2005 年股东大会 · 下午场

Q&A resumes

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

We'll "do pretty well" when inflation is high

WARREN BUFFETTSo, with that, we'll go to area 9.

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

WARREN BUFFETTWell, we think, by and large, we have businesses that will do pretty well in inflation. But inflation destroys value, but it destroys it very unequally. The best business to have during inflation is one that retains its earning power in real dollars without commensurate investment to, in effect, fund the inflation-produced nominal growth. The worst kind of business is where you have to keep putting more and more money into a lousy business. In effect, the airlines have been hurt by inflation over the last 40 years, because now they have to put a whole lot of money in a lousy investment, which is a plane, compared to 30 or 40 years ago. And they have to stay in the game. They have to keep buying new planes. And the new planes cost far more now, and the returns continue to be inadequate. So the best protection is a very good business that does not require big capital investment. And, you know, the best investment at all — of all — I mean, if you're the leading brain surgeon in town or the leading lawyer in town or the — whatever it may be — you don't have to keep re-educating yourself to be that in current terms. You bought your expertise when you went to medical school or law school in old dollars, and you don't have to keep reinvesting. And you retain your earning power in current dollars. We — Charlie and I are always suspicious that inflation will regain some of the momentum it had a couple of decades ago. We always think it's in sort of remission. We thought the talk about deflation was total nonsense. And certainly, the trade picture is one that you would think would accentuate any inflationary trends that might otherwise be experienced. I mean, obviously, the price of oil in euros has gone up far less than the price has gone up in dollars. And you and I are buying gasoline in dollars, so we have seen a bigger increase in our fuel costs because of the decline of the dollar than we would've seen if we lived in Europe, or some other — or Australia, for that matter. So, it's — inflation is always a factor in calculating the kind of investment, the kind of business, that we want to buy. But it doesn't — it isn't like it crowds out all other factors. I mean, it's always been with us. We'll think about it always. See's Candy has done fine during an inflationary period because it does not have huge capital investments that have to be made in current dollars. Other businesses we have, you know, if we’re — the public utility business, for example — it costs a lot more money to maintain capital expenditures now in dollar terms than it would've 30 years ago. So you have to keep putting more and more money into a public utility. And you'd better hope that the rate of return allowed is commensurate in times of high inflation the same way that it might have been in low inflation with a lower rate of return. Charlie?

CHARLIE MUNGERYeah. Well, so far, the facts that are driving the dollar down in relation to other currencies have been restraining inflation in the United States. In other words, it's the competitive export advantages of the other people that are — that have so far restrained inflation here. So, it's —

WARREN BUFFETTYeah, you're paying less for shoes. You know, we got killed in the — in parts of our shoe business. And 30 years ago, of the billion-plus pairs of shoes used in the United States, a very high percentage were made here. And now, virtually none are. But if they were all being made here, you would be paying more for shoes. There's no question about that.

CHARLIE MUNGERYeah.

Buffett: Don't bet against America

WARREN BUFFETTNumber 10.

AUDIENCE MEMBERI'm a physician from St. Louis. And I want to thank you and everyone here, because I'm one of these doctors that really doesn't know anything about money or finance. The money comes in, but I don't know what to do with it. I'm not able to really evaluate the financial strength of a company, but I can evaluate the ethical strength of a company. And that's why I feel real comfortable — I think most of us here — having our savings in Berkshire Hathaway. And the —

WARREN BUFFETTThank you. (Applause)

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

WARREN BUFFETTWell, if the market gets cheaper, we will have many more opportunities to do intelligent things with money. Now whether we will blow on the money in the meantime or something is another question. But, you know, we are going to be buying things — one thing or another — operating businesses, stocks, high-yield bonds, whatever — we're going to be buying things for as long as I live, just like I'm going to be buying groceries —

CHARLIE MUNGERLonger than that, Warren.

WARREN BUFFETTYeah. (Laughter) Yeah. Charlie's just waiting to take over after I'm — (Laughter) And I'm going to be buying groceries the rest of life. Now, would I rather have grocery prices go up or down if I'm going to be buying groceries tomorrow and next week and next month and next year? And the answer is obviously, if I'm a net buyer, I would — I will do better if prices are lower. We have no — we're not good at forecasting markets. I mean, we, in a general way, knew that we were getting enormous bargains in the mid-'70s. We knew that the market went crazy to some extent in the late '90s. But we don't have much — we don't spend any time — Charlie and I spend no time — thinking or talking about what the stock market is going to do, because we don't know. We do know, sometimes, that we're getting very good value for our money when we buy some stocks or some bonds, as it may be. But we are not operating on the basis of any kind of macro forecast about stocks. And there's always a list of reasons — you gave a few — there's always a list of reasons why the country will have problems tomorrow. But there's always a list of opportunities which don't get mentioned quite as often. So, we don't sit down and make a list of the bad things that are happening in the economy and the good things that are happening, and therefore expecting the stock market — It might not — it doesn't behave that way even if you could correctly forecast some of the bad things or good things. Overall, I'm an enormous bull on the country. I mean, over time — I mean, this is the most remarkable success story in the history of the world, if you think about it. I mean, in 1790 we had less than four million people in this country. We had — there were 290 million people in China. There were 100 million people in Europe. You know, and they all had the same intellect we had. They're in the same general climate. They had lots of natural resources. And 215 years later, those 3.9 million people, I think, actually, you know, have 30 percent or so of the world's GDP. So, it does not make sense to bet against America. That doesn't mean all our policies are smart or anything, but I would not — I do not get pessimistic on the country. You know, I worry about the — I mean, the big worry is what can be done by either terrorists or governments that have access to nuclear, chemical, or biological weapons. But, in terms of the basic economics of the country, your children are going to live better than you live. And your grandchildren are going to live better than your children live. And we do not focus on macro factors. Charlie?

CHARLIE MUNGERWell, I agree with you that the economics of the country are probably going to increase for a considerable period ahead. But I suspect that, in very important ways, we are at or near the apex of a great civilization. (Laughter)

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

CHARLIE MUNGERNot yet.

WARREN BUFFETTOK. (Laughter) It's hard to get him to really agree with you. (Laughter) I've been working on it for years.

GM and Ford haunted by past commitments

WARREN BUFFETTNumber 11.

AUDIENCE MEMBERHello. My name is Randall Bellows. I'm from Chicago. And many years ago, Lauren, my wife, did a portrait of you drinking a can of Coke. Next year I'll bring one, drinking a can of Bud.

WARREN BUFFETTI think you'd better stick with Coke. (Laughs)

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

WARREN BUFFETTWell, I would say that Rick Wagoner at General Motors and Bill Ford at Ford, both have been handed, by managers of the past, extremely difficult hands to play. They're not the consequences of their own doing at all, but they have walked into what people call legacy situations. But they have inherited a cost structure brought about by contracts that were put in place, maybe decades ago, that make it very difficult for them to be competitive in today's world. I mean, just imagine if Ford or General Motors had signed contracts that made them pay several thousand dollars a ton more for steel than their competitors did. I mean, it would — people would immediately feel that was untenable. So, General Motors and Ford are in the position of having commitments, which are, in strong contractual terms, to pay sums for retired, particularly, workers in both the annuity field and in the health field that are staggeringly high compared to some of their competitors. And their competitors can buy steel at the same price, and they can buy aluminum at the same price, they can buy rubber at the same price. And when you get all through with it, if they have huge advantages on the health care and the annuity side, it's not going to be a fair fight. And those contracts, to some day — to some extent — go back to when General Motors had, for example, 50 percent-plus of the U.S. auto market. And now it has 25 percent. But I think even if it had 50 percent today it would be having trouble. So, it's a very, very tough situation. I'm not sure what I would do if you put me in charge of — I mean, as Bill Buckley said many years ago when he ran for mayor of New York, they said, "What's the first thing you're going to do if you get elected?" He said, "I'll ask for a recount." (Laughter) Well, that's a little the way I would feel if I got elected CEO of General Motors. From the standpoint of the UAW, you know, they have a contract, they made a deal. And they've got $90 billion in the pension fund. It's kind of interesting. The pension fund of General Motors possesses roughly $90 billion. The health care fund has a little more, too, another 20-some billion as I remember. The whole equity of General Motors is selling for about 14 billion. So after all these years, there's 90 billion set aside for the retirees, and there's 14 billion of equity value that's been heading south for the owners. And, it would seem that if General Motors had a steel contract that called for — let's say there's a ton of steel in every car — and I'm not saying there is — and if they were paying $2,000 a ton over market — or what their competitors were paying — people would say that that is not a viable situation for the long term. But they're in a similar situation because the contracts they voluntarily signed. And part of the reason they signed those — and undoubtedly — was that they bore no accounting consequences at the time. It's a terrible mistake for managers not to think in terms of reality rather than the accounting numbers. But back in the '60s, you did not have to account for pensions on an accrual basis. And up till the '90s, you didn't have to account for health care — or the late '80s, whenever it was — on an accrual basis. And so people said, "Well, if we don't have to count it, it isn't real." Well, believe me, it's real. And the managers today are facing the consequences of that. So, you know, they've got very tough hands to play. And, you know, I read about it in the papers. I don't know what's going on there necessarily, but something will have to — in my view — something will have to give in that matter. And before you answer the asbestos thing, Charlie, what do you think about them?

CHARLIE MUNGERWarren gave a very optimistic prognosis — (laughter) — in my view. I think — just because it hasn't happened yet doesn't mean that the problem isn't real. If you jump out of the window on the 42nd floor, and you're still doing fine on the way down as you pass the 20th — (laughter) — it doesn't mean you don't have a serious problem. (Laughter) If I were the governor of Michigan, or the president of the United States, or a director of General Motors or Ford, or a family member of Ford, I would want to address the problem right now. I do not think it's getting better or that Yehuda is going to come over the mountain with a magic wand and make it go away. I think it would be better faced.

WARREN BUFFETTYou want to try the asbestos? (Laughter) Give us another cheery — (Laughter) Around the office he's known as Pollyanna. (Laughter)

Munger: "Terrible" and "gutless" behavior led to asbestos problem

CHARLIE MUNGERWell, the asbestos thing has involved terrible behavior by some lying doctors, terrible behavior by a bunch of lawyers who suborned perjury, and gutless behavior by certain important courts, and even more gutless behavior by politicians who take care of themselves first, naturally. And it's — these are the forces that are bearing on the problem. It's obviously not going to be handled very well. So, it's a perfectly terrible situation. You keep hoping that it will be so obviously bad that it will finally be addressed. Some of that happened in California. The workmen's comp system in California had immense fraud in it, particularly egregious fraud by lots of doctors and lots of lawyers and lots of claimants. And it was so awful that it affected the whole employment prospects in California. And with the [California Governor Arnold] Schwarzenegger revolution, that was partly corrected — I would say maybe 15 percent corrected. And, but it took —

WARREN BUFFETTFive hundred pushups, Charlie.

CHARLIE MUNGERWhat?

WARREN BUFFETTFive hundred pushups unless it's 100 percent. (Laughter)

CHARLIE MUNGERSo, I think that if it gets bad enough, there is some possibility there will be more correction. In a sense, it's totally crazy for a court system to be paying tons of money to people that have smoked two packs of cigarettes all their life and have one little spot on a lung that no honest doctor would know what the hell it caused. And they aren't yet sick, and they're nearly dead anyway from their other behaviors and longevity. And it's just, it never should have been allowed. But once you get a powerful political force, even judges fear consequences. And it's very easy just to drift along with an evil system. Luckily, we aren't using this particular — there are two kinds of asbestos, one of which is virtually harmless and the other which caused all this damage. And we stopped using the damaging asbestos. And eventually the asbestos problem will go away. But how many people it will leave in some kind of financial wreckage before the storm is over, I can't tell. I don't think the last Indian has bit the dust, do you, Warren?

WARREN BUFFETTNo, I'm — no.

CHARLIE MUNGERI think the — but the behavior is so terrible. It's that kind of behavior that makes me talk about apexes of the civilization.

Our successors will provide the "same wonderful lack of oversight"

WARREN BUFFETTNumber 12.

AUDIENCE MEMBERNow, Mr. Buffett and Mr. Munger, my name is Marc Rabinov from Melbourne, Australia. I think it's rare for diverse collections of businesses to be successful. And I believe an important part of Berkshire's success has been your skillful oversight of the wholly-owned subsidiaries. My question is, what advice would you give to your successor in managing our diverse portfolio of businesses?

WARREN BUFFETTYeah, well, it's a very good point that Charlie and I have been known to rail a bit about companies that go and buy this business and that business. And, of course, that's exactly what we've done ourselves over the years. I think the motivations have been somewhat different, perhaps, than in many of the cases. And then I think the way we've approached it has been different. We've — we have been reasonably successful although we've had some notable failures. But we've been reasonably successful in creating a climate where the people who built the businesses continue to run them with the same enthusiasm and energy after they sell to us that they possessed early on. And I think that you can find all kinds of illustrations in the histories of businesses that are diversified. I mean, Gillette bought 20-some businesses. I remember, back in the '60s, Coke bought all kinds of businesses. And certainly the cigarette companies did, all kinds of people. The oil companies for a while were doing it. And generally, the experiences were not very good when they got outside of their own fields. But I think when those companies bought businesses, they really thought they were going to take them over and run them themselves. And Charlie and I are under no illusions that we can run the businesses that we buy as well as, or nearly as well as, the people that have been running them over time. And, we don't have group vice presidents that — in Omaha — we don't have a whole bunch of directives going out. We don't have companies that were run one way and then we're going to run them entirely differently, and have them reporting in all kinds of special ways to us, and have a human relations department and a public relations department, then the legal department — all kinds of things in Omaha — telling them how to run their businesses. We think that destroys — can destroy — many good businesses — certainly can destroy the incentive of the people that have already gotten rich to stay around and make us rich in turn. So, I think that has been an important difference. I think it's been demonstrated well enough to all of those around Berkshire that it's been a very good place, generally, I think, for people, in terms of how they feel about working there. And I think they recognize it works. So, the successor, to me, will come from within Berkshire. They will have seen how it worked. They will believe in it. They will be surrounded by people who have worked in this manner. And I don't think it will be the most difficult job in the world to keep that engine going down the tracks at 90 miles an hour. I mean, it isn't like they have to create the system. They will inherit a system. And I would be amazed if any of the three successors that we will talk about with the directors on Monday, if any of them would not recognize the inherent special values in the system as it now works and take up one of these other models that clearly has been disastrous for one company after another that's diversified. Charlie?

CHARLIE MUNGERYeah. I don't agree with you that the success at Berkshire has come from our oversight of the subsidiary —

WARREN BUFFETTNo.

CHARLIE MUNGER— companies. It's come from our lack of oversight of the subsidiary companies. And I think our successors will be able to provide the same wonderful lack of oversight — (laughter) — that we have provided. And if you're not going to use a lot of oversight, you've got to be very careful in what you bring into your corporate family. And you've got to be very careful in treating, honorably and well, the people who are running the businesses over which you're not giving any oversight to speak of. And I think our system is — it's very different from a General Electric system. And I think their system works very well for them, but I don't think it's the only system in the world that works in corporate capitalism. And I think the Berkshire system will work very well after we're gone.

WARREN BUFFETTIt's a very simple system. I mean, GE works exceptionally well. But when I go back to some of the conglomerates — and that's not a term that I shrink from, but most people do because they think it brings down their P/E or something — but we are a conglomerate. And I hope we become more of a conglomerate. The — we don’t — we haven't succeeded because we had great complicated systems or some magic formulas we apply or anything. We've succeeded because we don't have — we have simplicity itself. We take people that know how to play their game very well, and we let them play the game. And it's just worked in one field after another. And every now and then we make a mistake. And we'll — you know, there'll be more mistakes made. But overwhelmingly, it works. And it doesn't require some great business insight or anything like that, in terms of whoever's running this place, to keep that kind of machine in motion. I mean, it is not complicated. The bigger worry would be that the culture would get tampered with in some way and people would try to oversteer, basically. But that won't happen. Our board won't let it happen. And the ownership won't let it happen. And I think we've got something that'll work for a very, very, very long time. And that's why I'm comfortable with the fact that every share I have will go to a foundation that I care about having — getting good financial results in the future. And I'm quite happy to have them have 100 percent of their money in Berkshire.

Berkshire's best-ever investments: GEICO and Ajit Jain

WARREN BUFFETTNumber 1.

AUDIENCE MEMBERJonathan Mills (PH) from London, England. What has been the single best investment of your careers? And why do you consider it to be the best, excluding Berkshire Hathaway itself?

WARREN BUFFETTYeah, well probably the best investment, if you're talking about business, was getting Charlie as a partner. And he works cheap, too. (Laughs) The — we've had — you can't measure it by dollar terms because, obviously, we're doing bigger things now than early on. I mean, See's was an enormously important part of our success. It doesn't contribute a huge percentage of our net income now, but it provided income that let us buy other things in the past. It taught us a lot of lessons about business, all kinds of things. So, we've — probably, in terms of what it's done already and where it's going to go over time, probably the single best investment was the first half of GEICO, which we purchased for $40 million. Now the second half cost us 2 billion. I'm glad I didn't buy it in thirds. (Laughter) But, you know, that 40 million will — for half the company — will turn out very well. But GEICO — some of our businesses have growth potential, some don't. And we don't require growth potential as part of a business. If a business makes good money and we can use it to buy other businesses, one of the advantages of the Berkshire system is we have a tax efficient and kind of frictionless way of moving money to the best opportunities. And GEICO, internally, has still enormous possibilities for growth. Incidentally, we've — you know, I watched that movie and I kept touting the American Express card. But here is our GEICO card, which I'm sure all of you are eligible for. And I don't advise people using credit cards to revolve. But the truth is that people do, so use a GEICO card if you're going to behave in — if you're going to charge anything. I still advise you to pay off your account before it starts revolving. And I think it's a terrible mistake for people to get hooked on revolving credit at high interest rates. And I — that's the first thing I tell students is that, if they don't remember anything else I say, just, you know, don't fool around with charge cards and run up balances that keep getting larger and larger. But GEICO — GEICO has well over six million customers now. As was mentioned, we entered New Jersey last year. We're adding very rapidly there. It's a great, great business model. And it's run by a superb human being and businessman, Tony Nicely. And I think it's got a huge potential. But I love them all.

CHARLIE MUNGERWell, but GEICO, after all, cost $2 billion for the second half and —

WARREN BUFFETTRight.

CHARLIE MUNGER— a significant number of tens of millions for the first half. Now the search expenses that brought us Ajit Jain, now there was an investment that really paid a dividend. I can think of no higher return investment that we've ever made that was better than that one. (Applause) And I think that's a good life lesson. In other words, getting the right people into your system can frequently be more important than anything else.

NYSE should not being trying to earn a profit

WARREN BUFFETTOK. Let's try number 2.

AUDIENCE MEMBERI'm Maggie Gilliam (PH) from New York City. As someone who visited the New York Stock Exchange at a very early age and have been touting its merits over the years, could you comment a little bit about what you think of the shenanigans going on currently?

WARREN BUFFETTWell —

CHARLIE MUNGERWhere?

WARREN BUFFETTAt the exchange.

CHARLIE MUNGEROh. Warren, you're so good at this. (Laughter)

WARREN BUFFETTYou mean at shenanigans or — I personally think it would be better if the New York Stock Exchange remained as a neutral — and it's not strictly a non-profit, it'll earn some money — but as a not-for-big-profit, we'll put it, institution. I mean, the exchange has done a very good job over centuries. It's one of the most important institutions in the world. And the enemy of investment performance is activity. And the creator of profit in a profit-minded exchange is activity. So, I personally would rather not have an exchange which is trying to increase its earnings per share annually, and thereby wanting to encourage people to trade more actively and create more income for itself. That will not be, in my view, good for the American investor. So, I think that the exchange of yesterday may be better for the American investor than what looks like it may be the exchange of the tomorrow. Now there may be all kinds of reasons that are — people find compelling why they want to turn it into a for-profit exchange. But I know the American investor will not be better off if volume doubles on the New York Stock Exchange. And I know that the New York Stock Exchange as a for-profit institution would be trying to figure out ways to have that volume increase and to perhaps even charge more money one way or the other. I mean, you know, the profit of an exchange, the profit of the people working on them, in a sense that's the frictional cost of capitalism. That's coming out of the earnings of the businesses. And, you know, IBM or General Motors or General Electric will not earn more money because their stock turns over more frequently. But a for-profit exchange will earn more money. And I do not like the idea of the exchange getting on the side that's against the long-term interest of investors. Charlie?

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

WARREN BUFFETTI wish I'd gone to first grade where he did. (Laughter)

CHARLIE MUNGERI didn't hear that.

WARREN BUFFETTI said I wish I'd gone to first grade where you did.

Buffett (D) and Munger (R) both endorse Social Security

WARREN BUFFETTNumber 3. (Laughter)

AUDIENCE MEMBERGood afternoon, gentlemen. My name is Glen Strong (PH). I'm from Canton, Ohio. I want to extend a warm thank you to Warren's daughter, Susan, for the fine introduction that she provided for this gathering.

WARREN BUFFETTThank you. (Applause)

AUDIENCE MEMBERAlso, a special thank you to your wife, Susan. I thank her for the contributions that she made to the company and for the outstanding example that she obviously set for her husband and the many people that she must have come into contact with. (Applause) Today, I'm asking for your opinion on Social Security. Shall we call it the government-sponsored Ponzi scheme for retirees? I am interested in your views on private accounts, age adjustments for retirees, and tax adjustments for the employees. What would you promote if you were in the Oval Office? Thank you.

WARREN BUFFETTYeah, the Social Security was introduced in the, what, '36 or '37. My grandfather used to have Charlie bring two pennies to work at the Buffett & Son Grocery Store on Saturday in order to pay his share of Social Security. Didn't want Charlie getting any false ideas that there was a free lunch in this world. And he gave him a half-hour lecture on the evils of socialism. So, we've had a lot of exposure to Social Security, the various arguments on it. It was proposed, of course, as insurance, because basically that was the only way [President Franklin] Roosevelt could get it passed. The idea of transfer payments did not — would not have washed in the '30s, certainly. You know, and I think the first woman that received a Social Security check paid in a total of $22 or something and got 2,400. So, it wasn't insurance. It wasn't insurance at all. And the transfer payment by the people who are in their productive years to the people who are past their productive years — and we'll get into definitial require — terms as to whether it's 65 or 67 now, you're past productive years — but essentially it's a transfer payment. I basically believe that anything that would take Social Security payments below their present guaranteed level is a mistake. I think that in this country — extraordinarily rich country — that the people in their productive years can take care of those outside in both areas, even though the ratio of productive to non-productive has changed and is changing. But we take care of our young. And a rich country takes care of its young and it takes care of its old. And incidentally, taking care of its young, when we educate five children in the family, we don't expect that family to pay, you know, five times the tax or something like that. We recognize that in taking care of the young, that it should not be based on a per capita basis or based on the size of the family. We provide good school — we try to provide good schools — and health and everything for the young overall as part of our overall responsibility. I believe that a rich country should be doing the same for the older people. There are — you know, Charlie and I came into this world wired in a way that enables us to get very, very, very rich — rich far beyond any possible needs that we could have. And not everybody's wired the same way. Now if you come into this world wired with an I.Q. of 85 or something of the sort, or disabled or whatever it may be, you know, you are not going to do as well in a market economy, remotely as well, as we do. But you still provide much of what makes Charlie and I very rich. And, you know, and when it comes to fighting in Iraq or something of the sort, you know, then that becomes an equal opportunity type thing. But when it comes to making a lot of money, it's not equal opportunity in this country. So I believe that a rich country like ours should not give lower benefits than what takes place now. And I certainly don't think that — and we've got all kinds of mechanisms for saving that are extremely good. We have 401(k)s in the country. We have taxes on dividends and capital gains at 15 percent, so the money I earn gets taxed at a lower rate than the money that a receptionist in our office may earn. And I would not be doing so well if I were stuck over in Bangladesh or someplace. So this society is providing huge benefits to me that other societies would not. And I think that the obligation for the people who do well in this society is to provide a reasonable level of sustenance for those beyond their productive years. We've got the capability to do it. You know, right now we quit taxing for Social Security at $90,000. But — and that means that everybody in my office is paying — or most of them — are paying 12.4 — 12.2 or 12.4 percent, counting what the company contributes, toward this. People talk about double taxation of dividends; they're getting taxed for Social Security and they're getting taxed for income on their income. And they're paying a higher rate, or an equal rate overall, in many cases, to the same rate — compared to the rate that I pay. And I think that's sort of nonsense in this society. So, I don't want to do anything — anything — that hurts the level of the bottom 20 or 30 percent, in terms of their income. I see people living with fear about health care or living with fear about running out of money in their old age. And I think a society should try to minimize the fear that their inhabitants experience. And that doesn't mean just fear of getting mugged or something. It means fear that the last 25 years of their life, they're not going to have much income. So, I would — and the degree to which the administration or other people are worrying about the deficit in Social Security 25 years out, when they have a $500 billion deficit excluding the Social Security surplus now, I mean, just strikes me as nonsense. (Applause) Here we are deploring something that's going to happen in 20 years that's a fraction of what is happening right now while they're cheering, you know, basically, and talking about further favoritism in the tax laws. So, I have great trouble with people that say, you know, that this system can't sustain — right now, 4 and a fraction percent of our GDP goes to Social Security. Fifty years from now, 6 percent — no, 6 and a fraction percent — well, believe me, our GDP will be far larger 50 years from now. And going from 4 percent to 6 percent does not strike me as a terrible prospect. If you ask me what I would do to change it now, I would means test it. I would lift the $90,000 way up. In fact, I might apply it, you know, on all income. Then you'd really get people's attention. But — and I would gradually — and we're in the process of doing this — but I would certainly increase the retirement age. I mean, the world in 2005 is much different than the world in 1937, in terms of longevity prospects and the ability to function productively. Charlie, what do you say?

CHARLIE MUNGERWell, that's the view from Berkshire's Democratic chairman. (Laughter and applause) And the odd part of Berkshire on this issue is that the right-wing Republican who is speaking feels more strongly than Warren that the Republicans are out of their cotton-picking minds to be — (applause) — taking on this issue right now. I do not — If the country is going to get richer at 1 or 2 percent per annum for a long time ahead, and it's going to have more old people who are living longer and spending money on medical care, the idea that eventually a higher share of GDP would be going through Social Security to retirees and so on than we now have is not anathema to me. It's exactly — it's an exactly logical way to be spending money under different circumstances. And if the government runs out a little short of money as it gets more Social Security obligations, I see nothing wrong with having some consumption taxes or whatever to pay in a reasonable way for what is a very reasonable expenditure. Social Security is very successful. Apart from the disability element, which is relatively small, there's practically no fraud. It's hard to fake being dead. (Laughter) And furthermore, it's a reward for work. All kinds of people are working in this country because they want to eventually qualify for Social Security, just as many people are doing dangerous military service because they want the pension that will come eventually. So, Social Security is a very capitalistic institution with profoundly good effects. It's one of the most successful things the government has ever done in terms of efficiency and good effects. And a Republican administration that may shortly have to do something really unpleasant, like face down North Korea or Iran over atom bombs, is wasting its good will over some twaddle that a bunch of economists that haven't thought it through properly devoutly believe? It's a very sad occurrence. (Applause)

Don't blame the ratings agencies

WARREN BUFFETTNumber 4.

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

WARREN BUFFETTWell, financial companies are more difficult to analyze than many companies. I mean, the — it is more — if you take the insurance business, you know, the biggest single element that is very difficult to evaluate, even if you own the company, is the loss and loss adjustment expense reserve. And that has a huge impact on reported earnings of any given period. And the shorter the period, the more the impact can be from just small changes in assumptions. You know, we carry, we'll say 45 billion of loss reserves. But, you know, if I had to bet my life on whether 45 billion turned out to be a little over or a little under, I mean, it'd be a — I'd think a long time. And you could just as easily have a figure of 45 1/2 billion or 44 1/2 billion. And if you were concerned about reporting given earnings in a given period, that would be an easy game to play. In a bank, you know, it basically is whether the loans are any good. And I've been on the boards of banks. And that's — you know, I've gotten surprises. It's tough to tell. It's — financial companies — if you're analyzing something like WD-40, you know, or See's Candy, or our brick business, or whatever, you know, they may have good or bad prospects but you're not likely to be fooling yourself much about what's going on currently. But with financial institutions, it's much tougher. Then you add — throw in derivatives on top of it, and, you know, it's — no one probably knows, you know, perfectly, what some of the — or even within a reasonable range — the exact condition of some of the biggest, you know, banks in the world. And — but that brings you back to the due diligence question of the agencies. You had very high-grade, very smart — financially smart — people on the boards of both Freddie and Fannie. And yet, you know, one was five billion and one was apparently nine billion. Those are big numbers. And I don't think those people were negligent. And it's just, it's very, very tough to know precisely what's going on in a financial institution. Charlie and I were directors of Salomon [Brothers]. And Charlie was on the audit committee. And I forget the size of a few of those things that you found. But, you know, what wasn't found — and that doesn't mean that people below are crooks or anything like that. It just means that it's very tough with thousands and thousands and thousands of complicated transactions, sometimes involving — the computations involving — multiple variables, it can be very hard to figure out where things stand at any given moment. And, of course, when the numbers get huge on both sides, and you get small changes in these huge numbers, they have this incredible effect on quarterly or yearly figures because it all comes lumped in — those adjustments — come lumped in a short period of time. So I just think you have to accept the fact that insurance, banking, finance companies — we've seen all kinds of finance company — both frauds and just big mistakes over time — of just one after another over the years. And the — it's just a more dangerous field to analyze. It doesn't mean you can't make money in it. We've made a lot of money on it. But it's difficult. Now, obviously a GEICO, where you're insuring pretty much the same thing — auto drivers — and you get — your statistics are much more valid in something like that than they will be if you're taking something that — like asbestos liability — you're subject to far greater errors in estimation. Doesn't mean that people aren't operating in good faith. But, you know, I would take — just take the asbestos estimates of the 20 largest insurance companies. I will bet you they're way off, but I don't know in which direction. And that's sort of the nature of financial companies. I wouldn't fault the rating agencies in terms of not being able to dig into the financials and find things that — You know, all of the companies that you've talked about have had big name auditors. And our auditors at Berkshire, how many hours did they spend last year? You know, I don't know whether — what it would be, probably 60, 70,000 hours. And I'm sure at other — you know, if you take major banks, they're spending more than that. But, you know, can they be certain of the numbers? I doubt it. Charlie?

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

We like our stocks but aren't buying more now

WARREN BUFFETTNumber 5?

AUDIENCE MEMBERGood afternoon, Mr. Buffett, Mr. Munger. Thank you very much for your wisdom and all your investment advice. I'm Adrian Sherr (PH) and I'm from Hong Kong. Back in the old days in Hong Kong when somebody turned 100, they got to have tea at Buckingham Palace with the queen. I don't know what you have here in America, but I hope that in 2030 we come back to watch you do 50 pushups at the White House. (Laughter)

CHARLIE MUNGERIt's not the way to bet.

WARREN BUFFETTWill you settle for 10? (Laughter)

AUDIENCE MEMBERMy question comes in two parts. Firstly, in 1968-69, you liquidated all your partnerships. And I guess, aside from your holdings in Berkshire Hathaway, you got completely out of the market and stayed out. In 2000-2001, you mentioned to us that in the coming decade the markets would go, at best, nowhere. However, despite $50 billion in cash, you and therefore us, remain substantially invested in the market. So my first question was, how and why is the investment climate different today than in 1968-69 that makes you comfortable remaining substantially invested?

WARREN BUFFETTYeah, well, we do own certain securities which we wouldn't — we probably wouldn't — buy at these prices. Some of them we would. Some of them we wouldn't. We're not unhappy with anything we own. We're not happy with putting more money in, so we're in a zone in some of those securities that — where we wouldn't buy and we wouldn't sell. Now part of it — that decision relates to the kind of quantities that we deal in. I mean, if we owned 100 shares of each one of the stocks that we own, you know, many billions of dollars' worth, it would be an easier decision to go in and out. But we would face significant costs — including taxes, but on top of taxes — in trying to go in and out of the big positions we have. And basically we like the businesses. So, we are not unhappy. We may feel like we wouldn't want to buy more here. But we are not unhappy about being in the businesses in which we have big equity holdings. Now notwithstanding all of that, a lower percentage of our intrinsic value is represented by the common stocks we own than just about at any time of our history, with the exception of a couple — well, the period right there at the end of 1969 when we liquidated the partnership. So, we have not made any big statement by purchases of stocks or the ownership of stocks that says we — in any way — says that we think that this is a particularly attractive time to own them. But we are not unhappy with Coca-Cola. We are not unhappy with American Express. We are not unhappy with — we are not unhappy with Wells Fargo or Moody's. Those are very, very good businesses that we own. Would we be buying them at today's prices if we, you know — well, the answer is we're not. You know, we've got money. And we may buy more later on. We're more likely to buy more later on than to sell those sort of investments. But there is a zone, which because of size, because of taxes, where we would neither be a buyer nor a seller. And we do not see lots of attractive stocks, but we also don't think that there's as much silliness in the market, by far, as there was 5 years ago roughly. Charlie?

CHARLIE MUNGERYeah. One of the things that's interesting about Berkshire lately is that if you take the last four or five things we did in the stock market, with a goodly number of millions, but — billions, really — but small in relation to Berkshire's overall size — our record is much like it used to be in some of the best days. Where we were able to move around with small amounts of money, the results were quite respectable. But where we were facing the problems of being enormously rich the way we were prevented from the nimble moneymaking record of the past, I don't think that's a permanent state of affairs, but it's never going away either. But it —

WARREN BUFFETTExplain that one. (Laughter)

CHARLIE MUNGERWell, I mean, it's that I think we may be able to deploy large amounts —

WARREN BUFFETTYeah.

CHARLIE MUNGER— of money eventually at very satisfactory rates. Whereas in recent times, we have deployed small amounts of money at very satisfactory rates. And better small than nil. And small is still billions. (Laughter)

"I don't see gold as a store of value"

WARREN BUFFETTNumber 6. (Laughter)

AUDIENCE MEMBERGood afternoon. My name is Mike McGowan (PH) and I'm from Pasadena, California. I had a pretty good question on Prop 13, but after watching the movie I don't think I'll ask it.

WARREN BUFFETTGood. (Laughter)

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

WARREN BUFFETTYeah. I would say that gold would be way down on my list as a store of value. I mean, I would much prefer owning a hundred acres of land near here in Nebraska, or an apartment house, or an index fund. Gold, we'll say, was freed up 30-odd years ago. But it adjusted to a market that still, if you go back to 1900, you know, you were talking $20 gold. Well, you take 20 to 400 in a hundred years. The Dow went from 60 to, what, 12- or 13,000 — 12,000 or whatever it might have been — in that same period, and paid you dividends during the time you owned it. It was 66, I think, at the start of the century. And I forget where it ended, but it's 11- or 12,000. And like I say, it was paying you something every quarter during that period. And if you owned gold, you paid $20 in 1900 or thereabouts. And then you — we'll say you had $400 a hundred years later. And in the meantime, you paid insurance and perhaps some storage cost. It really is not — it's not a store of value. And it's — I'm not arguing for paper money, but if you're worried about paper money — And I think, you know, it makes a lot of sense to worry about paper money over long periods of time — but it's just about — you know, it's just about the last thing I would want to own under those circumstances. You know, it has — a farm has utility, an apartment house has utility, a business, you know, will produce earnings. And some businesses will produce them in real terms as they go along. You know, I'd rather have the ability to sell people a pound of candy 20 years from now. And if they're dealing in seashells, I'll get an appropriate number of seashells instead of paper money for it. But I — it — I just don't — I don't see gold as a store of value. And it's — the truth is, it hasn't worked very well. But forget about whether it's worked well the last hundred years or the last 50 years or the last 10 years, I see no reason, you know, why it would work well in the future. I forget whether we're turning about three- or four-thousand tons of gold a year. And, you know, we take it out of the ground in South Africa and we put it in the ground at Fort Knox or someplace, you know, or in the New York Fed. I mean, and it doesn't do much along the way, for anybody. So, I — Charlie, how do you feel about gold?

CHARLIE MUNGERWell, I think gold was — and similar items — that was a great thing to have if you were a well-to-do Jewish family in Vienna in 1935, because you had hazards where that gold had enormous utility to you. But for Berkshire Hathaway sitting here in 2005, it just doesn't interest us at all.

No stock bubble right now, but no bargains, either

WARREN BUFFETTNumber 7.

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

WARREN BUFFETTYeah. Every now and then — I mean, and I agree — very infrequently, you probably can say something intelligent about markets as a whole. I mean, that you do see circumstances that are extreme enough that you can make a statement that is likely to look reasonably intelligent five or 10 years later. And I've seen a few of those times in my lifetime. I mean, I — and I've spoken out a couple of times. And I did in '69 and '74 and a few times. Most of the time, you know, you're in some in between zone. Obviously, you get more for your money in equities now than you got, say, in the summer of 1999, which is when I delivered a talk out of Sun Valley that later got turned into an article for Fortune. But that was an — I spoke out then because it was extreme. I mean, I knew in a general way that I was going to be right, particularly in certain aspects of the market, but I didn't know when, and then I didn't know how right or anything of the sort. And you could've done the same thing in the other direction back in the mid-'70s. I think that if you had to make a choice between owning long-term bonds, which are now yielding — the Treasury — only a little over 4 1/2 percent, or owning equities for the next 20 years, and you couldn't make — change that decision, I would certainly prefer equities. But I think people that have expectations that they can earn more than 6 or 7 percent in equities, and certainly when they start expecting double digits, I think the degree to what they have expectations, they can do that or that they can find somebody else to do it for them, I think they're making a big mistake. But 6 or 7 percent is not the end of the world at all. In fact, it — and it gets treated better tax-wise right now than it has almost any — well, really anytime in my lifetime. So — I don't think we're in bubble-type, at all, valuations in equities. And I don't think we're anywhere close to — remotely close to bargain valuations. And I don't think it's an extreme enough period that you can speak out in some very definitive way about the outlook. But if you told me I had to go away for 20 years and choose between what's obtainable in an index fund of equities or be committed to long-term bonds, I would rather take equities. But I think you will get a chance to do something that is more screamingly intelligent in not too many years — and maybe a lot shorter — than the alternatives that you're offered now. Charlie?

CHARLIE MUNGERWell, I can't improve on that at all.

"Bubble valuation problems" for real estate

WARREN BUFFETTWell then we'll go to number 8. (Laughter)

AUDIENCE MEMBERHello. My name is Hamid Rezapour. I'm from Orinda, California. I had a question about real estate. And I know this question was asked in previous shareholder meetings about, "How come Berkshire doesn't invest in real estate?" And I believe the answer was that, "We like operating business." So I want to make my question a little bit more specific towards commercial real estate. So, considering the characteristics of larger-size commercial real estate investments like REITs that can have the behavior and financial returns of an operating business, why not invest in real estate? Is it because you just don't like the returns? Or the business is just not attractive?

WARREN BUFFETTYeah, well, Charlie got his start in real estate. Right, Charlie?

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

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

CHARLIE MUNGERThat's for an individual, you regard them as unattractive?

WARREN BUFFETTYeah.

CHARLIE MUNGERAnd for a corporation, that much more so?

WARREN BUFFETTYeah, right. Right. It — the situation changed dramatically from five or six years ago. I mean, the stock market, in many respects, from the 1999-2000 period, is down significantly. REITs are up significantly. REITs were very unpopular five or six years ago. Now they're popular. It's better to pay attention to something that is being scorned than something that's being championed. And there's really been a big change in the REIT situation in the last five or six years.

CHARLIE MUNGERAnd the REITs have phony accounting.

WARREN BUFFETTOtherwise, we love them.

CHARLIE MUNGERYeah. (Laughter)

WARREN BUFFETTYou don't want to bring up anything in these meetings. (Laughter)

Global prosperity helps the U.S.

WARREN BUFFETTNumber 9.

AUDIENCE MEMBERGood afternoon. My name is Carlos Lock (PH). I'm from Lawrence, Kansas. The U.S. has had a dominant role in the world economy for about a hundred years. This dominance resembles that of an economic monopoly. Would you say that the U.S. is a quote- unquote, "a castle with a moat?" And if so, how can we make the moat any bigger? Thank you.

WARREN BUFFETTYeah, well, the U.S. has been pretty remarkable, as I indicated in my earlier comment. I mean, you know, essentially, the same population pool pretty much, and they've garnered over this 215-year period, a remarkable share of the world's wealth. And it's an interesting question as to just why this group of people here have been able to do so much better than the rest of the world, considering we're not any smarter or anything of the sort. It's not an economic castle anymore. I wouldn't call it that. What we do is no secret. And I think that the relative importance of America — I mean, we have been a dominant factor in the world, and post-World War II — and I think it will decline somewhat, although I'm not an alarmist on that. But I think to some extent, the rest of the world, or much of the rest — or some of the rest of the world — is catching on and adopting, you know, sort of best practices, as they say in industry. And our castle will grow in size, but there will be more castles around it. And I basically think that's a very good thing for the world. I think the more prosperous, generally, the rest of the world is, you know, the better, generally, it will be for us. And, you know, I've talked about our trade problems. The more trade we have, the better. We had 1.1 trillion of real trade last year in the country. We would've — with the world — and then we had another 600 billion — 6/10ths of a trillion — that, unilaterally, we bought. Well, I would love to see the 1.1 trillion grow and grow and grow. It'd be good for us and good for the rest of the world. But I don't think that our prosperity will come — in the future will come at the expense of the rest of the world at all. I do think that there were parts of the world that will grow economically from a lower base, but much faster than the U.S. And basically, I think that's a good thing. I mean, there are six billion people in this world, and a lot of them don't live very well. And I would hope that 20 or 50 years from now that it's a higher percentage of them would live well and that — but I don't think it comes out of our hide at all. Charlie?

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

WARREN BUFFETTMm-hmm.

"Unwise" economic policies, but no "Armageddon"

WARREN BUFFETTNumber 10.

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

WARREN BUFFETTWell, as I said earlier, I don't see how the situation resolves itself with a stronger dollar. Most people still seem fairly sanguine about the fact that there won't be anything terribly bumpy about it, that there'll be this so-called soft landing. And I don't know whether that'll be the case or not. But I would say that we're running the risk of having markets that could get chaotic if certain events converged, superimposed upon those factors that you just listed. But I don't — I'm not an Armageddon type at all on the economy. I mean, the things you named are important factors. I think that absent something happening in the terrorism field, I think that, you know, the citizens of the United States, on balance, will be living better ten years from now than now, and 20 years from now than now. But I do think that we're following policies that are unwise. But we've done that plenty of times over history. I mean, [investor] Peter Lynch has always said, you know, "Buy a business that's so good that an idiot can run it, because sooner or later one will." (Laughter) We've got a country that's so good that we can have policies that are counterproductive — (applause) — and we'll still come out OK. Just think of what we've had over the years. I mean, you know, Warren Harding, Chester Arthur? I mean, we've had a lot of things in this country. We had the Civil War. We had all kinds of things over the years. But the society has marched forward, with some fits and starts, but still at a very significant clip. The real GDP per capita is seven times, in the U.S., what it was a hundred years ago. Just think of that. One century in the human pageant, and a sevenfold increase in GDP per capita. It's remarkable. So, I acknowledge, you know, consumer debt doing what it's done and the trade deficit being what it is. And I think that those things — particularly the trade deficit — should be addressed, and promptly. But I don't think they pull down the whole place. They may create, you know, very severe dislocations in financial markets from time to time. But that's been the history of this country. I mean, we have had very dramatic things happen in financial markets over the years. And the country survives despite that. And sometimes there's great opportunity in those dislocations. There's likely to be. So I'm not pessimistic about the U.S. at all. You know, I can't imagine anyplace that I would rather be. But whether — when you say the two most likely outcomes, I think the eventual outcome is that the country does fine. But I think a — there's a significant possibility that you do have some chaotic financial markets at one time or another. But we've had them historically. Charlie?

CHARLIE MUNGERYeah, we don't have any great record as macroeconomic predictors. And I don't see any reason why we should really start now. Obviously, there are more chances for convulsion now. I mean, everybody from [former Federal Reserve Chairman] Paul Volcker on has looked at the current figures and said we could have some kind of convulsion as a consequence of (inaudible). Apart from knowing that, we have no contribution to make.

WARREN BUFFETTYeah, I do think, as I mentioned earlier, that far greater sums, relatively, in one asset class after another, are held by people who — where it's really on a hair-trigger type mechanism. So, the creation of lots of new financial instruments, the piling up of huge amounts by intermediaries or agency activities in terms of money management, I think they lend themselves to more explosive outcomes on any given day than might have been the case some years back when I was selling utility stocks to people, a hundred shares at a time in Omaha. I mean, those — that money was not on a hair-trigger basis. But as you turn it over to fund managers who think their job is to beat the S&P in — on a short-term basis — you are getting very short time horizons on huge amounts of money. And those people may think they are operating independently in one sense. But they're responding to the same stimuli. And they can, as they did in the fall of 1998, they can all head for the exits — or try to head for the exits — at one time. And the thing about financial instruments is there is no exit. I mean, the only way that you get rid of a financial — the only way you leave your seat in a burning theatre in financial markets is to find somebody else to take the seat. And that is not always easy.

CHARLIE MUNGERI think it —

WARREN BUFFETTHowever — go ahead.

CHARLIE MUNGER— I think it's also true that the amount of credit being used, not only by hedge funds but by ordinary investors, is way heavier than most people realize. It wasn't even controversial in this country when we came to introduce single-stock futures and what — you know, commonly traded puts and calls. And ordinary people got in trouble. If I'd been running the country, I never would have allowed that. I don't know what good it does for the country to have a wonderful — a lot of trading in puts and calls. One of my children knew a nice man who had a $2 1/2 million house and $5 million worth of wonderful securities. But he couldn't live as comfortably — he never worked — as he liked to live on the income from his $5 million of securities. And he got in the habit of picking up easy money with the credit systems of the world. He kept selling naked puts secured by his account, including puts on a whole lot of internet stocks. And in due time, he didn't have the $5 million of securities, and he didn't have the house, and he now works in a restaurant. That kind of self-destruction wasn't possible before we created all these wonderful trading opportunities involving credit. It was not a smart thing for this country to do, to legalize gambling everywhere and to bring it in a more facile form into our investment practices. (Applause)

WARREN BUFFETTIs there anyone we've forgotten to offend? I mean, we — (Laughter)

CHARLIE MUNGERYeah.

WARREN BUFFETT— we don't want to miss anyone. (Laughter)

Why Berkshire's board is better

WARREN BUFFETTNumber 11, please.

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

WARREN BUFFETTCharlie, why don't you take that one first?

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

WARREN BUFFETTYeah, it's a tough job, at times, to be a director. The real problem that you can face, and may often face, is when you're dealing with mediocrity. I mean, if you have a baseball team and you have a .240 hitter in the majors, a .240 hitter in the majors is still a pretty good baseball player. But if your job is to have a winning team, you get rid of him. And you find somebody that can bat .280 or .290 and field just as well. In business, the tough part is to get rid of something a notch or two above mediocrity, but not the best one that could be found. And when people meet every couple of months, and they come from different parts of the country, and they have the normal social instincts — they don't like to have rump meetings or to sort of talk behind people's backs — it's very difficult for a group, and particularly if it's a group like Charlie described where a significant number of them, the directors' fees they earn are important to their well-being, and they like — they'd love to be recommended for another board and add another $100,000 a year to their income. It's very difficult for somebody to lead a charge and all of a sudden start at the meeting or trying to arrange a rump meeting of some sort to say, you know, "We really think this guy at the head of the table's no good." And changing — dealing with mediocrity is — or, like I say, a notch above it, is a difficult problem if you're a board member. And we believe that, you know, independence is — it's a state of mind. I mean, it — and it's a willingness, but not the eagerness, to challenge the ideas of others. And to — if you see a merger that doesn't make sense — and Charlie and I have seen a lot of them, and we've been on the boards, and sometimes we've spoken up and sometimes we haven't spoken up — to be able to — you know, you can — the group around you, in terms of social behavior, can only tolerate a certain amount of obnoxiousness on the part of yourself. You have to sort of ration it out. And so you save yourself for big ones. And then, it's not necessarily an easy equation. And certainly, I would say, of the things I've seen proposed in the way of major acquisitions and — a significant percentage of them I wouldn't do myself. But would I overrule somebody else? I wouldn't get the votes probably anyway. And it's a very difficult thing to do. You could occasionally fire a bullet if you think it's important enough, and usually it doesn't do any good. So, I — we have a group that has — every one of them has significant money invested in Berkshire. They all bought it in the market just like you did. I mean, nobody — I mean, I've been on all these boards and they keep handing me things. And, you know, I had shares of this one and that one are given to me, or options or whatever, matching charitable contributions, all kinds of things. But we have real owners on our board. And what they make for being board members is really inconsequential, as I get reminded occasionally — (laughter) — compared to their investment. And they're friends of mine. They're smart. They're very smart. I mean, they are hand-picked, in terms of business brainpower and quality of a human being. And I really think that, you know, we have the best board in the country. But the people that want — who make their evaluations by checklist, you know, whether — either in terms of diversity or in terms of supposed independence — although I don't know how anybody that's getting half their income from board memberships can be independent — you know, we don't — we may not stack up so well. But it's the kind of board that I want to have, knowing that if I die tonight that virtually everything I have goes to a foundation. I want that foundation to have as much money over the years to spend as possible. And there's no group of people I'd rather have in charge of the decision subsequent to my death than the people that we've got on our —

Short gap due to tape change at time of recording

SPEAKERText on screen: "Tape Change"

Gates is smart but we must stock to our "circle of competence"

WARREN BUFFETT(Laughter) No, the answer is that Charlie and I, in managing Berkshire, try to do things — put money in things — that we understand. And when I mean understand, I mean, that we — where we think we know, in a reasonable way, what the economics will look like in five or 10 or 20 years. And Bill [Gates] is a lot smarter about a whole lot of things than I am. But it's still Charlie and I that have the responsibility for managing the money. And we'll stick in what we consider to be our circle of competence. And the fact that somebody else's circle is wider or different, you know, that's the way the world is. I'll listen to any idea Bill has. Believe me, I will listen to him. I mean, he is a — he's not only a smart manager, but he's a smart investor. And I think, actually our ideas on investment overlap to quite an extent. But I still wish I'd bought a little Microsoft when I first met him. (Laughs) Charlie?

If corporate directors need the money, they're not independent

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

WARREN BUFFETTYeah, I have never — I've been on 19 boards — I have never seen a director, where the directors' fees were important to them, object to an acquisition proposal, object to a compensation arrangement of the CEO. It's just never happened, you know — in my experience. And you know, they do not — they frequently do not — behave as they would if they owned the place. And basically we want people that behave as if they own the place.

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

WARREN BUFFETTYeah, we have one of our directors who was — who's been removed twice from compensation committees of other corporations because he had the temerity to actually question whether the compensation arrangement being suggested was the appropriate one. I mean, it — the — it's not — being put on the comp committee of American corporations, as I've said, they're not — they're looking for Chihuahuas, and not Great Danes and Dobermans and —

CHARLIE MUNGERYeah.

WARREN BUFFETTYeah. And I hope I'm not insulting any of my friends that are on comp committees. (Laughs)

CHARLIE MUNGERYou're insulting the dogs. (Laughter and applause)

Why we keep companies despite disappointing results

WARREN BUFFETTOK, number 1. (Laughter)

AUDIENCE MEMBERHello. I'm Rory Johnson (PH). I'm from Suffolk in the U.K. Do you have, or are there, any appropriate criteria, beyond purely financial returns, in assessing the success or otherwise of your investments?

WARREN BUFFETTWell, I would say that the financial returns, achieved in a way that we want them to be achieved, are the determinant of whether we've made an intelligent commitment. Now, we don't get rid of companies that don't meet our original expectations. There's a section in the back of our annual report on the economic principles. And I forget which one it is. It's toward the end. But we say that Charlie and I have this quirk, which business schools would teach is a mistake, in that if we have a business that's underperforming and we could sell it and put — and achieve greater returns someplace else, we don't do it. We say that if a business is going to permanently lose money, we'll get rid of it. If it has major labor problems over a period of time, we might get rid of it. But we are not going to engage in what we call gin-rummy type management where we pick up one card and discard another. And so we will not — if a business has been disappointing to us, but we like the people there and we're not having — not because of labor problems — and we're not going to have to put money in incessantly, we will stay with it when business school theory and management theory would say get rid of it and do something else. We don't disagree with the people that do it that way. It's just that we don't want to live our lives that way. And if we owned 100 percent of Berkshire we wouldn't do it that way. And we don't — we just — we want the shareholders to know that we have this mindset that may produce slightly suboptimal returns because of our attitude. But that's the way we're going to play it, and we tell people ahead of time that that's the way we're going to play it. We like being associated with the managers that we are, even the ones that are in — facing headwinds. I mean, but in a sense you almost identify more with the ones that are facing headwinds because they're doing a hell of a job under very tough conditions. And every business decision or investment decision isn't going to work out perfectly. And some businesses are going to run into unexpected surprises. But the people that have gone in with us have stuck with us in times like that. And our attitude is we'll stick with them. So to the — I would say that how the people behave with us after we buy the business is an important part of how we feel about, you know, the whole relationship as well as the returns achieved. Charlie?

Moral distinction between buying a stock and a company

CHARLIE MUNGERYeah. I think he's asking in part, are there some businesses we won't have as subsidiaries in Berkshire even though they're wonderful businesses? So, are we rejecting some business opportunities on moral grounds?

WARREN BUFFETTYeah, well we've referred in past meetings to one we did on that basis. We will own stocks of companies where we wouldn't want to own the whole business. I mean, you know, you can — I'm not sure that the logic is perfect on that, but we would not have trouble owning stock in a cigarette company. We wouldn't want to manufacture cigarettes, you know. We might own a retail company that sells cigarettes. I mean, there's all kinds of gradations. But we do not — there are things we don't want to own and be responsible for their businesses, where we have no problem owning their stocks or bonds. And some years back, Charlie and I went down to, where, Memphis?

CHARLIE MUNGERYeah.

WARREN BUFFETTYeah, we looked at a — and we were invited down, and we looked at a company that made a product that — perfectly legal — probably one of the best businesses I've ever seen, in terms of the economics of it.

CHARLIE MUNGERAbsolutely.

WARREN BUFFETTStill doing very well. And we met in the room with — we went to a hotel. We met in the room with the people that had the business. And people were perfectly decent people. And they described the business to us. And we went down in the lobby. And as I remember, we sat down in the lobby and just decided that we didn't want to be in that business. And, you know, the lines are not perfect on this sort of thing. I mean, it — I'm sure that there may be ads in the Buffalo News that are selling some investment service or something that I would cringe at if I knew the people involved or what they were selling. And it — if you own a big retail establishment, a retailer, general merchandise, you know, you're probably going to be selling cigarettes when you don't think that you should smoke yourself or that your children should smoke. And it's — they're not perfect. But we have turned down some — the most dramatic being that one because we went — took us a trip of 1,000 miles or so to finally face up to the fact that we didn't want to own it. Charlie, you have anything to add on it?

CHARLIE MUNGERNo, but that was interesting because we were young and poor then by modern standards. And, you know, we're very human. And we could see it was just, like, putting $100 million in a bushel basket and setting it on fire as we walked away. And — (Laughter)

WARREN BUFFETTYou're making me feel bad. (Laughter)

CHARLIE MUNGERWe made the decision all right and with no difficulty. But there was a certain twinge. (Laughter)

Munger's collected wisdom

WARREN BUFFETTNumber 2.

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

CHARLIE MUNGERWell, of course, Peter Kaufman has tried to do that in that book that he stitched together out of my old speeches plus a lot else. And I didn't want to do it. And he went and saw Warren, and Warren got enthusiastic. And Warren suggested this ridiculous name, “Poor Charlie's Almanack.” (Laughter) And between the two of them, they really got me to do it. But the whole idea of doing it is with just the motivation you're talking about. I think if you assimilate everything in that simple book, you will know a lot more than about 95 percent of your compatriots. And it's not that hard to do. So, Peter Kaufman has made it easy for you.

WARREN BUFFETTYeah, I couldn't be more enthusiastic about what you suggested. And it's been done. And it's a sensational book. And anybody that reads it is going to learn a whole, whole lot about life. And you'll learn even — to get you to read it, I'll tell you you'll even learn something about making money. The — and it's right next door here, they haven't sold out.

Future of pharmaceuticals is "too hard"

WARREN BUFFETTNumber 3, please?

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

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

CHARLIE MUNGERI share Warren's agnosticism on the subject. We just throw some decisions into the "too hard" pile and go on to others. (Laughter)

No "degree of difficulty" adjustment for investing

WARREN BUFFETTIncidentally, there's a lot of wisdom in that remark. I mean, there are things in life that you don't have to make a decision on and that are too hard. And many years ago on one of the reports, I said one of the interesting things about investment is that there's no degree of difficulty factor. I mean, if you're going to go diving in the Olympics and try to win a gold medal, you get paid more, in effect, for certain kinds of dives than others because they're more difficult. And they properly adjust for that factor. But in terms of investing, there is no degree of difficulty. If something is staring you right in the face and the easiest decision in the world, the payoff, can be huge. And we get paid, not for jumping over 7-foot bars, but for stepping over 1-foot bars. And the biggest thing we have to do is decide which ones are the 1-foot bars and which ones are the 7-foot bars so when we go to step we don't bump into the bar. And that is something that I think we're reasonably good at. Now maybe we cast out too many things as being too hard and thereby narrow our universe. But I'd rather have the narrow — the universe be a little too — interpret it as being a little too — a little smaller than it really is, than being interpreted as larger than it is. Charlie?

CHARLIE MUNGERObviously.

Avoiding emotional investment traps

WARREN BUFFETT4. (Laughter)

AUDIENCE MEMBERGood afternoon. I'm Whitney Tilson, a shareholder from New York City. And one of the things I find most refreshing and admirable about you, as corporate leaders, is that you're very candid about making mistakes, and — as you put it last year, Mr. Munger — rubbing your noses in it. Last year, Mr. Buffett, you talked about the $10 billion mistake of starting to buy Walmart and then stopping after it had ticked up a little bit. Today, you seem to allude to a somewhat similar mistake. You bought a stake in PetroChina. Then after it was disclosed that you owned it, it popped up a bit. And obviously in hindsight, you could have made a lot of money had you continued buying it. If these emotional traps — I think you called it "anchoring" at last year's annual meeting — are the traps that even people as experienced as you gentlemen are, occasionally fall into, I sort of wonder what hope do the rest of us have? So, my question is, is how do you — what are the mental tricks you have? Or how do you overcome these behavioral and emotional traps like anchoring? And what advice do you have for us?

WARREN BUFFETTWell, that's a good question. And, of course, it first — the first step is in recognition of the fact that they can be traps and that you will be affected by them. And you will make some mistakes because of them. But Charlie in his — in “Poor Charlie's Almanack,” which I probably do take credit for the name of, and the — he talks about the various psychological traps that people fall into. And simply reading that section, you will come away wiser than before you started on it. We will — our personalities are such that Charlie and I probably are a little less prone to some of those mistakes than other people are. But as our record clearly indicates, we still are prone to them. And we make them and we'll make them again. We're probably a little less inclined to make some of them than we were 30 or 40 years ago. But, you know, the nice thing about it is, though, is that if you make fewer of those mistakes than others, you know, they will continue making their share and you'll get very rich. Charlie?

CHARLIE MUNGERYeah. You don't have to have perfect wisdom to get very rich. All you've got to do is have slightly more than other people, on average, over a long time. (Applause)

WARREN BUFFETTYou know, it's the old story about the guy outrunning the bear. I mean, I don't have to outrun the bear. I just have to outrun that other fellow. And — (Laughter)

Low Treasury yields are a mystery

WARREN BUFFETTNumber 5.

AUDIENCE MEMBERHi, I'm Steve Casbell (PH) from Atlanta. With signs of inflation, you know, in commodities and oil, why do you think the 10-year is still — you know, the yield is 4.2 percent? And, you know, is it that the market sees signs of deflation coming in the future? And in addition to that, if you thought rates would stay at this level for an extended period, would you have a more favorable view of the market?

WARREN BUFFETTWell, the answer to the second part is yes. I mean, if somebody guaranteed me that the 10-year rate would never go above 4.2 percent for the next 50 years, we would have to readjust, recalibrate every decision we make around Berkshire. I think it was [Federal Reserve Chairman] Alan Greenspan, I don't know whether he's talking about the 10-year or what is the closest thing now to the 30-year — we don't issue 30-years anymore — but the — he referred to it as a conundrum. And after I looked it up, I decided I agreed with him. (Laughter) I don't understand it. And — but that's OK. There's a lot of things in financial markets I don't understand. And that doesn't mean I have to make a decision. I don't have to either go long or go short, the 10-year. Although by keeping as much money as we do short, we are in effect at least making the decision that we don't want to be long, long bonds. That doesn't mean we think it necessarily would be smart to be short them. But we do not want to be long, longer bonds. And I — If you'd told me two years ago that every move that the Fed would make in the last two years, and you told me all the other variables that would take place, and you'd asked me what the 10-year rate would be at this time, I would have been very wrong. So, you know, it's not a game I've excelled at so far. I'm puzzled by it. And we'll see where it is next year when we meet. Charlie?

CHARLIE MUNGERYeah, I think the one thing you can confidently predict is there won't be some automatic and rational correlation between inflation and interest rates. There will be weird diversions.

WARREN BUFFETTDo you want to elaborate on how these weird things will manifest themselves?

CHARLIE MUNGERNo, no. All I know is it happens.

WARREN BUFFETTYeah.

CHARLIE MUNGERFrequently very surprising.

WARREN BUFFETTWell, it surprised us on this so far, didn't it?

CHARLIE MUNGERSure.

WARREN BUFFETTYeah.

"Finite" insurance

WARREN BUFFETTNumber 6.

AUDIENCE MEMBERHi. Glenn Tongue from New York City. I hope this does not overstate your ground rules. I've read what you have written about finance reinsurance in the annual report. There's been much erroneous stuff written recently about finite reinsurance. Can you simply explain the product and its importance to Berkshire?

WARREN BUFFETTYeah, well it's a good question because the term has been used, "finite reinsurance." And, you know, basically almost all insurance is finite. I mean, if you have a $200,000 homeowner's policy, or if you have a 100/300 auto liability, that's a finite policy. The insurance company will pay you that much and pay you no more. And with the exception of workers' comp, and maybe there's something else I'm forgetting about, but basically all insurance is denominated in some amount with a limit. That 500 million we wrote on that airport, I mean, we can lose 500 million but I don't think we can lose 501 million. And so the — I think the term finite has gotten — it's gotten to be convenient to use without anybody totally describing it well. Actually, when the SEC sent out its first request for information, I think they called it non-traditional insurance. And I think that may be a better term to use in terms of what's being looked at. And there is nothing wrong — I mean, there's nothing wrong at all with finite insurance. We're issuing finite insurance policies every day at our — on our auto policies and everything else. And there's nothing wrong, in my view, at all with retroactive contracts. For example, we wrote — a few years back we wrote a — and this is very rough, but it'd been in the press, so that I'm not violating any confidences of clients — We wrote a contract as I remember — and I may be just a little off on this — that to pay, when INA was being sold to ACE, we — to pay 2 1/2 billion of claims from the past. And I think we got a premium around 1 1/4 billion on it. Now, we were making an estimate or a guess as to whether the whole 2 1/2 billion would be paid, how fast it would be paid, and a lot of things. And ACE, on the other hand, was getting rid of 2 1/2 billion of potential liabilities, and they did not have the capital strength of Berkshire. And that contract went before the Pennsylvania Insurance Department. It was improved. I mean, it had value to both parties. It had — you can argue it had value to the public in that Berkshire was a stronger insurer. Actually, in the first quarter of last year in our 10-Q, you will see that we recorded a loss of $100 million because the payment pattern on that contract turned out to be faster than we anticipated. I mean, there was risk involved. But it was all retroactive and a perfectly proper contract, in my view, or I think anybody's view. And we would do more of that business. In fact, we looked at a very, very big one here recently. What I think the — and understandably — the authorities are looking for is that contracts that had no purpose and that were possibly misused by some party in accounting. And the facts on that remain to be seen. But I think calling it finite, it just isn't the right descriptive word. I think that, like I say, non-traditional — we can have a lot of non — we issue non-traditional products all the time. I mean, I talked last year about the billion-dollar thing for PepsiCo. That certainly isn't traditional. But it's real insurance. And the question is whether risk is transferred. But the risk on the ACE contract, for example, was several. One is, we had a risk as to whether the whole 2 1/2 billion would be paid. Second, was how fast it would be paid. And the third risk is what you can do with the money in between. And money hasn't been worth very much to us lately. So, there was risk in that. And that's what insurance is all about. Charlie?

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

WARREN BUFFETTBut, of course, insurance is a way to reduce volatility, and a perfectly proper way. I mean, if you pay $1,000 a year on your auto premiums for the next 30 years, it isn't — You are going to have a more regular income stream than if you wait and have one $25,000 accident one year and don't pay the premiums in the other years. So, I mean, people have bought insurance to reduce the volatility in their own personal results and their own business results. So, reducing volatility, per se, is not bad at all. It's the reason —

CHARLIE MUNGERNo.

WARREN BUFFETT— there are $400 billion worth of insurance premiums paid in this country every year. But that doesn't — you know, you can also get into abuses of that. And that's what they're — the people are looking to find and see what the real situation is.

Buffett: I make mistakes but don't agonize over decisions

WARREN BUFFETTNumber 7?

AUDIENCE MEMBERWow, this more nerve-wracking than I thought it would be. Hello, Warren, Charlie. My name is Aki Progakis. I'm from Montreal, Canada. Warren, I wrote a letter back in January. I wrote a letter to you recommending a beautiful Canadian retail company in which I described my analysis to you. I'd like to thank you for taking the time to respond to me. You said some nice kind words. That meant a lot to me. And I think you're an amazing individual. My question go — (audio dropout) — people, what is the single most difficult decision you've had to make in your lifetime, whether it be business or personal?

WARREN BUFFETTI think I'm going to let Charlie answer that one first. (Laughter)

CHARLIE MUNGERYeah. I would argue that that may be one that you shouldn't ask. (Laughter and applause) Or let's put it this way, I think you should answer it with several interesting examples before you ask us to answer it. (Laughter)

WARREN BUFFETTThat's a (Inaudible). (Laughter) It's interesting. As Charlie was talking, I was — I have — I can't think of a lot of difficult — I can think of a lot of wrong decisions I've made. But I certainly can't think of anything I agonized over making for any long period of time. Like I say, that isn't — you know, I mean, it's calling balls and strikes. I mean, you got a second there and if you don't do it in that — you're no longer an umpire. So, I've made plenty of wrong decisions. I'm going to make plenty more. That's just part of living. But I don't think in terms of being difficult as measured by the time it took me to do it or the — not a lot of them pop to mind. And if they do I'll probably give you the same answer as Charlie. Charlie, have you thought of any more there while we were talking?

CHARLIE MUNGERNo. Let's go on to another.

WARREN BUFFETTOK. (Laughter) That was not a bad decision.

Real estate brokerage will get a "lot bigger"

WARREN BUFFETTNumber 8. (Laughter) But thank you.

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

WARREN BUFFETTYeah, I'll be glad to. But the — we are hoping to build a powerhouse that's built very much on the model of today. In other words, we do not envision big changes in residential real estate brokerage, which is what we're in. We — as we put in — they talk about sides in real estate, the buy side and the sell side. We participated in sides that totaled $50-odd billion last year. And we are the second largest residential real estate brokerage firm in the country. But we expect that business really to be conducted quite similarly in the future to how it has been in the past. Now there are people that disagree with that and think that way more will happen via the internet. But, you know, the purchase of a home is the single most important transaction for most people in their lifetimes. It's — it can be partly emotional. It's partly something that they appreciate people guiding them through. It's something where I think one-on-one will be very important in the future as it has been so far. And in this country, there are going to be millions and millions and millions of homes that get sold every year. It's — just in terms of people moving and dying and moving up in their economic potential. So, there — the real estate brokerage business is going to be a very, very big business. And I think it will tend to be a very local business. And we have bought leading local firms in a number of markets. And they have retained their individual identity. We have not gone for a Century 21 or something approach, where we put them all under the umbrella of a single brand. Rather we have these individual brands in given communities. And they're usually very strong brands in each community. But we've only scratched the surface. And I would expect — and it has nothing to do with the potential for real estate or anything. It just relates to the fact that tens and tens and tens of millions of people own their own homes. And some are going to move around every year. And there's — I think that they're going to continue to have a real estate broker involved in most of the transactions. And we would like to be very big in that business. We already are big, but we're going to — I would think it's almost certain that we will be a lot bigger in that business five or 10 years from now — I mean, a lot bigger — than we are now. And it's a question of acquiring these firms. Generally, they're — you know, they're proprietorships. They're owned by a single individual or a family. And they come up periodically because of the family circumstances or the individual circumstances of somebody. But there's a lot of them out there. And we're a logical buyer. And we've been found to be a good owner. So I think it's going to be a good-sized field for us over time. Charlie?

CHARLIE MUNGERYeah, we voted by buying the brokerage operation instead of the real estate. Obviously, we regard it as having better economics than the underlying real estate which Berkshire could buy.

Munger: "Stupid and dishonorable accountants"

WARREN BUFFETTNumber 9.

AUDIENCE MEMBERHello. My name is Martin White. I'm in the insurance business in London. And quite separately, together with other volunteers, I also help to run the only independent lobby group for private shareholders in the U.K. I would like to ask you your thoughts on two aspects of worldwide solvency and how assets and liabilities are recognized in everyone's accounts. I suppose both are about whether the regulators have the bottle to do the right thing in spite of possible complaints from companies. One aspect is about how insurance liabilities and assets are valued for solvency purposes and the discussions that are going on to develop new accounting standards worldwide. The other aspect is about derivatives, the potential "weapons of financial mass destruction." For those derivatives which don't have quotes, I suspect we could find out how big a black hole there might be if the regulators around the world required everyone to report at the same date for each derivative they have, their current recognized asset or negative assets, and most importantly, who the counterparty was. So, the regulators, sharing information collected from both sides, could see what the worldwide aggregate misstatement was. On insurance solvency, if we started with a fair attempt at mean discounted liabilities, and then added a large chunk for safety, and for reinsurance assets, did the same, discounted, but this time the safety chunk was deducted, life would be a lot simpler and there would be a lot more consistency and, I suspect, safety, than under the current undiscounted regime. I think both problems need regulatory attention. What are your thoughts?

WARREN BUFFETTWell, on a subject of discounting reserves — which essentially means taking what you expect to pay in the future and then taking in the appropriate interest rate and carrying at some lower figure now, because you don't have to pay now, but later — You know, I can certainly make the purist argument — or the argument of the purist — for the fact that that might be the most accurate way. And certainly, of course, in the life insurance field, it is prevalent. But I would say there has been such a tendency of managements to understate reserves worldwide, and in some cases by extraordinary amounts, that I think anything that pushes in the direction of carrying those reserves at even lower amounts — And I realize you stuck in that part about the healthy bumping of them, too — but I think anything that — any accounting that lets — gives people a rationale for making reserves even lower than they have been, on balance, is dangerous. There is such a tendency on what they call long-tail business — or business where you don't expect to actually make the payments for a few years or more — I think there's such a tendency to view those with optimism, particularly when somebody's going to retire in a couple years or their options are about to run out or whatever it may be, that I don't like giving them the extra leeway of discounting on top of that. The derivatives question you raise is really interesting, but it would be mind-boggling to implement. I mean, it’s always fascinating to me how people can write a derivative contract, you know. And both sides of it — the trader will be, perhaps at least, showing a profit on it, you know, by the end of the month or something of the sort, that — you know, usually the contracts aren’t that precisely matched because you have all kinds of other contracts that bear on the one you’re doing. But I would say that the trader's estimate, and maybe the auditor's estimate, of the value of all derivatives contracts outstanding in the world, would end up with — quite a large positive sum for something that essentially will wash out as a zero sum. And I can tell you from the fact that I inherited a book of 23,000 contracts that's far, far, far from the largest or the second largest or the third largest in the world. And the complexity of those contracts, and the complexity of unwinding them now where we're three years into it — and we've done an awful lot of it, but we've been operating in a benign environment — I don't think any regulator, and I'm not sure any auditor, when you get up to really extensive derivative books, in effect, can get their minds around evaluation. I know that, you know, as I pointed out in our report, ours were supposedly marked to market. And people think of that as something that you just go out and hit bids and, you know, within a few days wind up something. And if you're trading government bonds, you know, you can do that. And if you're trading actually active equities, you can do it. But when you start trading derivatives, it's unbelievable what you can find. And I've had a couple of experiences with them. Charlie, what are your thoughts?

CHARLIE MUNGERWell, my thoughts are that stupid and dishonorable accountants allowed the genie of totally improper accounting to come out of the bottle and descend in the derivative books of the world. Once that has happened and people have used it to create masses of assets and masses of earnings reports and bonuses and status and so on and so on and so on, getting the genie back in the bottle is no small task because you have these huge vested interests who are fighting you. And what ordinary housewife, as she puts the toast in in the morning, is thinking, "My god, I've got to do something about derivatives?" You know? (Laughter) So the people that are — have vested interest in the current system are powerful. And the rest of the people don't care. And so this evil genie stays out of the bottle and does more and more mischief with each passing day. If you're trying to fix this, you are going to have a very interesting life. (Laughter)

Q&A ends

WARREN BUFFETTIt's 3 o'clock now. If you haven't had enough, [TV journalist] Charlie Rose has a show on, on Channel 12 tonight at 8 o'clock where there's another hour and a half of interviews he did with me and with Bill Gates and various people.