underwriting The Homestate companies of the Berkshire Hathaway Insurance Group — in Colorado, Kansas and approach in a soft market environment resulted in loss of market share. In California, Cypress Insurance Company significantly reduced its in-force workers' compensation business as a result of a highly competitive market as well as management turnover at the unit. It should be understood that no management judgments with respect to the Insurance Group's operations The preceding discussion is given to explain the downward trend in dollar amount of premiums. regard to volume. are based on volume of business done. Instead, members are encouraged to reject underpriced risks without Summarized below is loss and loss expense data from primary or direct insurance underwriting: Unpaid losses and loss expenses at beginning of year.... 1990 000s Omitted Incurred losses recorded: $639,146 $667,592 1989 $628.077 1988 Current year occurrences All prior years' occurrences. (18,343) 120,376 (20.034) 145,907 225,309 Payments with respect to: 102,033 125,873 _(29,144) 196,165 All prior years' occurrences. Current year occurrences..... 132,851 21,742 27,645 $586,586 154,593 126,674 39,263 $639,146 154,319 117,387 Unpaid losses and loss expenses at end of year .... $667,592 156,650 occurrences." They are corrections of estimation error that are credited or charged to earnings in the year Credits against incurred losses were recorded in each of the last three years for "all prior year made. Relating these credits for each year to the related estimated unpaid amounts at the beginning of the to Berkshire's management and shareholders to infer that the "savings" reveal that the estimated beginning- respective year, the "savings" were: 1990 — 2.9%, 1989 — 3.0% and 1988 — 4.6%. It would be comforting But that would be wrong because, obviously, all of the cases have not been settled. However, several years of-the-year unpaid amounts were too high and by a measurable amount that fell between 2.9% and 4.6%. of favorable loss development is more comforting than several years of unfavorable development, and 1990 was the Insurance Group's fourth successive year of favorable development for the primary or direct operations. For 1987, the first of the four, favorable development amounted to 2.2% of beginning-of-the- amounting to 7.6% of the beginning liability. year estimated unpaid amounts. In contrast, however, for 1986, unfavorable development was recorded, 42

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Insurance Underwriting (continued) commercial automobile business of the "primary group" defined above. That was true of $14 million of 1988 The favorable development recorded in 1989 and 1990 related principally to the traditional savings, while an additional $8.5 million of that year's savings derived from excess-of-loss claims-made type liability coverages. Reinsurance Assumed reinsurance activity. However, all of the reinsuring activities of the Berkshire Hathaway Insurance Group In past years, in this section, we set apart the structured settlement activity from the "conventional" three tables are restated from prior years' are combined for purposes of this 1990 discussion and, accordingly, prior year data shown in the following presentations. reinsurance contracts that insured other insurers and reinsurers against sustaining adverse loss development In 1990, the Insurance Group derived the majority of their insurance premium volume from of $378 million. with respect to their own loss reserves. These were sizeable contracts that generated 1990 premium income for the past three years are summarized in the following table. Underwriting results, determined on a GAAP basis, with respect to the reinsurance assumed business 1990 Dollars in Thousands Premiums written. Amount Premiums earned $435,205 % Amount 1989 $126,430 % Amount 1988 $265,871 % Losses and loss expenses $437,525 Underwriting expenses... 432,228 100.0 98.8 $205,358 183,518 100.0 Tolal losses and expenses.. 32,490 7.4 50,484 89.4 $291,926 241,530 100.0 24.5 78,943 82.7 Underwriting (Loss) - pre-tax. $(27,193) 464,718 106.2 $(28,644) 113.9 320,473 27.1 234,002 $ (28,547) 109.8 Disaggregated data relating to reinsuring activities of the Insurance Group are presented below. Premiums Earned Underwriting Loss Dollars in Millions Year-End Reserves* Major quota share reinsurance $130.6 $215.5 Other reinsurance except $ 12.3 332.6 $411.9 $434.8 Structured settlements... structured settlements $437.5 $205.4 $291.9 $27.2 $ 28.6 $ 28.5 $1,463.7 $797.2 $739.6 197.1 128.9 *Unpaid losses and loss adjustment expenses Premiums earned from major quota share reinsurance shown above for 1989 and 1988 reflect those from the arrangement under which, for a four year term from September 1, 1985 through August 31, 1989, National Indemnity assumed 7% of the business written by the Fireman's Fund Insurance Companies. the premiums earned in 1990 preponderantly represent the consideration received for the adverse loss For the category in the above table captioned "other reinsurance excluding structured settlements," development contracts referred to in the second paragraph of this discussion of reinsurance assumed. No underwriting gain or loss was recorded for 1990 with respect to those contracts entered into in the fourth quarter of 1990. Amortization of the $350,787,000 deferred charges established in 1990 with respect thereto will commence in 1991. accretion of the liabilities therefor, except that a modest amount of actuarial gain was credited in 1989. The underwriting loss from structured settlements in each of the past three years reflect principally 43

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Management's Discussion (continued) Insurance Segment Investment Income Following is a summary of Insurance Group net investment income for the past three years. 000s Omitted Investment Investment Income Applicable Applicable Income After Before Income Minority Taxes and Taxes Taxes Interest Minority Int. 1989 1990. $327,047 $ 41,264 $ 3,170 $282,613 1988 243,599 26,756 3,201 213,642 231,250 30,698 2,773 197,779 approximately $900 million additional capital to the Group, and reinvested earnings of the Group for that Invested assets increased in each of the past three years. During that period, Berkshire contributed period amounted to approximately $850 million. Additionally contributing to the increase in invested assets during the three-year period was about $175,000,000 increased "float" from policyholder funds. (That term denotes the sum of unpaid losses, unpaid loss adjustment expenses and unearned premiums, less the aggregate of agents' balances receivable, amounts recoverable as reinsurance on paid losses, deferred policy acquisition costs and deferred charges re reinsurance, the net amount of which totalled approximately $1,632,000,000 at the end of 1990.) investment in the Gillette convertible preferred stock that will be converted on April 1, 1991 into Gillette The Insurance Group received 1990 dividend income of $52,500,000 with respect to its $600,000,000 common stock. Annual dividends from such common stock, at Gillette's current common dividend payment rate, would amount to approximately $13,000,000. Thus, some decrease from the 1990 level of Insurance Group investment income may occur in 1991. Manufacturing, Merchandising and Services Results of operations for the past three years of Berkshire's diverse non-insurance businesses are aggregated in the following table. Dollar amounts are in thousands. 1990 1989 1988 Revenues..... $1,657,025 Amount 10000 % $1,601,858 Amount % 1,429,652 227,373 86.3 Applicable minority interest 88,952 13.7 1,389,317 100.0 $1,486,194 Amount Costs and expenses...... Net earnings.. $ 132,209 6,212 5.4 212,541 86.7 0.3 82,644 13.3 1,274,466 100.0 Applicable income taxes ...... Earnings before income taxes.. 8.0 $ 124,129 5,768 5.2 211,728 14.2 85.8 0.4 80,154 5.4 7.7 $ 126,260 5,314 8.4 0.4 A mounts reflected above for "Revenues" exclude certain items of investment income earned by the corporate entities conducting these businesses where that income is not clearly attributable to the capital earned in prior years — $11.6 million in 1989 and $14.5 million in 1988, but for purposes of comparability allocated to the businesses. Such items aggregated $40.9 million for 1990. Lesser amounts of such items were to 1990 data, data for the prior years are restated to remove the items and their effects on taxes, minority interest and earnings. insurance businesses — including the six non-insurance "reportable business segments" - identified on The above data for 1990 and 1989 represents the combined results from operations of the non- and Loan Association and moderate scale real estate management activities of Berkshire and Wesco. page 50 plus financing operations of the Scott Fetzer Financial Group, plus operations of Mutual Savings 44

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Manufacturing, Merchandising and Services (continued) by approximately $51 million or about 5%, and their operating profits before taxes were greater in 1990 than Revenues of the six non-insurance reportable business segments were greater in 1990 than in 1989 pre-tax profits from the twenty five-plus operations were generated by those six business segments. Further in 1989 by approximately $12 million or about 7% Thus, virtually all of the increased 1990 revenues and information about each of the six follows. See's Candy Business See's candy business recorded its highest-ever annual sales volume in 1990. However, the physical volume was up over 1989 by less than 1%. An increase of approximately 4.5% in pounds sold in response to quantity orders was reduced by a decrease of about 2% in pounds sold from the retail stores. A selling volume of sales, resulted in a $10.1 million, 5.4% increase in 1990 candy sales revenue over 1989. price increase of about 5%, initiated at the beginning of the year, together with the slight increase in physical traffic at West Coast mall stores has continued into 1991. Unless this pressure abates on retail sales, it is The slowing in 1990 retail store volume was more notable in the last quarter of the year. Reduced unlikely that increases in revenue or operating profit can be achieved at See's in the current year, notwithstanding some increase in 1991 selling prices. Newspaper Business profits were virtually unchanged from, those for the prior year's first nine months. However, in 1990's fourth The total newspaper revenues for the first nine months of 1990 were about 1% ahead of, and pre-tax quarter, a marked decline occurred in virtually every category of advertising lineage and revenue, with the result that revenues at the Buffalo News were down from 1989's fourth quarter periods by approximately $1.3 million, or 3%. declined 5% in 1990 to $43.4 million, from $45.4 million in 1989. The decrease in annual profits is the first As a result of the fourth quarter recessionary pressures, newspaper operating profits before taxes paper in 1983 (when the paper's annual operating profits were $19 million). But, the pressures on revenues experienced for the Buffalo News since Berkshire succeeded to 100% from its earlier 60% ownership of the and earnings are seen as continuing, so that another and somewhat greater decline is in prospect for the paper's 1991 earnings. Retailing of Home Furnishings quarter sales increased by a lesser 1%. Higher 1990 sales came primarily from increased sales of electronics The Nebraska Furniture Mart's revenues increased 4% in 1990 over 1989. However, 1990's fourth and appliances, as the Mart increased its share of the area market for those products. pressures, 1990 added costs were incurred to achieve improved customer service, particularly payroll costs Costs at the Mart in 1990 increased over 1989 at a greater rate than sales. In addition to inflationary for added point-of-sale personnel. Encyclopedias, Other Reference Materials as did domestic sales of publications other than encyclopedias. Domestic unit sales of and dollar revenue Revenues of this segment were about 1% higher for 1990 than for 1989. International sales increased encyclopedias was disappointing in 1990, possibly because of inadequate recruitment of sales representatives. from the latter declined in each of the past two years. Response to domestic special promotions of the to $31.6 million. Among other factors contributing to this increase were lower 1990 costs relating to relocating Pre-tax profit of this segment in 1990 increased over 1989 by approximately $6.3 million, or 25%, and reorganizing the activities of the segment. Such costs incurred were $6.9 million in 1989 versus 515 million in 1990. Also foreign currency exchange gains of approximately $700,000 were recorded for the segment in 1990, contrasted to foreign exchange losses in 1989 that amounted to approximately $550,000. 45

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Management's Discussion (continued) Manufacturing, Merchandising and Services (continued) Introduction in 1990 of the Generation III model Kirby vacuum cleaner generated significant Home Cleaning Systems consumer response. Unit sales of Kirby cleaners in 1990 were up 8% domestically and 20% internationally over 1989. The unit price of the new model is higher than for the replaced Legend II model, so that dollar revenues of this segment increased 18% from 1989 to 1990. Success in marketing the new Kirby product masked a $2 million decline in 1990 from sales, principally to retailers, of specialty vacuum products. Fechheimer Uniforms 1990 over 1989. Operating profits of the operation would have been slightly higher in 1990 than for those Revenues from this uniform manufacturing and marketing operation were up slightly - 1% - in of unused, appreciated real estate. Fourth quarter 1990 results also compared unfavorably with fourth quarter of the prior year except for a $500,000 gain realized in the prior year's fourth quarter upon sale of a parcel 1989 results because of a larger than anticipated year-end LIFO inventory adjustment. Except for the latter gradually decreased in integrating into the operations a manufacturing facility acquired in 1989. Further bookkeeping adjustment, levels of profitability of the segment gradually improved during 1990 as problems improved operating results from this segment are in prospect for 1991. Interest Expense the 1989 and 1990 increases reflect the expense recorded for accretion of the zero coupon convertible Interest on debt increased in both 1990 and 1989, reflecting increased outstanding borrowings. Both subordinated notes issued on September 28, 1989. The 1990 increase over 1989 additionally reflects the added borrowing costs with respect to the increase in the average outstanding obligations under investment contracts. Realized Investment Gain The amount - recorded by Berkshire when appreciated securities are sold - tends to fluctuate significantly Realized investment gain has been a recurring element in Berkshire's net earnings for many years. of realized investment gain for any period has no predictive value, and variations in amount from period from period to period, with a meaningful effect upon Berkshire's consolidated net earnings. But, the amount to period have no practical analytical value, given the pre-existence of substantial unrealized price appreciation in Berkshire's consolidated investment portfolio. Liquidity and Capital Resources Berkshire shareholders' equity has increased from approximately $2.84 billion at December 31, 1987 to Berkshire's Consolidated Balance Sheet as of December 31, 1990, reflects continuing capital strength. approximately $5.29 billion at December 31, 1990. In that three-year period, realized and unrealized securities gains increased equity capital by approximately $1.46 billion. Reinvested earnings, other than realized securities gains, were approximately $984 million for the three years. Berkshire senior debt. Indebtedness of creditors that is subordinated to senior debt normally receives a rating In early 1991, Standard and Poor's Corporation reaffirmed its assignment of a AAA credit rating to notes retains an AA + rating from that rating agency. one gradation lower than for the senior debt. Accordingly, Berkshire's issue of zero coupon subordinated 46

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BERKSHIRE HATHAWAY INC. INSURANCE GROUP headed by National Indemnity Company headquartered in Omaha, Nebraska. The Berkshire's insurance business is conducted by 12 separate subsidiaries, members underwrite multiple lines of principally casualty coverages for primarily bus operators, and casualty coverages for especially large or unusual risks. The commercial accounts, providing, for example, liability coverages for truck and in New York City, solicit and underwrite the latter. Members domiciled in Commercial Casualty/Professional Liability/Special Risks Division, with offices property/casualty insurance to "homestate" residents. A California domiciled the states of Colorado, Kansas and Nebraska provide standard multiple-line member provides principally workers' compensation insurance to employers in property/casualty insurers and A Reinsurance Division in New York City provides treaty reinsurance to other This division is currently one of the leading providers reinsurance and property/catastrophe retrocessional protection (i.e., reinsurance for reinsurers). unparalleled high levels, significantly higher tha maintain inape industry this The Berkshire Hathaway Group's net premiums written in 1990 were approximately 9% of the Group's strength differentiates Group members from their competitors. For example, the year-end statutory surplus. That compares to an industry average premiums-to- provided to insureds of the Group are particularly persuasive in marketing of surplus ratio of about 155% (for 1989). The obvious margins of safety thus individually negotiated insurance and reinsurance contracts. Group - unaudited and not fully adjusted to conform to Generally Accepted Combined financial statements of the Berkshire Hathaway Inc. Insurance Accounting Principles - are presented on the following two pages. 47

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BERKSHIRE HATHAWAY INC. INSURANCE GROUP (dollars in millions) Balance Sheets December 31, Assets 1990 1989 Investments: Fixed maturities at amortized cost: Bonds: RJR Nabisco... Wash. Pub. Power Supply System $ 187.7 Redeemable preferred stocks: Other 188.9 $ 136.5 377.4 409.4 194.0 Champion International ... Gillette......... 279.0 USAir Salomon Inc 600.0 279.0 637.0 624.0 600.0 Equity securities at market: Other 348.0 0.7 348.0 0.7 Common stocks: Capital Cities/ABC, Inc. GEICO .. Coca-Cola Company. 2,166.0 1,354.4 1,799.2 1,664.2 Wells Fargo Company Washington Post. 1.110.6 342.1 1,044.6 232.9 278.7 486.4 Nonredeemable preferred stocks Other. 60.6 72.6 63.1 23.5 Receivables.. Cash and cash equivalents.. 8,176.0 7,733.2 222.2 115.6 45.4 Other. Deferred costs 364.2 71.0 2.3 15.0 2.3 $8,880.3 $7,866.9 Liabilities Unearned premiums.. Loss and loss adjustment expenses. $2,050.3 226.0 126.4 $1,436.3 Income taxes (Deferred: $1,081.1, 1990; $1,095.3, 1989) . Accounts payable, accruals and other. 143.6 1,099.0 1,136.2 201.0 Equity 3.501.7 2,917.1 Minority shareholders'..... Berkshire shareholders' 5,338.8 39.8 4,914.6 35.2 5,378.6 4,949.8 $8,880.3 $7,866.9 These statements do not conform to GAAP in all respects These statements are unaudited 48

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BERKSHIRE HATHAWAY INC. INSURANCE GROUP Statements of Earnings (dollars in millions) Premiums written. 1989 $ 296.1 emiums earne Underwriting expenses ses and loss expens $ 394.3 309.4 Total losses and expenses 109.3 Net investment income.. Underwriting loss - pre-tax. 418.7 (24.4) Realized investment gain 243.9 Income tax expense.. Earnings from operations before income taxes 220i. Minority interest. Net earnings ... 3.0 $ 347.2 Statements of Net Investment Income (dollars in millions) 1990 1989 1988 Interest: Substantially exempt from Federal income taxes: Wash. Pub. Power Supply System Taxable: Other. $ 27.1 30.5 $ 27.3 51.6 $ 34.6 64.6 RJR Nabisco 27.0 3.4 Other.. 91.2 6.6 100.8 18.5 145.9 46.7 Dividends: Champion International Capital Cities/ABC, Inc. 25.8 0.6 0.6 37.3 1.9 0.6 52.5 13.7 31.3 - GEICO ... Coca-Cola Company... 12.3 4.4 56.1 23.5 11.2 Gillette. 32.2 56.1 - USAir... Salomon Inc 10.8 6.9 12.9 56.1 3.2 - Washington Post... 335.9 8.8 6.1 2.0 - 2.7 Other. Wells Fargo Company. $ 327.0 (8.9) 250.7 231.9 11.0 Investment expenses..... $ 2463) $ 231.2 _(0.Z) Net investment income... These statements do not conform to GAAP in all respects These statements are unaudited 49

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BERKSHIRE HATHAWAY INC. MANUFACTURING, PUBLISHING AND RETAILING BUSINESSES not fully adjusted to conform to Generally Accepted Accounting Principles - are presented on the following page. The Combined financial statements of Berkshire's Manufacturing, Publishing and Retailing businesses - unaudited and operations whose data have been combined in these presentations include Berkshire's six non-insurance "reportable business segments," as well as the following: Operation Activity/product/service Adalet...... Conduit fittings, explosion proof fittings, junction boxes Borsheim's....... Blue Chip Stamps.. Retailing of fine jewelry Trading stamps Carefree .. Campbell Hausfeld Roll-up awnings, other RV accessories Air compressors and accessories, painting systems Halex..... France .. Zinc and aluminum die cast fittings Appliance controls, ignition and sign transformers Meriam....... KEW Products Automotive compounds New America Electric Pressure and flow measurement devices Northland... Fractional horsepower motors Manufacturer of electrical equipment Precision. Powerwinch Steel service center Boat winches, windlasses Scot Labs Quikut ... Cleaning and maintenance chemicals Varieties of cutlery Stahl .... Wayne Home Equipment Custom steel services bodies and tool boxes for trucks Western Enterprises Compressed gas fittings and regulators Furnace burners; sump, utility and sewage pumps Western Plastics... Molded plastic components The six non-insurance "reportable business segments" are more fully described below. It is the only metropolitan newspaper published daily within a ten county upstate New York distribution area that comprises Newspaper - The Buffalo News, a division of Berkshire, publishes a Sunday edition and seven editions each weekday. one of the nation's 50 largest primary market areas. Fechheimers manufactures its products at plants in Kentucky, Ohio, Tennessee and Texas, for marketing through forty- Uniform Manufacturing and Distribution - Berkshire acquired its 85% ownership interest of Fechheimers in mid-1986. two company-owned retail distribution centers and by independent dealers who together serve more than 200 of the country's major metropolitan areas. and products, sold to approximately 700 factory distributors who in turn sell them to a network of area distributors and Home Cleaning Systems — This segment of Berkshire's business is principally represented by Kirby cleaning systems dealers. Independent dealers employ in-the-home demonstrations for direct resale to consumers. Douglas Products department stores, catalogue showrooms and hardware stores. Data with respect to Cleveland Wood Products Company, Company manufactures specialty vacuum cleaners such as hand-held electric and cordless units distributed through a manufacturer of vacuum cleaner brushes, is also reported within this segment. a very large - over 200,000 square feet - retail outlet and sizable warehouse facilities in Omaha, Nebraska. It serves a Retailing of Home Furnishings - The Nebraska Furniture Mart operates a home furnishing retail business from trade area with a radius around Omaha of approximately 300 miles. Berkshire owns 80% of this business; key managers own 20%. large kitchens in California. See's distributes its candies through its own retail stores - over 200 in number - located Candy - See's produces boxed chocolates and other confectionery products with an emphasis on quality in two in 12 western and midwestern states, including Hawaii. A meaningful volume of candy business is also recorded for direct shipments made nationwide from a seasonally-varying number of quantity order distribution centers. libraries. Its chief products include: The World Book Encyclopedia, the world's largest-selling encyclopedia; Childcraft, Encyclopedias, Other Reference Materials — World Book publishes educational products for homes, schools, and other educational material are marketed in the United States and Canada by a large direct-selling force of some 35,000 a resource library for young children; and Early World of Learning, a readiness program for preschoolers. These and publication for owners of earlier editions, and other products are sold by direct mail and telemarketing. An international members. A newly copyrighted edition of World Book is published each year. The World Book Year Book, an updating the world. group distributes these and other specially created products in Australia, the British Isles, and other key markets around 50

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BERKSHIRE HATHAWAY INC. FINANCE-TYPE BUSINESSES Mutual Savings and Loan Association and its subsidiary and Scott Fetzer Financial Group, Inc. and its subsidiaries make up Berkshire's finance-type operations. (dollars in millions) Balance Sheets 1990 December 31, 1989 Assets Investments at cost: Cash and cash equivalents $ 72.9 $ 40.0 Fixed maturities: Redeemable preferred stocks 17.5 17.0 17.5 30.5 Equity securities: Nonredeemable preferred stocks FHLMC common stock 71.7 36.8 36.8 71.7 Installment and other receivables Collateralized loans receivable (1) 169.7 131.1 153.8 21.2 11.1 173.2 Other. Prepaid income taxes 17.2 12.9 $ 549.0 $ 553.6 Liabilities Accounts payable, accruals and other Savings accounts $ 286.4 22.2 $ 293.1 157.1 1.3 18.4 Income taxes. 159.6 1.5 Term debt and other borrowings. 467.0 472.6 Equity Minority shareholders 71.9 10.1 71.3 9.7 Berkshire shareholders' 82.0 $ 553.6 81.0 $ 549.0 Statements of Earnings (dollars in millions) 1990 1989 1988 Revenues: Interest and fees on loans and financed receivables... Interest and dividends on investment securities. $ 51.9 $ 49.4 19.2 $ 50.2 18.3 20.9 Sundry income 70.5 0.3 68.9 0.3 71.7 0.6 Expenses: Interest on savings accounts 22.0 13.9 21.5 14.1 20.8 Interest on debt... 14.3 General and administrative. 57.0 20.7 20.8 23.3 56.2 58.2 Earnings from operations before income taxes 13.5 12.7 13.5 Income tax expense 1.7 11.5 1.2 11.5 2.0 Minority interest. 11.8 Net earnings. $ 11.0 0.8 $ 10.7 0.8 $ 10.5 1.0 (1) Includes mortgage-backed securities of $23.7, 1990 and $34.3, 1989. These statements do not conform to GAAP in all respects These statements are unaudited 52

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BERKSHIRE HATHAWAY INC. NON-OPERATING ACTIVITIES These statements reflect the consolidated financial stalement values for assets, liabilities, shareholders' equity, revenue and expenses that were at asianed any Bed page (pagop to saroup in the unaudied, and not fly CAP: adius. Statements of Net Assets (dollars in millions) December 31 Assets 1990 1989 Investments: Cash and cash equivalents...... $ 29.9 $ 96.0 Fixed maturities Bonds: RJR Nabisco. Redeemable preferred stocks Other. 252.6 81.0 74.3 74.8 11.5 81.0 0.2 Property account adjustments (1) Common stocks. 20.1 Prepaid income taxes. Unamortized goodwill (1) 136.5 73.6 140.5 79.5 Other. 32.8 8.0 64.7 9.0 $ Liabilities 708.8 $ 557.2 Income taxes Accounts payable, accruals and other $ 33.8 1,046.2 (7.8) $ (24.7) 31.6 Term debt and other borrowings 1,072.2 816.8 809.9 Equity Berkshire shareholders' Minority shareholders' 3784) 15.0 (272.3) 12.7 $ (363.4) 708.8 $ (259.6) 557.2 Statements of Earnings (dollars in millions) 1990 1989 1988 Revenues: Interest and dividend income $ Sundry income 41.1 61.3 20.2 $ .9.3 7.2 $ 28.5 7.4 16.5 35.9 Expenses: Shareholder designated contributions Corporate administration.. 4.1 5.8 3.4 3.4 5.9 5.0 3.8 3.5 Other costs and expenses Interest on debt.. Property account adjustments (1) Amortization of goodwill (1).... 6.0 37.3 6.0 2.7 30.7 6.9 28 91.3 56.9 0.9 49.6 0,5 Income tax credit... Excess of expenses before income taxes (30.0) (22.4) 7.6 (40.4) (30.6) 9.8 (13.7) (12.5) 1.2 Net loss Minority interest 1.1 0.6 (13.6) 1.1 (1) "Property account adjustments" and goodwill arose in accounting for business acquisitions. These statements do not conform to GAAP in all respects These statements are unaudited 53

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BERKSHIRE HATHAWAY INC. SHAREHOLDER-DESIGNATED CONTRIBUTIONS October 14, 1981, the Chairman sent to the shareholders a letter* explaining the program. Portions of that The Company has conducted this program of corporate giving during each of the past ten years. On that, in most years, should produce a significant benefit for charities of your choice. "On September 30, 1981 Berkshire received a tax ruling from the U.S. Treasury Department hat he owns - will be able to designate recipients of charitable contributions by our company. You'l "Fach Berkshire shareholder - on a basis proportional to the number of shares of Berkshire ame the charity: Berkshire will write the check. The ruling states that there will be no persona tax consequences to our shareholders from making such designations. exercised by the owners in closely-held businesses, is almost exclusively exercised by the managers "Thus, our approximately 1500 owners now can exercise a perquisite that, although routinely in more widely-held businesses. no input at all from shareholders, in two main categories: "In a widely-held corporation the executives ordinarily arrange all charitable donations, with (1) Donations considered to benefit the corporation directly in an amount (2) Donations considered to benefit the corporation indirectly through hard- roughly commensurate with the cost of the donation; and to-measure, long-delayed feedback effects of various kinds. all charitable donations in the first category. However, the aggregate level of giving in such category "I and other Berkshire executives have arranged in the past, as we will arrange in the future, has been quite low, and very likely will remain quite low, because not many gifts can be shown to produce roughly commensurate direct benefits to Berkshire. comfortable with ordinary corporate practice and had no better practice to substitute. What bothers "In the second category, Berkshire's charitable gifts have been virtually nil, because I am not the asking and how corporate peers are responding than on an objective evaluation of the donee's me about ordinary corporate practice is the way gifts tend to be made based more on who does activities. Conventionality often overpowers rationality. "A common result is the use of the stockholder's money to implement the charitable inclinations Frequently there is an added incongruity; many corporate managers deplore governmental allocation of the taxpayer's dollar but embrace enthusiastically their own allocation of the shareholder's dollar. your personal judgments by writing checks on my bank account for charities of your choice, I feel "For Berkshire, a different model seems appropriate. Just as I wouldn't want you to implement it inappropriate to write checks on your corporate "bank account" for charities of my choice. Your charitable interests in a tax-deductible manner reside largely at the corporate level rather than in charitable preferences are as good as mine and, for both you and me, funds available to foster our own hands. not larger public companies. If you and I each own 50% of a corporation, our charitable decision 'Under such circumstances, I believe Berkshire should imitate more closely-held companies, have first claim on our available charitable funds. Any balance available after the "operations-related" making would be simple. Charities very directly related to the operations of the business would proportional to our ownership interest. If the manager of our company had some suggestions, we contributions would be divided among various charitable interests of the two of us, on a basis roughly aspect of the business we probably would behave as if we were a partnership. would listen carefully - but the final decision would be ours. Despite our corporate form, in this *Copyright © 1981 By Warren E. Buffett All Rights Reserved 54

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we operate through a large, fairly widely-held corporation. Our Treasury ruling will allow such "Wherever feasible, I believe in maintaining such a partnership frame of mind, even though partnership-like behavior in this area... understandable, that a large and growing number of major corporations have charitable policies "I am pleased that Berkshire donations can become owner-directed. It is ironic, but

• many even match gifts made by directors) but none, to my knowledge, has a plan matching charitable

pursuant to which they will match gifts made by their employees (and - brace yourself for this one gifts by owners. I say "understandable" because much of the stock of many large corporations is that lack a long-term owner's perspective... owned on a "revolving door" basis by institutions that have short-term investment horizons, and "Our own shareholders are a different breed. As I mentioned in the 1979 annual report, at the beginning of the year. This long-term commitment to the business reflects an owner mentality which, end of each year more than 98% of our shares are owned by people who were shareholders at the is an example of that intent." as your manager, I intend to acknowledge in all feasible ways. The designated contributions policy ** * The history of contributions made pursuant to this program since its inception follows: Specified Amount Eligible* Shares Percent of Year per share Participating Contributed Amount Charities No. of 1981 1982 $1 $2 95.6% 1983 $3 96.4% 95.8% $1,783,655 $ 890,948 675 $3,179,049 $3,066,501 1,353 704 1985 1984 $4 $3 96.8% 97.2% $3,996,820 $4,006,260 1,724 1,519 1986 1987 $4 $5 97.1% 1988 1989 $6 $5 96.9% 97.4% 97.2% $4,965,665 $4,937,574 1,934 2,050 1990 $6 97.3% $5,867,254 2,319 $5,823,672 2,550

• Shares registered in street name are not eligible to participate.

2,600 In addition to the shareholder-designated contributions summarized above, Berkshire and its subsidiaries have made certain contributions pursuant to local level decisions of operating managers of the businesses.

substandard or no tax deductions. In other years Berkshire expects to inform shareholders of the amount The program may not be conducted in the occasional year, if any, when the contributions would produce respond with their designations. If the program is conducted in 1991, the notice will be mailed on or about per share that may be designated, and a reply form will accompany the notice allowing shareholders to 31, 1991, and shareholders will be given until November 15 to respond. September 15 to shareholders of record reflected in our Registrar's records as of the close of business August program. To qualify, shares must be registered on August 31 in the owner's individual name(s) or the name Shareholders should note the fact that shares held in street name are not eligible to participate in the of an owning trust, corporation, partnership or estate, as applicable. 55

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The 1990 Annual Report of Wesco Financial Corporation included the following letter* to Wesco stockholders from the Chairman of the Company. WESCO FINANCIAL CORPORATION LETTER TO SHAREHOLDERS To Our Shareholders: ompany, headquartered in Omaha and currently engaged principally in the reinsurance business, an Wesco has three major subsidiaries, Mutual Savings, in Pasadena, Wesco-Financial Insurance products businesses. Consolidated net income for the two years just ended breaks down as follows (in recision Steel, headquartered in Chicago and engaged in the steel warehousing and specialty met 000s except for per-share amounts) ': Year Ended December 31, 1990 December 31, 1989 Wesco Per "Normal" net operating income of: Amount Amount Share Mutual Savings $4,099 $ .58 Wesco-Financial Insurance business. $ 4,191 14,924 2.10 14,276 $ .59 2.00 Precision Steel's businesses .. All other "normal" net operating income(2) ••• 1,985 .28 2,769 .39 25,038 4,030 3.52 .56 24,414 3,178 3.43 .45 Wesco consolidated net income Net gains on sales of marketable securities •.. 391 .05 $3.57 5,920 $25,429 $30,334 .83 $4.26 (1) All figures are net of income taxes. statements which follow standard accounting convention. The supplementary breakdown is furnished This supplementary breakdown of earnings differs somewhat from that used in audited financial because it is considered useful to shareholders. Mutual Savings $4,191,000 figure the previous year. Mutual Savings' "normal" net operating income of $4,099,000 in 1990 was almost equal to the As usual, these "normal-income" figures come from an abnormal savings and loan association. annual report. They show (1) total savings accounts declining to $286 million from $293 million the year Separate balance sheets of Mutual Savings at yearend 1989 and 1990 are set forth at the end of this any mature U.S. savings and loan association), (3) a substantial portion of savings account liabilities before, (2) a very high ratio of shareholders' equity to savings account liabilities (near the highest for mortgages) of about $131 million at the end of 1990, down moderately from $154 million at the end of offset by cash equivalents and marketable securities, and (4) a loan portfolio (mostly real estate equity in Mutual Savings overstates the amount realizable, after taxes, from sale or liquidation at book As pointed out in Note 9 to the accompanying financial statements, the book value of Wesco's value of the $47 million portion of Mutual Savings' shareholders equity which is considered bad debt value. Wesco would get only about $30.8 million, after paying income taxes, from the liquidation at book

• A few small sections of Mr. Munger's letter have been excluded: When Berkshire's report exceeds 72 pages, we have

flip was appropriate. In fact - as things turned out - I finally decided nine flips were appropriate. - W. E.B. problems in binding it. Because of this limitation, either Charlie's letter or mine had to be cut and I decided a coin 56

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Reproduced from 1990 Annual Report of Wesco Financial Corporation reserves for income tax purposes. The $4.1 million Mutual Savings earned in 1990 is an inadequate return (8.7%) on the $47 million amount at which we try to maintain shareholders' equity, but this same $4.1 million is a respectable return (13.3%) on the $30.8 million which would be the after-tax proceeds of liquidation at book value. an average interest rate of only 9.20%, probably near the lowest among U.S. savings and loan The loan portfolio at the end of 1990, although containing almost no risk of loss from defaults, bore almost entirely made up of instruments of short maturity or bearing interest rates that adjust automati- associations and roughly the same as the 9.23% rate at the end of 1989. Because the loan portfolio is unrealized appreciation in Mutual Savings' interest-bearing securities and public utility preferred stocks. cally with the market, there is now much less unrealized depreciation in the loan portfolio than the net That appreciation at December 31, 1990 was about $11 million. on loans remains too low to provide respectable profits, this "spread" improved again last year. The While the "spread" between Mutual Savings' average interest rates paid on savings and received "spread" improved because interest rates paid on savings declined. Moreover, the disadvantage from inadequate "spread" has been reduced in each recent year by the effect of various forms of tax- advantaged antidote to inadequate interest rate margin on loans is the risk that preferred stock and advantaged investment, primarily preferred stock and municipal bonds. The negative side of this tax- to cover Mutual Savings' interest and other costs, if the general level of interest rates should sharply municipal bonds, with their fixed yield and long life, will decline in value, and not provide enough income amount of its net worth. rise. In view of this risk, Mutual Savings' total commitment has been kept conservative, relative to the causing Mutual Savings, step by step, to dispose of the preferred stock portion ($54.4 million, at cost, at New federal legislation enacted in 1989, widely known under the acronym "FIRREA," is now preserve earning power because tax-equivalent yield is so high (about 15% at December 31, 1990). December 31, 1990) of its tax-advantaged assets. Ownership of preferred stock has heretofore helped make impracticable the replacement, as they mature, of Mutual Savings' direct holdings of municipal Adding to our forced-disposition-of-desirable-assets problem, recent changes in income-tax law now bonds ($16.9 million, at cost, at December 31, 1990). The municipal bonds also have a high tax- expect virtually all benefit from tax-advantaged investment to vanish from Mutual Savings. equivalent yield (about 17.5% at December 31, 1990). By mid-1994, and possibiy much sooner, we ends June 30, 1991) requiring 60% of assets to be in various housing-related categories. It will shortly Mutual Savings remains a "qualified thrift lender" under the old federal regulatory standard (which change its asset mix as necessary to comply with a new standard, imposed by FIRREA, which requires that 70% of assets be maintained in a more restricted list of housing-related assets. its required 70% in housing-related assets within the following five categories: Until U.S. laws governing financial institutions are further revised, Mutual Savings expects to keep (1) mortgages issued in the course of sale of individual parcels, as Mutual Savings disposes of toreclosed seaside property in Santa Barbara, California; (2) directly made, fixed-rate house mortgages with short expected lives; (3) indirectly made fixed-rate house mortgages with short expected lives, purchased in the open market in the form of mortgage-backed securities; (4) a modest amount of directly made, long-term house mortgages with variable interest rates that fluctuate with the market up to 25% per annum; (5) a substantial number of directly made, long-term, fixed-rate house mortgages given only to within sever miles of Mutual Savingsoffice,and support Mutual Savings tons with hone persons of low-to-moderate income, many in minority groups, who have good credit, reside equities amounting to at least 20% of house value, with the maximum size of mortgage permitted being about $191,000. mortgages for local people of low-to-moderate income. Indeed this category is expected to cover a We will work hard to expand assets in category (5), covering small, long-term, fixed-rate house slightly below-market interest rates. Therefore, each new loan will cause an immediate economic loss, majority in number of all new directly made mortgages. We expect to impose no loan fees and to charge which will hit our earnings statement even before we sell the loans, as we plan to do. The loans will be 57

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Reproduced from 1990 Annual Report of Wesco Financial Corporation resold, not because they are inferior credit instruments, but because we do not wish to endure the asset-versus-liability maturity mismatch imposed by any long-term, fixed-rate mortgage. covered by category (5). As a result, in our area there can now be no lack of availability in this category FIRREA has increased pressure on both banks and associations to expand lending of the sort face a shortage of qualified applicants. Given this shortage, as we now compete with bigger, better loan of market-rate loans, meeting legislative objectives, for persons with good credit. Instead, all lenders departments of larger institutions, the most efficient way to get our share of qualifying loans is to quote below-market interest rates and loan charges. our share, which we can well afford to do. We regret that we waited so long to compete vigorously for We do not resent making these loss-causing loans. We intend, with pleasure, to make more than simplicity. We were formerly brain-blocked, because (1) we didn't want to hold any long-term, fixed-rate these loans and that we required regulatory prompting before we found a satisfactory solution of such variable-rate loan we were willing to make, (3) we had never routinely resold loans or deliberately loans, (2) we didn't want to impose on moderate-income borrowers the risks implicit in the only kind of loaned at a loss, and (4) we were preoccupied with avoiding calamitous results which came to many That aspect of our program is the result of our initiative alone. other savings and loan operators. Regulators, of course, have not demanded that we now lend at a loss. category (4), covering our variable-rate loans which can escalate to bear interest rates of 25%. These We have had trouble attracting a significant volume of loans, with satisfactory characteristics, in loans have been in short supply despite our use of a very low interest rate spread (about 2 percentage variable-rate loans, we have encountered several collection delays, partly attributable to an incompetent points over the one-year U.S. Treasury rate). Moreover, while we have realized no losses on our significance. policy decision of the Chairman. These two factors cause us to expect this category to shrink to minor category for us. But it could eventually amount to a substantial percentage of assets, depending on what Category (3), the short-term, fixed-rate, mortgage-backed security category, is a "last-resort" is available elsewhere. Despite our love of comedy, we are going to avoid the newest form of "Jump Z tranches in REMICS." As we select mortgage-backed securities, we will probably not be buying any complex instruments. This refers to a particular subdivided by obliging issuers, advised by obliging investment bankers, into two new contractual contractual fraction — the "Z Form" - of a pool of mortgages, now fractions: (1) the "Sticky Jump Z" and (2) the "Non-Sticky Jump Z." At this rate, subdivision will soon get down to quarks. prospect of state and federal examiners, none of whom has a Ph.D. in physics, reviewing, one after the We are deterred from buying such securities partly by our hatred of complexity. We also dread the the wonders of modern finance go on without us as we yearn for a lost age when most reasonable other, our choices for soundness and billing us on a cost-plus basis to reflect value thus added. Some of people could, with effort, understand what was going on. (exclusive of the one-time effect of development of our foreclosed seaside property) to continue to In total, during the next few years, our policies will very likely cause our housing-related assets may not quite cover incremental interest and operating costs as we invest each new dollar of savings. It produce close to the lowest average gross return in the savings and loan industry. Incremental returns is quite conceivable that Mutual Savings will decline in size because it should decline in size. shareholders with moderate expectations. Our optimism comes mainly (1) from an expected minor Even so, we expect that Mutual Savings will muddle through in a manner satisfactory to Wesco boost caused by ownership of our large holding of Freddie Mac stock. Both of these grounds for profit boost from disposition of our foreclosed seaside property and (2) from an expected major profit optimism are discussed below. Barbara, acquired in 1966. By the time Mutual Savings started development (into 20 houses and 12 Mutual Savings has a buried value in a piece of foreclosed property: 22 seaside acres in Santa built-in appreciation will now be captured through development, assuming no large reverses caused by lots) in order to facilitate sale, the value of this property had appreciated by at least $12 million. The collapse of housing prices or unanticipated new regulatory troubles. 58

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Reproduced from 1990 Annual Report of Wesco Financial Corporation sale of about half the parcels during the next year. There will be little or no profit added to built-in The first house is nearly finished, and about 15 houses are under construction. We expect to close appreciation by the development process. Seaside land development, under present regulatory and happenings and closely resembles a Chevy Chase movie of extreme duration. market conditions in California, tends to be a no-profit activity - if you are lucky. It is full of queer Home Loan Mortgage Corporation (widely known as "Freddie Mac") to 2,400,000 shares, 4% of total In 1988 Mutual Savings made a large and unusual purchase. It increased its holdings of Federal per share in trading on the New York Stock Exchange at the end of 1990. Thus, based on 1990 yearend shares outstanding. Mutual Savings' average cost is $29.89 per share, compared to a price of $48.75 trading prices, Mutual Savings had an unrealized pre-tax profit in Freddie Mac shares of about $45.3 million. At current tax rates the potential after-tax profit is about $26.7 million, or $3.75 per Wesco share outstanding. now owned privately, largely by institutional investors. It is now led by a very smart CEO, Leland Freddie Mac, created and long run by a federal agency (the Federal Home Loan Bank Board), is Banc One and Henry Kaufman, former chief economist of Salomon Brothers. Freddie Mac supports Brendsel, and governed by an outstanding independent board of directors, including John B. McCoy of backed securities that it guarantees and promptly sells. In the process Freddie Mac earns fees and housing primarily by purchasing housing mortgage loans for immediate transmutation into mortgage- "spreads" while avoiding most interest-rate-change risk. This is a much better business than that by Freddie Mac's high percentage returns earned on equity capital in recent years. One ironic cause of carried on by most (or indeed most of the top 10% of) savings and loan associations, as demonstrated replaces much of the former function of the savings and loan industry. Freddie Mac's high returns on the high returns is that this creation of federal regulators pays no deposit-insurance premiums as it was only 5.35% on its $29.89 average cost per share. Post-tax, the dividend yield was only 4.4%, but this At Freddie Mac's 1990 dividend rate ($1.60 per annum per share), Mutual Savings' pre-tax yield Freddie Mac has a creditable history of avoiding really hurtful loan losses and increasing its earnings amounted to about 75% of the current after-tax yield from very high grade mortgages. Moreover, figures for 1985-1990: and dividend rate, virtues that contribute to increases in the market price of its stock. Following are Dividends Year-End Freddie Mac's Year Ended 12/31: per Share Earnings per Share Market Price Return Earned per Share on All 1986 1985.. $2.98 $ .53 1.13 $ 9.19 Average Equity 1988 1987 4.53 3.72 7.28(1) 5.73 1.10 15.17 30.0% 1.25 12.12 28.5 6.90 1.60 50.50 28.2 1989 1.60(2) 67.12 27.5 1990 48.75 25.0 20.4 ('' restated raised to annualized rate of $2.00 per share on March 8, 1991 1990 (from $67.12 per share to $48.75 per share, in trading on the New York Stock Exchange). One Despite Freddie Mac's strong competitive position, its stock declined in market value by 27% ir reason for the decline was unanticipated losses from apartment house loans, particularly in New York apartment house loan buying program. But it remains the guarantor or owner of some old loans nd Atlanta. As a result. Freddie Mac wisely discontinued the most obviously dangerous part of its will create misery for years. It was probably ill-advised for Freddie Mac, given its position and financial (fortunately a small portion of total apartment house loans and a really tiny portion of total loans) that leverage and the nation's needs, (1) ever to finance anything except owner-occupied, single-family, non-vacation houses, for which substantial down payments had been made by credit-worthy people, and (2) ever to deal with anyone other than mortgage originators and servicers of obvious integrity and 59

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Reproduced from 1990 Annual Report of Wesco Financial Corporation what he doesn't have and doesn't need, it seems unwise for Freddie Mac to stretch its leveraged competence. Just as it is unwise for an individual to risk losing what he has and needs in an effort to gain resources beyond purchase from obviously responsible people of carefully selected first mortgages on individual houses. Each lender, including the one writing this letter, seems destined to learn through painful, personal experience two obvious lessons from the past: (1) The first chance you have to avoid a loss from a foolish loan is by refusing to make it; there is no second chance. (2) As you occupy some high-profit niche in a competitive order, you must know how much of your how much merely reflects the good fortune of being in your present niche. present prosperity is caused by talents and momentum assuring success in new activities, and In common experience, including ours, lesson (1) is eventually learned, but lesson (2) resists learning, despite high pain inflicted by multiple reverses. scale and will no more significantly impair its long-term prospects than the salad oil swindle of 1963 As nearly as we can foretell, Freddie Mac's troubles with apartment house loans are endurable in of Freddie Mac all seem to have absorbed a catechism appropriate for Freddie Mac and to be willing to impaired the long-term prospects of American Express. Moreover, the present managers and directors endure political friction burns as necessary to keep operations sound. We like our large position. do not count as "housing-related assets" in the new 70%-of-assets test, and (2) must be written down, Strangely, Mutual Savings' holdings of Freddie Mac, while lawful to own under FIRREA, (1) so far in stages, to a value of zero for regulatory accounting purposes. As these provisions start to bind, another Wesco subsidiary in return for cash. Mutual Savings will dispose of part of its Freddie Mac stock. One option is the transfer of stock to we are satisfied at the moment with our temporizing strategy. We expect further changes, possibly What future in the savings and loan business do we expect? We don't know anything more than that radical, in the bank/savings-and-loan-association field, to which we will adapt as they unfold. further legislation seems inevitable. We can predict neither the changes, nor whether the changes will The present situation, with its many insolvent and almost-insolvent institutions, is such a mess that make matters better or worse. But we do have some opinions. These opinions are almost totally out of most of all, among banking lobbyists. Despite this unconventionality, our opinions are now given to step with current thinking in academia, among government officials, among banking executives and, action. We also hope, but only slightly, that the opinions, set forth below, will have a wider, civic utility. Wesco shareholders because they may provide some insight into our institutional nature and likely future First, let us turn to banking, after which we will consider the savings and loan business. The sum of all deposit-insurance losses in banking will probably be much lower than the $200 billion or so recently caused by savings and loan associations. But there are a lot of very sick banks, and would be much to regret in the nature of our modern banks as they have increasingly emphasized deposit-insurance losses are sure to be large. Moreover, even if there had been no such losses, there lending for consumption (even lending at 20% for vacations in Tahiti) and lending to financial promoters to both big and small businesses, of what Pierre DuPont provided to General Motors. Plainly, we have a and real estate developers. We have come a long way from an ideal emphasizing the banker's provision, two-forked banking problem, with a questionable shift in priorities accompanying rising insolvencies. new competitors, including money-market funds possessing a large competitive edge. costs that came from (1) decontrol of interest rates paid by insured institutions plus (2) pressure from heavily regulated bank, paying high deposit-insurance premiums, with what has been created in an Exactly how great is the money-market funds' competitive edge? To see, compare the average 60

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Reproduced from 1990 Annual Report of Wesco Financial Corporation billion fund (The Common Fund for Short Term Investments) did all of the following: extreme form of uninsured money-market fund. In the fiscal year ended June 30, 1990 one such $4 (1) kept its assets in liquid short-term obligations of the U.S. government and other credit-worthy entities; (2) furnished efficient checkwriting privileges and wire transfer service to its depositors; (3) kept its total operating costs under two-tenths of 1% of deposits per annum as it avoided costs of maintaining branch offices, deposit insurance, etc.; (4) furnished no capital of its own as a cushion supporting promises to depositors; and (5) paid very competitive rates on its interest-bearing accounts, as a result of which it grew 27% in example all costs combined have been controlled so as to be roughly equal to what the average local This example demonstrates the raw competitive power of keeping things simple. Indeed, in this advantage. The new competition is a juggernaut. bank pays for federal deposit insurance alone! We are not dealing with some minor competitive bite out of the market formerly served by banks (and savings and loan associations) burdened by much How important has the new competitor become? Naturally, the new competitor has taken a huge higher costs. How could it be otherwise? Here is a dramatic graph reprinted from what is surely among the best magazines in the world, England's The Economist: From nowhere Amounts outstanding. December $bn 600 Super-NOW accounts 400 honey marke 300 oney-market 200 leposit account: 100 Source: Federal Reserve and checking accounts. And, by an odd stroke of good fortune, their light regulation by an overburdened The money-market funds are, in substance, "non-bank" banks, furnishing interest-bearing savings investment largely confined to reasonably safe and liquid categories. This has spawned simple SEC has turned out to be more advantageous than no regulation at all. The rules of the SEC force operations with very low costs. in business. For instance, look at (1) GEICO, a hugely successful auto insurer almost 50% owned by The simple, low-cost*, cream-the-market approach thus taken (or stumbled into) often works well Price, which are now clobbering retailing competitors as they get total "markup" under 10%. And this Wesco's parent corporation or (2) various membership warehouse clubs, in the form invented by Sol approach, as would be expected, is working like gangbusters for the money-market funds, as you see in the graph from The Economist. more of the market while, at the same time, each bank's banking competitors could bid as they wished What were the effects on banks as these new and successful, low-cost competitors took more and

• Total costs are low, even though they include fees containing a substantial profit element that are paid by the

"non-bank" banks to the "non-independent" independent managing companies employed in conformity with not clear that it befits a banking system. "Pretending" under misleading labels is not a good idea in banks. All mutual fund practice. While Lewis Carroll might have liked the consistency of the nomenclature just used, it is "pretending" habits tend to spread. 61

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Reproduced from 1990 Annual Report of Wesco Financial Corporation promoters and real estate developers. Indeed, many of our most decisive bankers, quite logically, important linkage between our best banks and our best businesses. The banks had been forced into an stopped trying to make loans to their most credit-worthy customers, accepting the disappearance of any entirely different market niche (which already had some occupants): high-interest-rate lending. It is hard to know for sure, because, throughout the past, high-interest-rate lending was hard to fund And what can be expected when virtually all banks become specialists in high-interest-rate lending? high-interest-rate lending is a comparatively recent phenomenon, made possible by governmental since it came from skeptical sources, instead of from government-insured deposits. Really large-scale, exists gives a likely answer: many bank insolvencies will come. Just as the simple, low-cost, cream-the- support in the form of deposit insurance used by banks with altered natures. But such experience as prices, is a common loser. High interest rate lending as a field has usually provided (1) some winners market strategy is a common business winner, the opposite strategy, involving high costs and high and (2) many casualties, often coming in bunches after periods of "follow-the-leader" asset-quality should naturally worsen as the high-interest-rate lending field both expands and becomes overcrowded, debasement. (Remember the widespread disasters in R.E.I.T. lending.) And the past bad experience driven by governmental support. "When more efficient, uninsured and less regulated financial institutions creamed off profitable lines of We are not alone in our diagnosis. Here is an except from a recent Wall Street Journal editorial: diverted money into Boston's building boom, which inevitably became a bust." business, the [Bank of New England] was left concentrated in commercial real estate. This artificially widespread bad loans (where the higher interest rates do not adequately cover increased risk of loss) Granting the presence of perverse incentives, what are the operating mechanics that cause cost pressure, is, by definition, not rational, at least for the lending banks and the wider civilization. How under our present system? After all, the bad lending, while it has a surface plausibility to bankers under then does bad lending occur so often? now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is It occurs (partly) because there are predictable irrationalities among people as social animals. It is peoples' conduct, now widely called "social proof." So, once some banker has apparently (but not where our system has placed our bankers, are extra likely to react unwisely to the example of other folly," relying on the "social proof," is the natural consequence. Additional massive irrational lending is really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative "crowd discussed later in this letter. It is hard to be wise when the messages which drive you are wrong "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner messages provided by a mal-designed system. not to allow the mixture. So also, in the American banking system. To us, a lot of foolish, unproductive In chemistry, if you mix items that explode in combination, you always get in trouble until you learn lending and many bank insolvencies are the natural consequences, given existing American banking culture, of the combination of the following two elements alone: (1) virtually unlimited deposit insurance; and (2) uncontrolled interest rates on insured deposits. good." Then, if factor (3) below is added to an already unsound combination, we think deposit- These two elements combine to create a Gresham's law effect, in which "bad lending tends to drive out insurance troubles are sure to be further expanded - and not by a small amount: (3) relatively unregulated, non-insured, low-cost "non-bank" banks. responds (in a natural, unthinking reaction) by raising deposit-insurance prices, we think it creates a Moreover, when the government starts suffering big deposit-insurance losses, if it continuously "runaway-feedback" mode and makes its problems worse. This happens because the government, by price-raising "cure" is the equivalent of trying to extinguish a fire with kerosene. adding even more cost pressure on banks, increases the cause of the troubles it is trying to cure. The 62 J

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Reproduced from 1990 Annual Report of Wesco Financial Corporation combining (1) "free-market" pricing of interest rates with (2) government guarantees of payment. If Many eminent "experts" would not agree with our notions about systemic irresponsibility from many eminent "experts" are wrong, how could this happen? Our explanation is that the "experts" are discretionary interest rates on deposits have a "free-market" image, making it easy to conclude, over-charmed with an admirable, powerful, predictive model, coming down from Adam Smith. Those automatically, that the discretionary rates, like other free-market processes, must be good. Indeed, they non-free-market element. are appraised as remaining good even when combined with governmental deposit insurance, a radical one tends to use only models from one's own segment of a discipline, ignoring or underweighing others. Such illogical thinking displays the standard folly bedeviling the "expert" role in any soft science: overconfident misuse. Furthermore, the more powertul and useful is any model, the more error it tends to produce through mischief than bad ideas. He had it right. It is so easy for us all to push a really good idea to wretched This brings to mind Ben Graham's paradoxical observation that good ideas cause more investment "social proof" (from other experts), and brains (including ours) often turn to mush. It would be nice if excess, as in the case of the Florida land bubble or the "nifty fifty" corporate stocks. Then mix in a little his later years. great old models never tricked us, but, alas, "some dreams are not to be." Even Einstein got tricked in banking system, it follows that merely giving banks the right to branch across state lines, to sell We may be right or wrong. But, if we are right, if there are deep, structural faults in the American insurance, or to enter investment banking (or all of the above) is not going to end our troubles. modifications in the system, each of which has powerful, vocal opponents. What are the more extreme Instead, a good long-term fix can come only after the government considers more extreme modifications to consider? We think the list includes: (1) greatly reducing deposit insurance; (3) bringing back some form of controls on interest paid on insured deposits; (2) eliminating money-market funds; (4) intensifying regulatory control of bank lending in an attempt to reduce loan losses; (5) forcing more conservative accounting covering bank lending; (6) forcing weak banks into other hands before the weak banks become insolvent; and (7) forcing insolvent banks into competing local banks, or entirely out of business, instead of into strong, out-of-state banks. Let us next attempt a brief discussion of the merits and/or political prospects of each of these seven governmental options. Option (1): greatly reducing deposit insurance: solve the overcrowding problem by bringing back cholera. Accordingly, proponents of this option To many people, remembering former banking panics, this option, adopted fully, seems like trying to regardless of law, are "too big to fail" in all advanced countries) and (2) bringing back deposit losses typically would limit its effects by (1) bringing back bank "runs" only for small banks (big banks, like discrimination, it seems unlikely that reductions in deposit insurance are going to be made on a scale only to some rich depositors. Because voters don't like bank "runs" of any size, and small banks don't insurance coverage, in a move driven by legislative remembrance of many abuses involving stockbro- that solves the structural defect problem. Conceivably, "brokered" deposits could be removed from ker-assisted financing of despicable insured institutions. (Many stockbrokers could easily see that the fools, presiding over piles of junk loans and junk securities. The stockbrokers thus knew, or should have insured certificates of deposit they were paid to sell were issued by institutions managed by knaves and known, that their government was being robbed. To sell certificates under such conditions was a lot like finding currency in a post office bag and deciding it was ethical to keep it.) 63

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Reproduced from 1990 Annual Report of Wesco Financial Corporation Option (2): eliminating the money-market funds: being without public policy input when some clever person combined (1) mutual fund status under the This option is almost never discussed. This seems peculiar. The money-market funds came into essence, a virtually unregulated, S.E.C. With (2) purchase, under subcontract, of services from a bank. What was created was, in accounts. The creation of such entities would probably not have been authorized if new legislation had , uninsured bank furnishing interest-bearing savings and checking been necessary. Where else do we have virtually identical regulated and unregulated entities operating on the same scale, side by side? If new legislation had been needed, the following questions might have been raised: (1) What do money-market funds do for "community" lending, lifeline services to the elderly, etc.? (2) Are they fair to existing institutions? (3) Won't the new "non-bank" banks make it harder for the Federal Reserve System to render constructive economic service? (4) Since the public is already on the hook as guarantor of solvency of existing institutions, is it operators to add to the competition? (This question would not be hard to answer in a private wise for the guarantor to risk losses from allowing uninsured, cream-the-market, more efficient would consider it very foolish to allow McDonald's to commence operations by his side when setting. If you were guarantor of all obligations of your brother-in-law's hamburger joint, you you possessed the ability to prevent it.) (5) Considering all of the above (and more), are the money-market funds in the long-term interest of the soundness and service of the total banking system? genie is now out of the bottle. And, considering his size, it would be hard to put him back. The prospects These questions are still good questions. But possession is strength under law. The money-market of rebottling are plainly remote. Option (3): bringing back some form of controls on interest paid on insured deposits: you or 1 would consider if we had to guarantee all obligations of that hamburger joint owned by a This option, too, is now seldom discussed. Again, this seems peculiar. It is among the first things 8%, than we would burn currency in the fireplace. In fact, we would suspect dishonorable "monkey brother-in-law. We would no more guarantee an 11% obligation for him, when we could easily borrow at business" if an 11% transaction occurred. a former version of such controls constricted housing credit when interest rates rose to high levels. No One reason for present lack of legislative interest in interest-rate controls lies in the knowledge that one now seems interested in trying to develop new controls, more flexible in form and practice, that States) had during a long period of control of interest rates paid by banks. The interest-rate-control would avoid former defects. Nor is anyone much interested in the success the Japanese (or the United option, at the moment, seems dead. Option (4): intensifying regulatory control of bank lending in an attempt to reduce loan losses: has successful counterparts in non-banking businesses. For instance, take McDonald's franchised This option is already being exercised - erratically - with effects both good and bad. It certainly have to operate in a very limited, foolproof way. Moreover, the McDonald's approach once worked in restaurants. If you want to use the McDonald's authenticating name and arches on your restaurant, you banking. When deposit insurance first came in, and long thereafter, most insured banks operated in government won't now act like McDonald's, or itself in a former era. (If it wished to do that, it might now sound fashion, often through ill-paid employees. But, based on all recent precedents, the purchases of commercial paper, and take deposit insurance away from all the banks and savings and give deposit insurance to all the simple, sound money-market funds, lending to big business through loan associations!) Government, instead, will probably take the more limited approach of concurrently: (1) leaving banking over-stressed by competition, (2) leaving banking very complicated, (3) trying to and then (4) monitoring bank operations through overburdened civil servants. These limited remedies prevent problems by writing massive, hard-to-understand regulations that create more work for lawyers, may be better than nothing, but their prospects for causing a real banking fix seem poor. It is almost a 64

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Reproduced from 1990 Annual Report of Wesco Financial Corporation can't fix our troubles. We can expect limited good effects from Option 4 and the continuation of general rule of American life that, when incentives are all wrong, controls (even criminal-law controls) important, basic problems. Option (5): forcing more conservative accounting covering bank lending: much to delay loan write-ofts, when loans go sour, so as not to over-correct weak banks. We are not Bank accounting is a hot current topic, but conservatism is not the goal. Everyone is wondering how going to enter the lists on that problem. The almost-never-discussed problem that interests us is that presented by newly made loans, result is that all interest accrued, and sometimes some up-front fees, are treated as fully earned, even bearing high interest rates, that under current bank accounting tend to be treated as "born good." The though the final outcome of the whole loan transaction is far from clear. To us, this is counterproductive accounting, even though we use it ourselves when pushed by convention. banking system. In essence, it "front ends" into reported income revenues that would have been We think current accounting for many high-interest-rate loans has terrible consequences in the deferred until much later, after risky bets were more clearly won, if more conservative accounting had pigeons, since he is "reinforced" into continuing and expanding bad lending through the pleasure of been employed. This practice turns many a banker into a human version of one of B. F. Skinner's seeing good figures in the short term. The good figures substitute nicely in the mind for nonexistent respond to a mere association because it has usually portended a reality that would make the response underlying institutional good, partly through the process, originally demonstrated by Pavlov, wherein we correct. capital during any transition they make toward less conservative lending. And then, if more lending of Under prevailing accounting, banks now ordinarily report increases in both earnings and equity for an additional period. If an increase in institutional size is deemed necessary, it is, of course, assured that type is done, and is accompanied by growth in institutional size, good reported figures will continue by the bank's access to the government's credit through deposit insurance. average, handle temptations implicit in this sort of accounting. Indeed, the succumbing to the tempta- We think acculturated corporate nature, in American financial institutions, simply cannot, on tions, in a manner not consistent with long-term institutional interest, often occurs through a subcon- scious process. The subconscious process includes bad effects from both (1) "social proof," and (2) a "reality-denial" institutional size. Under our present system a Columbia Savings, and many less obscene versions of its mode that creates bias in people stimulated, honored and paid in proportion to model, are almost inevitable. But this outcome is not sufficient to protect the deposit insurer from unacceptable ultimate losses. In due Of course, a large minority, even a majority, of bankers will remain sound, despite the temptations. course, given present conditions, the deposit insurer will suffer from what some wag called the problem of there being so many more banks than bankers. ing to shareholders, designed to force "back-ending" into reported income of revenue from various What should now be considered are mandatory accounting changes, including changes in account- types of gamy lending (and letters of credit), in lieu of allowing "front-ending" to continue. The changes have long done by choice. Eventually, credibility might be returned to banks' audited financial state- would cause American bank accounting, by fiat, to imitate what some of the best European bankers ments, now often regarded as fairy tales. important accounting changes will be made. Typical bank reaction to such proposals is, at best, that of Despite the obvious (to us) accounting defects that bedevil our system, we don't think any wise and periods for accomplishing even the simplest, "no-brainer" changes in accounting convention tend to the man who asked, well before his ultimate sainthood: "God, give me chastity, but not yet." Also, time Option (6): forcing weak banks into other hands before the weak banks become insolvent: when all shareholders' equity is gone and the deposit insurer has a large loss. This is "bonkers," due This option is also a hot topic. Usual governmental practice at the moment is to force merger only process gone mad. It seems entirely logical now to commence the forced merger or closure of many of the nation's 13,000 banks and to do it in many cases before a weak bank is insolvent. Because the need 65

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Reproduced from 1990 Annual Report of Wesco Financial Corporation is so obvious, laws and customs may possibly change to cause more of this to happen. And interstate branching may be allowed in order to enlarge the number of potential bank buyers. While these steps seem helpful, they won't fix the problem of deep structural fault in the system - at least within any acceptable time period. Look at the present carnage in airlines. Even when we are airline-style solution in banking, we will have to endure years, maybe decades, of suffering. down to fewer than a dozen significant operators, messy airline failures continue. If we wait for an instead of into strong out-of-state banks: Option (7): forcing insolvent banks into competing local banks, or entirely out of business, with an insolvent bank by choosing between two options: According to Martin Mayer, writing recently in The Wall Street Journal, the FDIC now typically deals (1) forcing the insolvent bank into a competing local bank, or entirely out of business, thus dampening local competition; or (2) first, replacing all the insolvent bank's bad assets with good assets, and, second, selling it to remaining also-weak-and-also-insured banks in the area. some skillful out-of-state buyer, after which process the new bank can help clobber the option (2). According to Mayer, the FDIC thus arranged that "overcapacity was rigorously maintained." Mayer believes it was "insane" for the FDIC to do as it did in many instances, which was to select unlucky and were guarantor for seven local brothers-in-law, each with a troubled hamburger joint, what Mayer raises an interesting question. Coming back to the analogy earlier used, if you or 1 were really defunct joint so that it was better than the others, and, second, guaranteeing the obligations of a new would we do when the first one went broke? We would surely reject the idea of, first, fixing up the facility. and more skillful out-of-state operator who wanted to enter the market by taking over the improved were formerly too many filling Mayer is right insofar as he implies that there are too many banks and bank branches, just as there figure in the Mikado. stations "never will be missed," so perhaps the FDIC should "have a little list," like the bloodthirsty stations, sometimes three or four at an intersection. The departed filling system is right out of Alice in Wonderland, so maybe it's like non-Euclidean geometry and only Alice-in- Beyond that, we are not certain that Mayer's conclusions will always prove right. The basic banking least to a government. The bank failures cascade, on and on, refreshed by new governmental acts, so Wonderland-type cures really fit in. After all, the scenario which troubles Mayer has a perverse beauty, at that the FDIC can be saving a large part of the banking system each year for a long time. present banking system, like it or not, we would occasionally do what Mayer finds objectionable, in those And we must admit that, if we were the FDIC and were thus forced to participate heavily in our for instance, occasionally sell a sick bank to John McCoy (of Banc One), even when this brought a new rare cases when we saw a chance for greatly improving banking culture in some community. We would, bank to a state full of troubled banks, if every in-state bank seemed too weak or foolish to be selected as in our long-term interest, (2) we were supporting a sound model, and (3) eventually, as the example an alternative buyer. We would figure that (1) some subsequent insolvencies of other local banks were pleasant lull before the silly system caused new troubles to pop up, maybe even under McCoy's spread, our troubles as deposit-insurer of a silly system would be reduced. We would then have a 22222 successors at Banc One. consequences. Outside science, it is amazing how little impact there can be from a powerful idea, While Mayer's subject is interesting, we probably don't have to worry much about worldly published in a prominent place (such as the Journal). Everyone's experience is that you teach only what a reader almost knows, and that seldom. or substantially right, it is hard to be optimistic about coming legislative "reform" of banking. Perhaps If our foregoing comments about systemic irresponsibility and chances for a rational cure are right, the best we can hope for is Menckenian reform where old error is replaced, not by truth, but by new error. It is also possible that we will see exactly the same old systemic error repeated, but bearing bells 66

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Renroduced from 1090 Annual Report of Wesco Financial Corporation and whistles in the form of new bank powers. This outcome is roughly what is recommended by the banking lobby, which has evidently learned nothing from the history of the savings and loan laws. legislators were so outraged that they attempted what they thought was extreme reform: FIRREA. This Let us next turn to the savings and loan field. Here, faced with a more disastrous mess, the legislation took a "back-to-basics" approach and has since been interpreted by regulators who seem to believe, understandably, that they must act as though they were tough "bouncers," given the job of bringing order to a drunken braw! (a description that understates what the regulators faced). keep institutions healthy. Most executives we know at other associations concentrate only on the This regulatory approach is now squeezing out (1) much folly, and (2) some non-folly needed to present FIRREA enforcement as the equivalent of Mark Twain's prescription for preventing children's negative side and are outraged at instances of regulatory elimination of non-folly. They tend to construe stuttering: "Remove the lower jaw." new rules, interpreted by tough "bouncers," and that the "bouncing" process, done with sufficient vigor, Our view is different, even though we are much harmed by FIRREA. We think the system needed fire." Nonetheless, the process must go on. inevitably involves some lumps for the undeserving. There may even be some deaths from "friendly with their "never again" mindset, fix the most important systemic error in the savings and loan industry? What concerns us is the most important question of all. Did our legislators, through FIRREA, even We think not. the best banks (which themselves have plenty of troubles). This conclusion is supported by both As the dust has cleared, the best savings and loan associations are clearly worse businesses than Stocks of the best associations now sell at much lower price / book-value ratios than stocks of the best (1) stock market prices and (2) action of governmental liquidators in response to market conditions. banks. And governmental liquidators are constantly selling association branches to banks while almost desirable for owners as banks. The two institutional types remain different and unequal, while quite never selling bank branches to associations. FIRREA has not made associations, on average, as comparable in essential residual function, now that Fannie Mae and Freddie Mac exist to perform a lion's share of the finance function supporting housing. borrower, still tries to use short-term savings accounts to finance long-term housing lending. This is, in The savings and loan system, in a modern era in which the government is always a large net essence, a very bad idea, violating the logic of an elementary prescription: "If a thing isn't worth doing at all, it isn't worth doing well." of variable-rate loans. But the variable-rate loans typically "cap" interest rate escalation at a few To be sure, some fix of systemic maturity-mismatch risk is now attempted, through encouragement percentage points, which must be done for moderate-income borrowers to prevent both (1) unaccept- able hardship and (2) sudden falls in non-housing spending. This compromise is like having building codes in California protect only up to 5 points on the Richter earthquake scale. The compromise is almost sure to bring back, probably at a remote date, another horrible collapse of the savings and loan Western Savings and World Savings. These people have logical operations bearing one big systemic As we say this, we are not critical of the best California associations, such as Home Savings, Great would try to imitate them. But we would have a big disadvantage: "we don't know how to get there from risk that cannot be avoided by permanent players. If we had to plav forever under current rules, we one is sentencing us to play forever in a game with a systemic risk we don't like and in which we are at a here,"because they have such momentum in systems, particularly in loan origination. Fortunately, no big disadvantage. Instead, we have temporized with a different, acceptable "there" in a form combining (1) a big holding of Freddie Mac, with (2) financial flexibility to adapt as we choose to new conditions. As any responsible calamity-howler should, we will now risk playing the fool in public by attempting to So much for ridicule, pessimistic speculations, and excuses for our defects, always easy to provide. say what we would do with the bank/money-market fund/savings and loan system if we were Congress: (1) Because we have a help-housing bias, we would keep government-assisted housing finance for low-to-moderate-income people. We would do this by forcing pension funds to maintain a significant portion of their assets in housing-related assets in the form of Freddie Mac and Fannie Mae mortgage-backed securities representing interests in fixed-rate mortgages. This 67

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Reproduced from 1990 Annual Report of Wesco Financial Corporation requirement strikes us as fair, given the tax exemption possessed by the pension funds. And (a) massive assets, and (b) liabilities with maturities matching homeowners' needs for long- the pension funds are the logical suppliers of housing finance because they by nature have term, fixed-rate credit. Our reason for specifying Freddie Mac and Fannie Mae securities as a and more cheaply than would any government bureaucracy. In quantitative terms, we would conduit for housing assistance is our belief that these entities would assure loan quality better have won their spurs. leave housing finance more assisted than it is now, particularly for first-time home buyers who (2) We would merge the banks, money-market funds and savings and loan associations into one banking system, with insured deposits. The new banking system would be separate from both the following characteristics: (a) industry and (b) the part of investment banking likely to disappoint investors. It would have (i) There would be one federal regulator that also served as deposit-insurer, in lieu of the truly crazy, inefficient Balkanization of our present regulatory and insurance apparatus. (Eliminating Balkanization would do more than reduce costs, delays, confusion and insurance loss payer and the bank-controlling loss preventer one and the same. The competition in laxity. There is a system-design advantage in making the deposit- systems be organized, to the extent feasible, so that decision-makers, not others, bear system then becomes more "responsible" in the Frankelian sense, requiring that consequences of decisions.) (i) There would be no bank-holding companies, but the new banks would have a monopoly offered on behalf of a single vendor. (The new law would permit tax-free spinoffs of in offering check-writing privileges, debit cards and credit cards, except for credit cards come into compliance. Spun-off non-banks could include specialists in high-interest-rate existing banks, newly organized banks, and non-banks to help existing corporations lending to businesses.) (iii) Flexible, government-regulator-run controls would set a ceiling on interest that could be there is a limit to the competition that is desirable. Besides, many banks will behave badly paid on bank accounts. (If you are going to guarantee the credit of an entire industry, in their important function when they are under the extreme cost pressure, not normal in government, through deposit insurance.) business, that occurs when one's competitors are all financed without limit by the (iv) All capital satisfying regulatory requirements would have to be in the form of stock, either common or preferred, except for "grandfathered" debt. (v) Stockbrokers (and others) could buy for customers all the insured certificates of deposit from the banks issuing the certificates. (Abuse it and lose it," is our motto.) they wished, but they could not, in exchange, receive commissions or other advantages (vi) The federal regulator would have clear power, exercisable without an excess of "due process" or "second guessing, before they became insolvent. Banks could ordinarily avoid such calamities, after a first " to close out or force sale or merger of weak banks well nothing novel in such a system. Close-out orders, issued well short of insolvency, have warning, by raising new capital through "rights" issues, or in some other way. (There is long been standard practice under regulatory practice governing securities and currency traders.) (vii) Bank accounting for all purposes would count much revenue as profit only after all dividends, of course, could be paid only from the more conservatively reported profits. significant risk had been removed from the transactions generating the revenues. Bank tism in accounting. (It is a terrible mistake, a novice's mistake, to try to control important Income tax would be deferred on the deferred revenues required by this new conserva- behavior with an all-stick-and-no-carrot approach. Therefore, the carrot-providing tax deferment would be wise.) 68

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Reproduced from 1990 Annual Report of Wesco Financial Corporation (vill) There would be no 2,000-page mass of government regulations. But there would be some rule for business and real estate loans such as: loan as you wish, but no new loans count as bank assets unless supported by substantial equity, a stipulation that would create a large margin of safety. (ix) Deposit-insurance rates would promptly be lowered from present levels, but under a new system so tough that risk of loss to the deposit insurer would be reduced, even after taking into account the effects from lower rates. (x) The whole system would be designed to have the best businesses, small and large, again become intimate with the best banks. The banks would again concentrate on being consumers who are not "fiscaholics". High-interest-rate lending, to people with weak (1) relatively low-interest-rate lenders to high-quality businesses, and (2) lenders to credit, would be forced into non-banking systems retaining no common-management or common-premises links with banking. present system, which has helped cause a questionable shift in banking priorities and a big mess, with There is, no doubt, much wrong with our recommendations. But there is also much wrong with our recommendations would be as bad. And even if the new system had serious faults, it would probably be every prospect for more of the same. In contrast, there is little in history to suggest that our a better way station on the path to a banking system befitting a great country. In recent years the government has tried to maintain a useful, relatively trouble-free banking system responded by working worse, the government has increased both the burdens and the permitted scope by making the banking business bear increased competitive burdens, and, when the system has of banks' activities. After such revisions the system has again worked worse. Surely it is time to reverse tries to put a shell clearly short, expecting to get the desired result in due course. our approach. We should act like the artillery officer who, when he has put one shell over the target, next To this worry there are three answers: Some people might worry that banking would get too profitable under the system we recommend. (1) The prospect of better profits, with less risk, would tend to (a) reduce governmental losses as many billions of dollars worth of foreclosed thrift and bank assets are sold off by the FDIC, and tation of banking capital by shareholders, precisely what is needed. (b) enable the government, through tough capital standards, to cause eager private augmen- (2) Based on past experience, the nation's bankers (including us) may, on average, be up to the challenge of not earning excessive profits, even in an easier system. (3) If excessive profits came, they could easily be reduced in due course by a new governmental We now quitclaim legislative reform to those who make it their business. We also assure Wesco tax, charge or burden. shareholders that this reform-minded section of our letter to shareholders is an unlikely-to-be-repeated aberration. It was caused, in part, by a combination of (1) overwhelming disgust with the present scene, and (2) long association by the writer with an eccentric fellow who may not share all the notions herein expressed but who encourages this kind of writing. reason that accumulated wealth should never be spent on oneself or one's family, but instead should This eccentric, who heads Berkshire Hathaway, Wesco's parent corporation, believes for some merely serve, before it is given to charity, as an example of a certain approach to life and as a didactic not only during life but also after death. Shareholders who continue in such peculiar company are hereby platform. These uses, plus use in building the platform higher, are considered the only honorable ones warned by our example in writing this section: some of the eccentricities of this fellow are contagious, at least if association is long continued. 69

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Reproduced from 1990 Annual Report of Wesco Financial Corporation Consolidated Balance Sheet and Related Discussion net worth supports large outstanding promises to others and (2) reflects a continuing slow pace of Wesco's consolidated balance sheet (1) retains a strength befitting a company whose consolidated acquisition of additional businesses because few are found available, despite constant search, at prices deemed rational from the standpoint of Wesco shareholders. marketable equity securities was higher than their aggregate carrying value at December 31, 1990 by As indicated in the accompanying financial statements, the aggregate market value of Wesco's about $46 million, down significantly from about $98 million one year earlier. The consolidated aggregate aggregate carrying value by about $61.3 million. As earlier emphasized, about $56.2 million of this market value of all marketable securities, including bonds and other fixed-income securities, exceeded appreciation in stock of Freddie Mac. unrealized appreciation lies within the savings and loan subsidiary and includes $45.3 million of value." Wesco also has some unrealized appreciation in securities that is already in "carrying value." The foregoing paragraph deals only with unrealized appreciation of securities above "carrying million in appreciation in common stocks (mostly stock of The Coca-Cola Company). Under a peculiar This has happened because Wesco's insurance subsidiary at December 31, 1990 had about $40.9 taxes that would be due if the stocks were sold, is already included in Wesco's audited net worth, even accounting convention applicable only to insurance companies, this appreciation, minus the income though the gain has never passed through any audited report of income. the savings and loan and insurance subsidiaries and those held temporarily elsewhere pending sale to As indicated in Schedule I accompanying Wesco's financial statements, investments, both those in fund business concentration of investments, we seek to better understand the few decisions we make.* extension, tend to be concentrated in very few places. Through this practice of rentable square feet, including Mutual Savings' space, in a modern office building, plus (2) an additional Wesco's Pasadena real estate comprises a full block containing (1) about 125,000 first-class net be wiser to destroy than improve. This real estate has a market value substantially in excess of carrying net rentable 34,000 square feet of economically marginal space in old buildings, which it would probably 9.25% fixed) against this real estate exceeding its depreciated carrying value ($3,163,000) in Wesco's value. The existence of unrealized appreciation is demonstrated by (1) mortgage debt ($4,524,000 at year) to Wesco after debt service on the mortgage. The modern office building is 99% rented, despite a balance sheet at December 31, 1990, and (2) substantial current net cash flow (about $1 million per

• It is interesting to compare Wesco's approach (deliberate non-diversification of investments in an attempt to

bonds. The Milken approach, supported by theories of many finance professors, argued that (1) market be more skillful per transaction) with an approach promoted for years by Michael Milken to help sell junk outcomes); (2) therefore, the prices at which new issues of junk bonds came to market were fair in a prices were efficient in a world where investors get paid extra for enduring volatility (wide of loss) and also provided some premium return to cover volatility exposure; and (3) therefore, if a savings probabilistic sense (meaning that the high promised interest rates covered increased statistical expectancy and loan association (or other institution) arranged diversification, say, by buying, without much examination, better-than-average-results position of a gambling a large part of each new Milken issue of junk bonds, the association would work itself into the sure to-get- theorizing has now wreaked havoc at institutions, governed by true-believers, which backed their conclusions house proprietor with a "house" edge. This type of by buying Milken's "bonds." Contrary to the theorizing, widely diversified purchases of such bonds" have in he had to believe in order to maintain an endurable self-image. But how can we explain why anyone else most cases produced dismal results. We can all understand why Milken behaved as he did and believed what Vegas? We suggest this cause: many of the foolish buyers, and their advisers, were trained by finance believed that Milken was paid 5% commissions to put "bond" buyers in the position of the house in Las while they ignored other models that would have warned of danger. This is a common type of "expert" error, professors who pushed beloved models efficient market theory and modern portfolio theory) way too far, as we have earlier indicated. 70

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Reproduced from 1990 Annual Report of Wesco Financial Corporation glut of vacant office space in Pasadena. We charge just-below-standard rents and run the building as a sort of first-class club for tenants we admire. With these practices, a prime location and superior parking facilities, we anticipate tuture increases in cash flow, but not in 1991 and 1992. The next two years are not likely to be good years for most owners of commercial real estate. tal liquid assets. Wesco prat be car long-term borrowing in advanc Wesco remains in a prudent position when total debt is compared to total shareholders' equity and values its AAt credit rating. i specific need, in order to have maximum financial flexibility to face both hazards and opportunities. used in one or more business extensions. The extension activity requires patience, at least for people It is expected that the balance sheet strength of the consolidated enterprise will in due course be ers' equity, about 12% in 1988-90, was dependent to a significant extent on securities gains, irregular by The ratio of Wesco's annual reported consolidated net income to reported consolidated sharehold- nature. for-one split) traded at about $6. At yearend 1990, the stock traded at $47% and it has paid modest When Berkshire Hathaway bought into Wesco in 1973, the present stock (adjusted for a later three- dividends, increased every year, during Berkshire Hathaway's stewardship. considering the power of compound interest and the generally favorable business climate. And now, The financial results for Wesco shareholders have not been bad. But they are not outstanding, direct ownership of businesses with enough commercial advantage in place to assure permanent high after all these years, Wesco continues to have (1) a very strong balance sheet, and (2) a shortage of future returns on capital employed. In contrast, the parent company, Berkshire Hathaway, is better positioned. This outcome was explained in Wesco's annual report last year, to which we refer Wesco shareholders, new and old. 21½ cents per share, payable March 12, 1991, to shareholders of record as of the close of business on On January 24, 1991, Wesco increased its regular quarterly dividend from 20½ cents per share to February 28, 1991. and includes detailed information about Wesco and its subsidiaries as well as audited financial This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, Statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these Charles T manger Chairman of the Board Charles T. Munger March 8, 1991 71

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BERKSHIRE HATHAWAY INC. Selected Financial Data for the Past Five Years (dollars in thousands, except per share data) 1986 1987 1988 1989 1990 Revenues: Sales and service revenues... Interest and dividend income Insurance premiums earned $1,219,252 823,884 $1,326,829 Realized investment gain... 181,992 824,895 $1,407,642 $1,526,459 Sundry.. 220,764 237,319 131,671 314,251 584,235 394,279 $ 1,580,074 331,452 591,540 6,316 28,838 27.094 223,810 450,295 13,901 7,892 33,989 Total revenues. 3,574 $2,452,208 Earnings: $2,431,782 $2,464,893 $2,483,892 $ 2,659,472 Before realized investment gain Realized investment gain... $ 131,464 150,897 $ 214,746 19,806 $ 313,441 85,829 $ 299,902 147,575 $ 370,745 Net earnings... 23,348 $ 282,361 $ 234,552 $ 399,270 $ 447,477 $ Earnings per share: 394,093 Realized investment gain.. Before realized investment gain $ 131.57 114.62 $ 187.24 17.27 $ 273.37 74.86 $ 127.55 262.46 $ 323.39 Net earnings. 20.36 $ 246.19 $ Year-end data: 204.51 $ 348.23 $ 390.01 $ 343.75 Term debt and other borrowings Total assets.... $4,931,354 2,377,797 260,170 $5,863,235 2,841,659 289,886 $6,816,848 3,410,108 480,009 $9,459,594 1,007,516 $10,670,423 Common shares outstanding, Shareholders' equity 4,925,126 1,239,358 5,287,454 Shareholders' equity per in thousands... 1,147 1,147 1,146 1,146 1,146 outstanding share.. $ 2,073 2,477 $ 2.975 4,296 $ 4,612 COMMON STOCK Stock Transfer Agent Registrar for the Company's common stock. Correspondence with the Division may be directed to Customer Service The Bank of Boston Shareholder Services Division, P.O. Box 644, Boston, MA 02102 serves as Transfer Agent and Section, Mail Stop 45-02-09. Certificates for re-issue or transfer should be directed to the Transfer Processing Section, Mail Stop 45-0105. Certificates should not be mailed to the Company. Shareholders nominees holding at least 153,000 shares on behalf of beneficial-but-not-of-record owners. Management believes that The Company had approximalely 6,800 record holders of its common stock at March 4, 1991. Record owners included the Company has more than 14,000 beneficial owners. Price Range of Common Stock following table sets forth the high and low sales prices per share, as reported on the New York Stock Exchange Composite The Company's Common Stock is listed for trading on the New York Stock Exchange, trading symbol: BRK. The List, during the periods indicated: 1990 High Low 1989 Second Quarter First Quarter... $8,725 Third Quarter.. 7,675 $6,675 7,325 6,600 First Quarter. High Low Fourth Quarter. 6,900 5,500 5,550 Third Quarter.. Second Quarter. $5,025 7,000 $4,625 Fourth Quarter. 8,750 4,950 Dividends 8,900 7,950 6,600 Berkshire has not declared a cash dividend since 1967. 72

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BERKSHIRE HATHAWAY INC. DIRECTORS WARREN E. BUFFETT, Chairman Chief Executive Officer of Berkshire Chairman of the Board of Directors of CHARLES T. MUNGER, Vice Chairman Daily Journal Corporation, publisher of specialty newspapers in California KENNETH V. CHACE Retired, Former Chief Operating Officer of Textile Operations of Berkshire MALCOLM G. CHACE, JR. Retired, Former Chairman of Berkshire's Board ). VERNE McKENZIE Chief Financial Officer of Berkshire WALTER SCOTT, JR. Chairman and Chief Executive Officer of Peter Kiewit Sons', Inc., engaged worldwide in construction, mining and packaging. OFFICERS WARREN E. BUFFETT, Chairman and CEO CHARLES T. MUNGER, Vice Chairman ROBERT H. BIRD, Vice President MICHAEL A. GOLDBERG, Vice President STANFORD LIPSEY, Vice President J. VERNE McKENZIE, Vice President, Secretary MARC D. HAMBURG, Treasurer DANIEL J. JAKSICH, Controller ROBERT M. FITZSIMMONS, Director of Internal Auditing JERRY W. HUFTON, Director of Taxes J. WILLIAM SCOTT, Director of Financial Assets One is from reports for 1977 through 1983, the other, from reports for 1984 through 1988. Two compilations of letters from earlier Annual Reports are available upon request. at 3555 Farnam St., Suite 1440, Omaha, NE 68131. Single copies are furnished without charge in response to requests received by the Company

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BERKSHIRE HATHAWAY INC. Executive Offices - 1440 Kiewit Plaza, Omaha, Nebraska 68131