2006 Annual Meeting2006 年度股东大会

2006 meeting

Morning session

1. Welcome

WARREN BUFFETT: Good morning. I’m Warren; he’s Charlie.

There’s one thing I should probably clear up first because I know it’s puzzling you. In the movie, he always gets the girl.

Now, that’s hard to figure out, isn’t it? But I’ve — Charlie — but I finally understand what the — what’s happening.

It’s something called the “Anna Nicole Smith Rule.” That’s when choosing between two old rich guys, pick the older one. (Laughter)

Now, in a few minutes we’re going to open this up to your questions. We have a number of zones, and we’ll just proceed around zone by zone.

But before we do that, there are a few people I would like to thank, and then there’s a couple of short announcements I’d like to make.

First of all, if can we get the spotlight up there on Andy Heyward, Andy does that cartoon for us every year. He travels around. He gets the voices in there. Andy, where are you? (Applause)

He comes up with the ideas.

Andy is the — runs DiC Entertainment. DiC is the one I’ve told you about in the past that produced “Liberty’s Kids,” which I think is probably the best way not only for youngsters to learn American history, but for people my age as well.

I mean, it’s a terrific series of young kids — a couple of young ones in the time of the American Revolution. And I watched several of those episodes, and I’d forgotten a lot of American history since I was in school. It’s just a really — it’s a wonderful series.

It appeared on PBS over time. And if you’re looking to learn American history or have your children or grandchildren learn it, you couldn’t do better.

And in the months ahead, he’s working on the — what do we call it? — it’s the “Secret Millionaires Club.”

But it’s going to be a program that’s designed to teach young people some of the very basic lessons of — about money. How to avoid getting into trouble with it, how to use it effectively, and what your attitude should be toward it.

So, we’re looking forward to getting that out early next year. I’ll guarantee you that it will be a terrific program for teaching children and your grandchildren something about the subject of money.

I also want to thank Bob Iger. Bob is up there. Bob runs Disney. He’s doing a terrific job, and — (Applause)

I thought we could originally entice the “Desperate Housewives” into appearing simply by the chance to appear with Charlie. But after we made that appeal, we then went to Bob Iger and said, “See what you can do for us, Bob.” So thank you, Bob.

Also in that section, I’d like to have a special introduction for the man that first taught Charlie and me something about the value of franchises and the advisability of buying great businesses instead of cheap businesses.

Prior to the purchase of See’s Candies in 1972, I intended to look primarily at financial measures in buying businesses and buying things that were cheap in relation to book value, and we always tried to get a lot of tangible assets in relation to our money.

But we found out that the intangible assets, if properly nourished and if properly identified, you can make a whole lot more money with than buying a lot of tangible assets cheap.

And in 1972 — early in ’72, Charlie and I went to See’s Candy, which had been in the hands of the See family for many decades, and we bought it.

And, of course, Charlie and I didn’t know a thing about making candy — we were pretty good at eating it — and we needed someone to run the place.

We met a young fellow there. It was clear to both of us that he was the ideal person to run See’s Candy, and in just a few minutes we made a deal with him that’s lasted a lifetime.

And if Chuck Huggins and his wife, Donna, would stand up, I’d love to have you give them a real well-deserved round of applause. (Applause)

As you notice, my daughter Susie produced that movie. She does every year.

She works hard on it, and we don’t pay her anything, although she does remind me occasionally when I’m out at Borsheims that she worked very hard on the movie — (Laughter) — and I’ll see her there on Sunday.

And, Suz, if you would take a bow, please. (Applause)

And the impresario of this event, I just turn it over to her every year and forget about it.

But she puts on this show. She brings all the exhibitors in. She arranges everything. She moves into the hotel across the street a few days ahead of time, or a week ahead of time, and makes sure everything hums.

And Charlie and I just come down on the day of the meeting and take a bow. And that’s Kelly Muchmore-Broz.

Kelly, are you here? Where’s Kelly? There she is. Give her a big hand. (Applause)

We wouldn’t be having this without her.

2. Berkshire directors introduced

WARREN BUFFETT: Now I’d like to introduce our directors. We’re going to get to the business meeting at 3:15. We do the Q&A first, and we get to that later on.

But for those of you who won’t be around — and a lot of people tend to leave at lunchtime — I’d like to introduce the various directors. You’ve met Charlie and myself.

If you’ll just stand individually, we can withhold the applause, if any, until the end. (Laughter)

That way that embarrassing applause meter that we had on the Omaha Idol Show will not cause anyone distress.

Howard Buffett — Howie — Malcolm Chace, Bill Gates, David Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott, Jr. It’s a terrific group of directors. (Applause)

I know of — I literally know of no directors of any large, publicly-owned companies that have, universally, as significant a percentage of their net worth in the company, purchased in the open market, as that group. Do you, Charlie?

CHARLIE MUNGER: None.

WARREN BUFFETT: None. OK. (Laughter)

That may be all you hear from him, folks — (Laughter) — so kind of savor a little bit.

3. Jamie Lee Curtis

WARREN BUFFETT: I also would particularly like to thank Jamie Lee Curtis, even though she came up with the wrong guy at the end.

Jamie cooperated on this. We’re going to have, as a thank you — Jamie is very interested in the Park Century School. One of her sons goes to that school. It’s for gifted, but learning-challenged students.

They’re having an auction tonight, but it will continue subsequently. And Bill Gates and I have autographed a Monopoly set, and we will personally inscribe it to whoever the winner of that auction is.

So if you want to go to eBay and check that out, we promise that we will not similarly autograph anything else. So I hope that Jamie Lee and the school have a big success on that.

4. Berkshire’s Q1 earnings

WARREN BUFFETT: We have two announcements, one relatively unimportant but, nevertheless, pleasant, and that is that we released our earnings yesterday after the close.

And I think we can put those up on the screen. Having any luck on that? Did we withdraw those earnings, Marc? Oh, they still have another six hours of audit or so.

And, as you can see, we don’t pay any attention to realized gains or losses. We had some gains this year; we had some losses in the first quarter of last year.

So — but that’s meaningless in the short term. Over time, obviously, it makes a difference.

But the — you know, we do not pick anything to buy or sell in any given quarter or any given year in the way of securities based on the effect it will have on our income account for that period. It’s totally immaterial.

In fact, we’d rather sell things that we have a loss in, just from a tax standpoint.

If we have some high-tax cost stocks and some low-tax cost stock, we’ll sell the high one and record the loss because we would get a better tax result that way for the short term. So we ignore that.

But if you look at the operating earnings, you’ll see that in those main divisions that I take in the annual report — I show our four major businesses and then investment income is aside of it — things worked out pretty well in the first quarter for all of them.

I would caution you that, in our insurance underwriting, our worst quarter would normally be expected to be our third quarter. You’re not going to have hurricanes in this hemisphere in the first quarter.

The real exposure — the worst exposure — is in the third quarter, and then there’s a lesser exposure in the fourth quarter.

We write a lot of catastrophe insurance business.

Earthquakes, as far as we know, don’t have any particular seasonal aspect to them, but hurricanes definitely do.

And the interesting thing is that under standard accounting, if we write a hurricane policy for the calendar year 2006 and we receive a million dollars of premium, we would earn a quarter of a million in the first quarter and a quarter of a million in the second quarter and so on.

We would earn a pro rata throughout the year. And that, in our view, actually is not proper accounting, but it’s required accounting.

The real exposure to loss is primarily in the third quarter.

So you can’t take our insurance underwriting results in any way for a rather benign quarter, like the first quarter, and extrapolate them for the year. But, nevertheless, it was a very good year — a very good quarter.

GEICO had excellent growth, I believe that our — well, I’m almost certain that our growth in the first quarter was better than any of our main competitors, and, actually, by — probably by some margin — the underwriting was very good. Our reinsurance underwriting was very good.

Gen Re had a good quarter. Our smaller companies had a good quarter.

So things, generally, have been working very well in all four sectors.

And that’s nice, but that’s not terribly important. I mean, five years from now, nobody will remember whether the first quarter or the second quarter was good at Berkshire Hathaway.

5. Acquisition of “really extraordinary” ISCAR

WARREN BUFFETT: But what did happen, and which we announced last night — which was very important — the acquisition of a large, extremely well-managed, profitable, really extraordinary company called ISCAR.

And up until October of last year, I knew nothing of ISCAR. I did not know about their extraordinary management.

But I got a letter, and I got a letter from Eitan Wertheimer, and — maybe a page and a half, page and a quarter — and he told me something about this business.

And sometimes character and talents sort of just jump off the page at me, and this was one of those letters, and it came from Israel. And I expressed an interest, after reading this letter, in getting together with Eitan.

And not long thereafter, I met not only Eitan, but his CEO and president, a remarkable man named Jacob Harpaz; Danny Goldman, the CFO. And we met in Omaha. They subsequently met Charlie.

And this all came to fruition yesterday when we signed a contract. Now we have — well, before I go on to this, maybe Charlie would like to say a word or two about ISCAR.

He’s the — hard as it is for you to believe, he is not only — he’s as enthusiastic about this as I am.

Now, have you ever seen that before, I’d ask you? Charlie likes this one extraordinarily well. Charlie?

CHARLIE MUNGER: Well, this is a company that, from very modest beginnings, grows to be the best company in its field in the world. It’s not yet the biggest, but that leaves them something to do.

The average quality of the people in this company is not only extraordinary, it’s off the chart. And the beauty of this, as you look at the two of us, is they’re all young.

No, this is a real quality enterprise, and these people know how to do some things that we don’t know how to do. A lot.

So, of course we’re enthusiastic about the company. I’m always enthusiastic when I get to deal with some of the best people in the world.

I would like if we could get the spotlight down there. They’re right down here in front. I would like, individually, three managers to stand up.

And then Eitan is going to talk to us a bit, and then we have a — I think we’ve got it arranged so that we can have a short movie that will tell you something about ISCAR.

But, first of all, if Eitan Wertheimer would stand up and we can get the spotlight on him? Over there. OK.

Eitan, let me introduce the other two, and then can we have you speak to the group?

Jacob Harpaz is the president and the CEO. (Applause)

Take a good look at these people because they’re going to make you — they’re going to do very, very well for you.

And Danny Goldman. Danny, would you stand up? (Applause)

Thank you. And if you’ll give the microphone to Eitan, I think Eitan would like to talk to the group just a bit.

EITAN WERTHEIMER: Good morning, everybody. It’s Omaha. It’s spring. The fields are green. The days get longer. And we bring a big family into a new home.

I’m standing here before you representing 5,869 people, not only the people, but the families, their past and their future.

It took us three years to look what to do next. We are successful. We still have a lot of mistakes ahead of us to do.

Until we found one day somebody came to us and asked, “Have you heard about Berkshire Hathaway and Mr. Buffett?” We said, “Yes, we heard, but we never thought about it.”

And when we started studying about the company, we understood that this is the right combination for us, a family company with a strong culture and a culture we’d love to keep, a young group of people that will love to work, maybe not for very long, but not less than 20, 25 years from today.

And we decided, let’s try it. And we had a very interesting lesson from Warren, we had a very interesting lesson from Charlie, and we survived both of them. (Laughter)

I’m very happy that I represent here, not only the people that make the products and go to the customers, I also in a way represent the big family of customers that make — manufacture things.

They make cars go faster and safer. They’ll make airplanes fly. They will make the mold to make the bottles for the Coca-Cola. They’ll make a washing machine. They’ll make the tools to make a carpet.

They’ll make many things. And many times the people that manufacture are a little bit in the shade.

And I’m very proud to stand as a manufacturing guy, and say I’m standing for all of them, all our customers, which I must thank them every morning, not only for buying, but also for trying new ideas that we bring and working very hard to stay competitive.

Whoever will stay competitive will be there long-term. And this is also our goal.

Here is Mr. Harpaz, Jacob. In reality, my job is not to disturb. He, in a very gentle way, fired me ten years ago.

He performed and did better things than I could do, and it didn’t make sense that I’ll disturb him; so I went on to do other things. We’ve been in the company only 34 years, and the real job is done by Jacob and many, many other people.

I’m sure that you have seen the film “In 80 Days Around the World.” And we prepared for you, “In 61 Companies Around the World.” And I hope you enjoy it.

We definitely have to fulfill a lot of expectations. We definitely have to work very hard to make everybody very proud that we joined the family, also our people and for sure everybody in this room.

So let’s hope we’ll all be successful, and let’s look into the future. And I’m looking forward to come every spring, to Omaha, where the fields are green and the days get longer. Thank you. (Applause)

ON TAPE, ANNOUNCER: IMC presents “Better Solutions for a Better World.”

In 1889, the appearance of the first automobiles brought with it the need for sophisticated solutions in metal processing. Such were the beginnings of a new company, launched by engineers in the U.S.: Ingersoll.

In the decades to follow, another plant was set up in Germany. Since its creation, Ingersoll has established strong ties with industry, which has placed it firmly in a leadership position.

For over a century, time after time, Ingersoll has proved that the best solutions begin with the best engineers.

In 1999, Ingersoll joined the IMC Group and discovered that the sky is not the limit but only the starting point.

Meantime, at the turn of the 20th century, another metal processing plant was established on the other side of the world in South Korea: TaeguTec. In joining the IMC Group in 1997, TaeguTec reinforced its position as the main supplier of cutting tools for industry in the Far East.

Today TaeguTec has achieved unparalleled success, penetrating new markets, streamlining production process, and showing that precise global thinking can cancel distances.

In the middle of the 20th century, in the north of Israel, Stef Wertheimer had predicted, from his little shack in Nahariya, the global need for more advanced cutting tools. “The new world demands better solutions,” said Wertheimer, and established ISCAR.

In a relatively short time, ISCAR has become the second largest cutting tool manufacturer in the world, a leader in the area of metal removal.

ISCAR has revolutionized every aspect of machining. Its mission: to apply innovation, quality, and automation on the highest technological level.

Among ISCAR’s groundbreaking achievements are the revolution in cutoff applications; development of SELF-GRIP in the ’70s; the pioneering triumphs in milling; the HELIMILL in the ‘80s; the CHAMDRILL; the revolution in drilling in the ’90s and tangential positive milling; the innovative TANGMILL.

These innovations and more have reinforced ISCAR’s position as the world’s leader in development of cutting tools.

The combination of Ingersoll, TaeguTec, and ISCAR has given rise to the IMC Group, taking the best of all worlds and creating the world’s best tools.

Today’s rapidly advancing world demands that we constantly elevate standards, apply ourselves more and more to provide ever-smarter and precise solutions, pushes us to advance to improve ourselves, to lead.

ON TAPE, EITAN WERTHEIMER: You have to be a full line supplier. To be a global company means to be local in many countries, in many places around the world.”

ON TAPE, ANNOUNCER: Other IMC Group companies:

IT.TE.DI Italy, designers and manufacturers of PCD diamond tools for high-precision aluminum machining in the automotive and aerospace industry;

UOP Italy, producers of high-quality solid carbide and high-speed steel standard tools and special tailor-made designs for applications in the aerospace and dye and mold industries;

Outiltec France, expert creative solutions in extra-long gun drills for deep drilling and applications that require unique geometries;

Unitac Japan, deep-drilling BTA-style tools with brazed and indexable heads;

And Wertec Italy, design and manufacturer of unique counterboring tools for deep and complicated boring applications.

ON TAPE, JACOB HARPAZ: If you look outside and you see some cars over there, be aware that in each car at least one part is manufactured by one of the IMC companies, for sure.

ON TAPE, ANNOUNCER: Automotive.

ON TAPE, EITAN WERTHEIMER: Before you have a product line, the geography spread, the people that understand the language, you cannot start thinking, “May I try or may I not try to become automotive supplier?”

ON TAPE, ANNOUNCER: We at IMC have made the automotive industry the foremost objective for all the factories of the group. All the Ingersoll vessels connect to contribute massively to the work of the automotive industry in North America.

At the same time, on the other side of the globe, TaeguTec cutting tools joins the momentum of the rapidly-developing Japanese and Korean automotive industries.

The alliance between ISCAR’s developments and the IMC Group has led to comprehensive solutions, which contribute to the efficiency of global automotive production and pave the way for production cost savings.

ON TAPE, JACOB HARPAZ: We’re not only selling tools, we are selling technology. We are selling the customer a better way to make profit. And we believe, by giving a solution, it can increase its productivity. And the bottom line for the productivity, making more profit for his company.

ON TAPE, ANNOUNCER: Heavy industry.

The power of IMC comes clearly to the fore in heavy industry. The unique combination of the three main manufacturing plants creates new opportunities.

The geographic location of Ingersoll and TaeguTec has led the companies to develop specific heavy industry specialization. The innovative geometries developed by ISCAR, together with the design and production of tools made to conform to the special requirements of this industry, places IMC at the forefront of this important industry.

Aerospace.

The blend and precision and inventiveness ought to go far.

If you want to reach far and high, you must be on top of the game in technology, in understanding materials, (inaudible).

The aerospace industry demands machining solutions for exotic and difficult-to-process materials, proficiency in lightweight materials, such as aluminum, and the ability to machine parts that require massive processing capabilities.

The grouping of the three plants and the profound understanding of cutting materials and complex cutting geometries, along with the expertise and building large-size tools, make IMC the strategic partner for the aerospace industry.

General engineering.

All this vast engineering experience accumulated in every field, in every industry, and in every corner of the world, has paved the way for the development of new, groundbreaking tools, which streamline production processes, shorten machining time, and reduce costs for every customer in the world of general engineering.

ON TAPE, JACOB HARPAZ: After releasing the product into the market, we put another team — our own team — and they’ll now compete against the release of the product.

ON TAPE, EITAN WERTHEIMER: In exhibitions, we are recognized as a very, very innovative company. Many times the sentence is, “Let’s go there because they must have something new. They always have something new.” That’s a big compliment, and innovation will make the difference.

ON TAPE, STEF WERTHEIMER: I believe that, in a way, industry is an art in itself. It’s art. It’s creation. You create something.

ON TAPE, ANNOUNCER: You can see it immediately upon entering an IMC branch or factory. The house of IMC is, first and foremost, a home for employees and customers as one. Years of experience have taught us that this is a vital element for success.

ON TAPE, EITAN WERTHEIMER: Many companies have buildings and machines and a lot of real estate, but it’s only people that have a chance to make any difference.

ON TAPE, JACOB HARPAZ: I believe with the ambition of the people, with the hard work of the people, we are going to reach the position of being number 1.

ON TAPE, ANNOUNCER: The world demands better solutions. That is why we’re here. IMC. (Applause)

WARREN BUFFETT: This is an important acquisition, as we paid $4 billion for 80 percent of the company. The family remains in partnership with us. They retained 20 percent.

It’s the first business we’ve purchased that is based outside the United States. We have others that have operations there.

I think you’ll look back on this in five or ten years as being a very significant event in Berkshire’s history.

And it’s interesting. In this world, in which many businesses get auctioned off, figures get dressed up before they sell them and leveraged up and so on, we continue to hear from people periodically who consider their business as too important to auction.

And we’ve never really bought one at auction — have we, Charlie — that I can remember?

CHARLIE MUNGER: I can’t remember one either.

WARREN BUFFETT: Yeah. So there’s a benefit in that.

Because, in effect, the people that pass through that filter of caring enough about their business that they don’t simply put it up like a piece of meat at an auction are also the people, in our view, that make the best managers and make the best partners over time.

There is something going on in their brain that says this business is so important, and the people that are here are so important, and the customers we take care of are so important, that we actually care about the home in which these businesses reside.

And I think that filter works very much to our benefit. We’ve bought a number of businesses in the last 15 or 18 months where people have felt that way, and I think the crowning one here is ISCAR.

So, I welcome our new friends from Israel. I’m going to go over there and visit in September to see if there are any more girls out there like you, see if we can drum up a little more business.

6. Questions and answers

WARREN BUFFETT: And with that, let’s go on to the question period.

And we will do this until noon, at which time we’ll break for 45 minutes or so and come back, and then we’ll continue until about 3 o’clock.

Then we’ll break for about 15 minutes, have the formal business meeting from 3:15 to 3:16. (Laughter)

And then at 4 o’clock, Charlie and I are meeting with all of the people who came from outside of North America.

This year we had about 550 requests for tickets from countries outside of North America, as opposed to about 380 last year. So we’re looking forward to meeting all of you that have come a long way to attend this meeting.

7. We can “easily handle” Social Security

WARREN BUFFETT: Now, we’ve got a dozen zones in here, and we’ll start off with zone number 1.

AUDIENCE MEMBER: Yeah. My name is Edward Jannig (PH) from Denver, Colorado.

First, I want to thank Charlie and Peter Kaufman for their wonderful book. I think Benjamin Franklin would be very proud.

My question is, last year when asked about Social Security, you said that a country as rich as the U.S. should take care of their old people.

This year I read Pete Peterson’s book, “Running on Empty,” and I was wondering, from the standpoint that is the greatest benefit to society, where should you draw the line on entitlement spending?

And I was wondering if you gentlemen disagree on the subject at all.

WARREN BUFFETT: Now, you always have the question in every society — whether it’s formalized or not — you have the question of how you take care of the old and the young.

You know, you have people in their productive years turning out goods and services, and you have people that are too young to participate in the turning out of those goods and services but that, nevertheless, need them, and you have people that are old in the same position.

And starting in 1935, I believe, we statutorily formalized that idea. We’d always felt that way about the young, that school should be there for them when they couldn’t pay for them themselves, and that the society owed a duty to both classes. But in 1935, we took up the idea that the government would provide this base limit.

Now, I think there’s some merit to the argument that the 65 became outmoded as longevity improved. And that is now being changed, to some degree, and I think there’s probably some more change needed.

But this country has an output of almost $40,000 of GDP per person. And some people, like Charlie and myself, are very lucky to be wired in a way that in a market system we get enormously wealthy.

And other people are not so wired, and they come out and they, in a market system, do not necessarily do so well, and they’re fairly lucky if they provide for themselves during their working years and they do not have the ability to earn at a rate that takes care of them in later years.

And society has taken that on. Our country can easily handle the Social Security question.

I mean, it — and it’s kind of astounding to me that a government that is quite happy to run a 3- or $400 billion deficit now worries a lot about the fact they’re going to have a $100 billion deficit or something in Social Security 30 years from now. I mean, there’s a little bit of irony in that. (Applause)

It is true that, if we maintain the present age brackets, that eventually you have one person in the older years for every two that are producing in the younger years.

But we produce more every year as we go along. And there will always be a struggle in a representative society, in a democratic society, between how you divide up that pie.

But we have a huge pie. We have a growing pie. And we can very easily take care of people, in a manner at least as well as we take care of them now, in the future from that growing pie without the people in their productive years not — also having a gain in their standard of living.

CHARLIE MUNGER: Yeah. I think the world of Pete Peterson, but I don’t come to the same conclusion.

Of course, if we didn’t tinker with Social Security, it would eventually run low on funds.

But if the country is going to grow at 2 or 3 percent per annum for decades ahead, it’s child’s play to take a little larger share of the pie and divert it to the people who are older.

It would be crazy, I think, to think you would always freeze the share of money going to the old at exactly the same sum no matter how rich you got.

It’s a perfectly reasonable thing to do to pay a little more in the future to support what I regard as one of the most successful programs in the history of our country.

Social Security has a low overhead and does a world of good. It’s a very reasonable promise to make, and I wish my own party would wise up a little on how little an issue it is. (Applause)

WARREN BUFFETT: This is what happens when you ask a couple of guys our age how you feel about treating older people. (Laughter)

Incidentally, the — currently — and everybody likes to talk about the unified budget — you didn’t hear talk about the unified budget 30 years ago on the national level.

But the unified budget means that the Social Security surplus now gets counted toward reducing the overall budget. So they’re very happy at present to take the Social Security surplus and trumpet the number that is after that.

But then when they start talking about a Social Security deficit out 20 or 30 years, they tend to get — they want to separate that off and get very panicky about it. So I think there’s a lot of hypocrisy in the argument.

8. Different businesses, different compensation

WARREN BUFFETT: Let’s go to number 2.

AUDIENCE MEMBER: Good morning. My name is Phil Rafton (PH), shareholder from Orinda, California.

My question for you: How would you design a compensation system in a very cyclical industry that can swing from boom to bust?

You want to tie compensation to results in some way, but this can lead to huge swings in pay. And, for example, today in booming industries, like energy and mining, profits are large as a result of the boom in the industry and not necessarily the results of management skill.

Conversely, when the industry is down, profits are low due to no fault of management.

So, again, my question: How do you design a compensation package to best reward management performance?

WARREN BUFFETT: Yeah. That’s a terrific question. Because if you’re running a copper company now with copper at 3.50 a pound, you can coin money even if you happen to be the village idiot, you know.

And, similarly, when copper was 80 or 90 cents a pound, which has been most of our adult lifetime, in that general — there were fairly sparse times in mining much of the time.

And we design compensation systems at Berkshire. We have dozens and dozens of companies. Some of them are capital-intensive. Some of them are cyclical. Some of them don’t require much capital.

Some of them are terrific businesses if no one runs them. Some of them are very difficult businesses, even if the best of management comes.

And we have a wide variety of compensation systems. You’re wise when you say, “How do you design one for that kind of a situation?” Because so often people come in with, sort of, standardized systems or whatever the highest system they see is, and then apply it to their own benefits.

Most people, if left to select their own compensation systems, will come up with the appropriate, from their standpoint, comparable arrangement.

If we owned a copper mining company in its entirety, we would measure it, probably, more by cost of production than we would by whether copper was selling for $2.00 a pound or a dollar a pound.

I mean, they — the management has control — depending on the kind of ore bodies and everything — but they certainly have control over operating conditions. They do not have control over market prices.

And we would have something, I think, that would not fluctuate a lot in a business like that, the bonus available, but it would probably tie to what we thought was under the control of the individual who’s managing the business. That’s what we try to measure.

We try to understand the industry in which they operate, and we try to understand the things that the manager can have an impact on, and how well they’re doing in that.

We measure, at GEICO, for example, we measure by two unit measures: one is growth — unit growth — and one is the profitability of seasoned business.

New business costs money. We want new business; so we don’t charge that against the manager or the 20,000 other employees who share in it.

We do not want to pay for anything that is not under their control. We do not want to pay for the wrong things.

And I would say, in a cyclical business, that you — you know, if oil is $70 a barrel, I don’t think any particular management deserves credit for it. In fact, they all sort of deny that they’ve got anything to do with it when they get called before Congress.

But I would not give them credit for the fact that oil is $70 a barrel or $40 a barrel. I would give them credit for low finding costs for — over time.

I mean, what you really want to do, if you have a producing oil company, is you want a management that, over a five- or ten-year period, discovers and develops oil at lower-than-average unit cost.

There‘s been a huge difference in performance in that among even the major companies, and I would pay the people that did that well. I would pay them very well, because they’re creating wealth for me.

And I would not pay the guy a lot of money that simply is cashing in on $70 oil and that really has got a terrible record in finding it at reasonable prices. Charlie?

CHARLIE MUNGER: Yeah. It’s easy to have a fair compensation system like we have at Berkshire.

And a lot of other publicly-traded corporations also have fair compensation systems, but about half of them have grossly unfair systems in which the top people get paid too much.

We know how to fix Berkshire, but our ability to influence the half of American industry where the compensation systems are unfair has so far been about zero.

WARREN BUFFETT: Yeah. One thing you may find interesting, we have — I don’t know — 68 operating companies. We probably have — I probably have responsibility for the compensation system of, perhaps, 40 managers or thereabouts, because some of them have businesses grouped under them.

I can’t think — again, I can’t think of anyone we have lost over a 40-year period because of differences in views on compensation.

I also — we’ve never had a compensation consultant come into Berkshire. They may have had them at the subsidiaries, but they’re smart enough not to tell me. (Laughter)

They — it’s never happened. I mean, we do not — and we do not have lots of meetings. We don’t spend a lot of time on it. It is not rocket science.

It’s made more complicated than it needs to be, more confusing than it needs to be, because having a system that is complicated and confusing serves the needs of some who want to get paid a whole lot more than their worth.

And the system won’t change because it’s working to the advantage of the people that have their hand on the switch, the people that pick the human relations consultants and pick the people who are on the comp committee.

I was put on one comp committee, and Charlie can tell you what happened. (Laughter) He was there.

CHARLIE MUNGER: Yeah. We were the biggest shareholder at Solomon. Two of us were on the board, and Warren was on the comp committee.

And in that frenzy of envy, which characterizes compensation in investment banking, Warren remonstrated, softly, I thought, towards a slightly more rational result, and he was outvoted.

WARREN BUFFETT: Charlie used the term “envy” rather than “greed,” which is interesting, because that’s been our experience, is that envy is probably a bigger motivation, in terms of people wanting to be in that top quartile, or whatever it may be, than greed.

It’s a very interesting phenomenon that you can hand somebody a $2 million bonus, and they’re fine until they find out that the person next to them got 2-million-1, and then they’re sick for the next year. (Laughter)

Charlie has pointed out — you know, of the seven deadly sins — that envy is kind of the silliest because you don’t feel better. You know, I mean, if you get envious of somebody, you feel worse the whole time.

Now, you know, gluttony — you know, I’ve had some of my best times while being gluttonous. (Laughter)

There’s a real upside to gluttony. (Laughter)

We won’t get into lust. (Laughter)

But I’ve heard that there are upsides to that, occasionally.

But envy, you know, all you do is sit around and make yourself sick and can’t get to sleep. But that’s — it’s part of the human psyche, and you see it big time and you get this irony.

The SEC wants even more transparency on pay, which I think, you know, basically is a good idea except for the fact that it becomes a shopping list for every other CEO when they see that somebody is getting their haircuts paid for by the company.

They decide that they, too, need their haircuts paid for by the company, and they suddenly become big tippers.

9. Our managers are “trained” by our culture

WARREN BUFFETT: Let’s move on to number 3.

AUDIENCE MEMBER: Greetings to all of you from the Midwest of Europe. I’m Norman Wintrop (PH) from Bonn, Germany.

Thank you very much for writing your shareholder letter in such a way that we feel treated as partners.

Warren, in the shareholder letter, you ended with your thoughts on managing Berkshire Hathaway in the future.

May I ask you, how do you train your successors? What do you tell them? How do you summarize to them what is important to you?

And how, if you are able to do so, how would you measure whether or not they have lived up to your expectations?

WARREN BUFFETT: Well, that’s a good question.

And, I think, actually, in reading that letter — you know, that’s part of the — part of the reason it’s written — is to convey, not only to our partners, our shareholders, but also to our managers and anybody else in the public, you know, what Berkshire is all about.

This meeting, you know, in terms of what we do is intended to give a personality and a character to Berkshire. And we don’t say it’s better than anybody else’s, necessarily, but we do think it’s us.

And we think — we want managers to join us who believe in the sort of operation we have, a partnership with shareholders, a lifetime commitment to the businesses. We want those people to join us.

We want what they see after they join us to underscore the values we have. So everything we do we hope is consistent with what most people would call a “culture” at Berkshire.

So the written word, what they see, what they hear, what they observe. And that is training in itself.

It’s the same sort of training you get as a child. I mean, you — when you are in the home and you’re learning something every day by the behavior of these terribly important people, these big people that are around you.

And a home has a culture. A business has a culture. To some extent, a country can have a culture. And we try to do everything that’s consistent with that. We try to do nothing that is inconsistent with that.

And, believe me, if you’re a bright Berkshire manager — and they are bright — you know, they buy into it to start with, they see that it works, you know, and it doesn’t require formal lessons or mentoring or anything of the sort.

I mean, if you talk to our Berkshire managers, you would find that they think consistently with how, in effect, Charlie and I think.

There are plenty of people that don’t, and they don’t join us.

I mean, you know, we hear all the time from people — I’ve got one coming in a little while, actually, that, you know, nothing is going to come of it because this guy — I mean, his brain processes things different than mine does.

And I’m kind of interested in learning about his business, so we’ll get together, but it wouldn’t fit. You know, it would just not — it would be a mismatch.

And the nice thing about it is our culture is so well-defined that there aren’t many mistakes, in terms of people entering it or behaving in a way inconsistent with it. So I think that — I don’t think there’s any formal training necessary.

I mention in the annual report the fact that, if I die tonight, there are three obvious candidates to take my place.

Now, the board knows which one of them they would agree on tonight. Might be different three years from now, but any of those three would not miss a beat in terms of stepping into the culture that I hope we have here, because it’s theirs too.

Charlie?

CHARLIE MUNGER: Well, you know, if Warren has kept the faith until he’s 75 years old in maintaining a certain kind of culture and a certain way of thinking, do you really think he’s going to blow the job of passing the faith on?

What could be more important, in terms of his duties in life? You all have something — (Applause)

You all have something more important to do than worry about the fact that the candle is going to go out at Berkshire just because some people die.

This is a place where the faith is going to go on for a long time.

Of course, at headquarters, we aren’t training executives. We find them. And they’re not hard to find.

You know, if a mountain stands up like Everest, you don’t have to be genius to recognize that it’s a high mountain. (Laughter)

10. Irrational pricing of closed-end funds

WARREN BUFFETT: OK. Number 4?

AUDIENCE MEMBER: My name is Yuen Gunn (PH), and I’m from Whitehaven in England.

Actually, the last time I was this nervous asking a question, I’d just presented my wife with an engagement ring from Borsheims. (Laughter)

WARREN BUFFETT: Well, I hope you get nervous again. (Laughter)

AUDIENCE MEMBER: My question for you is, with the enthusiasm at the moment for emerging markets, many closed-end funds which contain emerging market stocks are trading at significant premiums to their net asset values, even when open-ended funds can be used to acquire similar portfolios of stocks for the net asset values.

This doesn’t seem very rational to me. Why do these premiums persist, and do you agree that it’s irrational?

WARREN BUFFETT: Yeah. I would say it would tend to be. I don’t know anything about the specifics that you’re referring to on emerging market funds. I haven’t looked at the size of the premiums.

But, history would certainly show that most closed-end funds — just about all closed-end funds — eventually go to discounts.

I actually worked — well, I’ll skip that analogy. But the — overwhelmingly, closed-end funds have gone to discounts.

You know, initially, if they’re sold with a 6 percent commission, of course, the initial people are getting 94 cents of net asset value by paying the dollar, but I know I — if I saw two — if I had an interest in buying into emerging markets through other people’s management and I could buy an open-end fund at X, or an asset value, and I had to pay 120 percent of X for some closed-end fund, you’d have to convince me very strongly that the management of the closed-end fund was better.

So I think you’re right. I don’t — again, I don’t know the — if the premium is a few percent, it doesn’t really make much difference.

But occasionally, Charlie and I have witnessed in the past closed-end funds that have sold even at 30 or 40 percent premiums over asset value.

Overseas Securities was a tiny fund that used to do that for years and baffled everybody. But eventually they will come back down to earth.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add. (Laughter)

WARREN BUFFETT: He’s hitting his stride now. (Laughter)

11. Corporate boards should think like owners

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: Warren and Charlie, I want to thank you for putting a once obscure Midwestern city on the map last year with your acquisition of Pete Liegl’s company, Forest River.

I’m Frank Martin (PH) from Elkhart, Indiana, the RV capital of the world. I also want to thank —

WARREN BUFFETT: Glad to have you here, Frank.

Frank has just brought out a book, incidentally, that’s a history of some of his annual letters. It’s a good book, and I recommend you get it.

AUDIENCE MEMBER: Thank you, Warren.

I also want to thank you for your influence over Robin Williams and other Hollywood stars. Those of you who have seen the movie “RV” realize that Warren will go to no ends to promote the products of the companies he acquires. (Laughter)

WARREN BUFFETT: A few people have already noticed that, actually, Frank. (Laughter)

AUDIENCE MEMBER: On a more serious note, there’s a small but growing trend in American business governance to move from plurality voting for directors to majority voting, long the standard in Great Britain.

What do you see as the upside and downside of majority voting, as it relates to raising the standard of ethics in the corporate boardroom?

WARREN BUFFETT: Charlie, you want to take a swing at that?

CHARLIE MUNGER: I don’t think it’ll have any effect at all on ethics in the corporate boardroom.

There get to be fashions in the governance subject. I think that the troubles in American corporations are not going to be fixed by something like that.

All these reforms have to be considered in the light of the kind of people that are likely to be activist in using new powers, and that crowd is a mixed crowd, to put it gently.

WARREN BUFFETT: The question in the boardroom is to what extent — and you have to understand, it’s partly a business situation; it’s partly a social situation.

The question is to what extent do the people that are participating there think like owners, and whether they know enough about business so that even if they’re trying to think like owners, that their decisions will be any good.

And Charlie and I have been on boards of companies with dual voting. Berkshire has that, although it’s so minor that it doesn’t really make any difference. But we’ve been on other boards.

I have never really seen any difference in behavior based on the nature of the votes that got them into the boardroom.

But there’s an enormous difference — I think you’d be blown away if you watched boardrooms over the years — there’s just an enormous difference in terms of, really, the business savvy of the people in the room, the degree to which they are thinking like owners as they go along.

And I’ve seen no — I don’t know that dual voting or the lack of dual voting really is going to have very much to do with that.

The key — I’ve mentioned it in the past — there’s all these fashions, as Charlie says, in corporate governance.

But the job of the board is to get the right CEO, to prevent that CEO from overreaching. Because sometimes you have some people that are very able, but they still want to take it all for themselves.

But if they take nothing and they’re the wrong CEO, they’re still a disaster. So low pay itself is not the criteria.

So you want the right CEO. You do not want them overreaching.

And then I think the board needs to exercise independent judgment on important acquisitions, because I think CEOs — even smart CEOs — are motivated, frequently, in acquisitions by other than rational reasons.

And in those three areas, you know, American directors have — I don’t think they’ve given a tremendous account of themselves in recent years, whether at dual system places or otherwise.

The only cure to better corporate governance, in my view, is that the very large shareholders start really zeroing in on whether those questions I just mentioned are being addressed properly.

If they go on to all these peripheral issues, you know, they have a lot of fun and they get in the papers. You know, they have little checklists and they can issue grades and all that. It isn’t going to do anything in terms of making American business work any better.

But if the eight or ten largest shareholder groups, if the really large institutional investors say, you know, “This compensation plan doesn’t make any sense and we’re not voting for the directors, and here’s why we’re not voting for the directors,” you’d get change. But so far, they’ve been unwilling to do that.

It takes the big shareholders. It’s not going to be done by any coalition of small shareholders or people sticking things on ballots. But the big shareholders of this country, you know, basically they — some of them farmed out their voting, even.

I was amazed to find that out, that a number of very large institutional investors have actually just turned their voting process over to somebody else. They don’t want to think like owners. And, you know, they bear — we all bear — the penalty for that.

12. Tech is still in the “too hard” pile

WARREN BUFFETT: Number 6?

AUDIENCE MEMBER: Hello. My name is Andy Pollen (PH) from Adrian, Michigan. Thank you, once again, for having me to Omaha.

My question is for Warren, but, Charlie, please add your thoughts as well.

Warren, I’ve heard you say many times that you don’t understand technology and that you rely on Bill for that, and that’s fine. And I see from this year’s movie that you’re learning, so that’s good.

WARREN BUFFETT: Slowly.

AUDIENCE MEMBER: I’m also curious to hear what you’ve learned so far about the other information technology companies, such as IBM, Sun Microsystems, Oracle, Dell, EMC, and Intel.

WARREN BUFFETT: I know — what I’ve learned is I know enough not — to know that I don’t know enough to make an investment decision.

The — Charlie and I have circles of competence that extend to evaluating a number of types of businesses, and there are a whole lot of businesses that we won’t be able to evaluate.

Some of them, I don’t think — I think very few people can evaluate.

I mean, you get outside of — you just get into businesses that — where the future is so likely to be different than the present that maybe there’s a few people that have great insights on it, but we sure don’t.

We are best at the businesses where we can come to a judgment that they’re going to look a good bit like they do now five years from now, ten years from now. They’ll be bigger. They’ll be doing different things, but the fundamentals will be the same.

ISCAR will be a bigger company five years from now. It may be a much bigger company, and we may get a chance to do interesting acquisitions.

But what you saw there, the fundamentals, won’t change. The way the people think won’t change.

I can name a number of businesses that are bound to change dramatically. I mean, when you think of how much the telecom business, for example, has changed over the last 15 or 20 years, it’s startling.

Even with hindsight, it’s a little hard to figure out, you know, who was going to make all the money and so on. There’s just — there’s just games that are too tough.

Charlie says, you know, “We’ve got three boxes at the company: in, out, and too hard.” (Laughter)

And a lot of things end up in the “too hard” pile, and it doesn’t bother us. You know, we don’t have to be able to do everything well.

If you go to the Olympics, you know, if you run the hundred meter well, you don’t have to throw the shotput. You know, some other guy can throw the shotput and you’ll still get a gold ribbon, you know, if you run the hundred meter fast enough.

So, we try to stay within the circle of competence.

Tom Watson, Sr. — I think it was Senior — yeah, Tom Watson, Sr. — many years ago said, “I’m no genius, but I’m smart in spots, and I stay around those spots.”

Well, that was pretty damn smart, you know. And we have found a lot of our managers who don’t think, you know, they can solve every problem in the world, but they run their businesses extraordinarily well.

You do not want to — Frank Martin mentioned Forest River. You do not want to go and compete with Pete Liegl and his business. He’s going to kill you. He’s very, very, very good.

But he doesn’t come around and try and tell us how to run the insurance business, because that’s not his game.

We look for people that are very good at things they understand. And we don’t get any inferiority complex at all about the fact that — well, I — you mentioned Intel, I believe.

I was virtually there at the birth of Intel because I was on the board of Grinnell, and Bob Noyce was the chairman of the board of Grinnell. And we bought — at Grinnell — we bought $300,000 worth of their original debentures.

And, you know, I knew Bob was always a very, very smart guy, but I wouldn’t have had the faintest idea how to evaluate the future of Intel then, and I really don’t have it now, you know.

And I think they probably had a few surprises themselves in the last few years with AMD and what’s been happening in their business.

But what that’s going to look like in five years, I don’t have any idea. And I’m not so sure, if you’re in the industry, you’d know exactly what it was going to look like in five years. Some businesses just are very, very hard to predict.

Charlie?

CHARLIE MUNGER: Yeah. One of the foreign correspondents last year, after looking at us carefully, said, in effect, “You guys don’t seem smart enough to do so much better than other people as you’re doing.” (Laughter)

WARREN BUFFETT: Were they looking at me or you, Charlie?

CHARLIE MUNGER: Both. (Laughter)

“Have you got an explanation?” And we said, “We know the edge of our competency better than most people do.”

It’s a very useful thing to know the edge of your competency. And I always say it’s not a competency if you don’t know the edge of it.

WARREN BUFFETT: I’ll have to think about that a little bit. (Laughter)

Bill will explain it to me later.

13. Too many tax breaks for the rich

WARREN BUFFETT: Area 7, please.

AUDIENCE MEMBER: I am John Bailey (PH) from Boston, Massachusetts.

I wanted to ask, Warren and Charlie, if you could consider three hypothetical securities for a long-term investment.

The first would be, like, a share in median family income for the United States. The background there that, in real terms, median family income has been stagnant for approximately 30 years.

The second security would be a share in all corporate income in the United States. The background there that corporate income has been taking an ever larger slice of GDP for several years.

And, finally, a bit more abstract, a share in all capital assets in the United States, and I would like to include all intangible capital assets, if possible.

So would any of these be of interest for a long-term holding, perhaps 20 years or so? And, if not, why not?

WARREN BUFFETT: Well, I think I’d rather buy ISCAR. (Laughter)

The corporate profits, as you point out, have been close to their highs, except for a very few years post- World War II, as a percentage of GDP. It’s hard to imagine being much larger.

It’s interesting. While corporate profits is reported — you take S&Ps, percentage of book, percentage of sales, put on the line, they’re all on the high end.

Corporate income taxes, really, are not that high relative to the total revenues of the country. So you can see that there’s been a little disconnect there in some manner.

But median family income is something that Charlie and I have never even considered. We’re not shooting for that.

It is certainly true that, in the last five to ten years, that the disparity in income has widened significantly and that the tax breaks for the wealthy have been extraordinary.

I’ve pointed out in the past that most of the members of the Forbes 400, myself included, pay a lower percentage of their income to the U.S. government, counting Social Security taxes, than does the receptionist that works in their office.

That was not true 30 years ago, and I don’t think it’s something that should be true in a rich society, but it has happened.

And I just computed my 2005 return. In 2004 — and I have no tax shelters. I don’t have a tax adviser. I just do things, and at the end of the year I add it all up.

In 2004, my rate was the lowest of the 15 or 16 people in the office, and in 2005, my rate was even lower.

And that’s courtesy of the U.S. government. It’s not courtesy of a lot of tax write-offs or anything of the sort.

And I think that’s — I think it’s crazy, and I don’t think the American people understand it very well. And I think that if they did understand it, they should, and would, be quite unhappy about it.

So I think that — I think that the lower incomes, median — and the medium — people making medium amounts of income, have not shared in the prosperity of the last decade or so in a way that’s all proportional to the way the wealthy participate in it.

The last point you mentioned was too esoteric for me, so I’ll pass it over to Charlie.

CHARLIE MUNGER: Yeah. The main figure that matters to all of us, including the people at the median, is how does GDP per capita grow? And those figures have been very good.

And so, I wouldn’t get too wild on the subject of median income. It isn’t like we’re all permanently in some status from nobody moving from status A to status B.

There’s a huge flux, both up and down. And what’s really important is that the pie keep growing at a decent clip.

All that said, I think that Warren is right, that some of those tax changes were a little crazy. I mean, they caused more envy than we needed. But I don’t think it’s all that important.

WARREN BUFFETT: Yeah. We might think it was more important if we were working at the median income, Charlie. (Laughter)

14. Munger: Ethanol is “stupid”

WARREN BUFFETT: Let’s go to Number 8.

AUDIENCE MEMBER: Good morning. I’m Diane Ryan (PH) from Kansas City.

My question is, what is your opinion on the economics of ethanol and as — just as a fuel additive?

And, as a potential investor, should I be looking at that industry?

WARREN BUFFETT: Well, I don’t know enough to answer the latter part. I know we don’t — Charlie and I would not know enough to evaluate ethanol projects.

We’ve been approached on them. And, of course, they’re quite popular now.

But in terms of figuring out what an ethanol plant is going to be earning on capital five or ten years from now, it’s far easier for us to figure out whether people will be drinking Coca-Cola, or even eating See’s Candy, which I highly recommend. (Laughter)

So, you know, it will depend on government policy. It will depend on a lot of variables that we’re not particularly good at predicting.

It’s easy to raise money for it now. I mean, it’s a popular item. You know, it’s hot.

And our general experience is that we don’t look at things very much that are hot at any given time.

I know nothing about the — you know, the biochemistry or anything of the sort.

I have a son who was a head of the ethanol board in Nebraska. And if I notice that he suddenly starts getting richer than I am, you know, I will suspect that I should start looking at ethanol very hard.

But so far, I haven’t seen tangible evidence of that.

There’s no question ethanol usage is going to grow. I mean, that we will see.

Generally speaking, ag processing — agriculture processing — businesses have not earned high returns on capital. I mean, if you look at Cargill, you look at ADM, you look at the big processers, that has not been a great business.

Ethanol could prove an exception, but I’m not sure how you gain a significant competitive advantage over time, you know, with any given ethanol plant.

And if you get too many of them around, you know, it will not be a good thing when you’re turning out a commodity.

Charlie?

CHARLIE MUNGER: Well, my attitude is even more hostile than Warren’s.

I have just enough glimmers of thermodynamics left in me to suspect that it takes more fossil fuel energy to create ethanol than you can get out of the ethanol you’ve created.

If so, that’s a very stupid way to try and solve an energy problem. (Applause)

WARREN BUFFETT: Well, considering my family situation, I would say I have friends who like ethanol, and I have friends who don’t like ethanol.

And I want my position to be perfectly clear: I’m for my friends. (Laughter)

15. Watch out for speculative commodity bubbles

WARREN BUFFETT: Let’s go to number 9.

AUDIENCE MEMBER: Hello. My name is Johann Freudenberg (PH) from Hanover, Germany.

Do you think we are in a commodity bubble? Thank you.

WARREN BUFFETT: Well, certainly — not in agriculture commodities, they haven’t done anything, if you’re talking about wheat or corn or soybeans or something.

But if you get into the metals, oil, there’s been a terrific move. The most extreme, probably, has been copper, I would say.

Oil, if you go back a few years to when it was $10 a barrel — it’s been more extreme than copper — but you were undoubtedly — it’s like most trends. At the beginning, it’s driven by fundamentals, and at some point, speculation takes over.

The very fact that — the fundamentals cause something that people looked at for years without getting excited about. Fundamentals change the picture in some way.

Copper does get a little short, you know, or people get a little worried about currency and, maybe, gold goes up or whatever it may be.

But, you know, it’s that old story of what the wise man does in the beginning, the fool does in the end.

And with any asset class that has a big move, that’s based initially on fundamentals, is going to attract speculative participation at some point, and that speculative participation can become dominant as time goes by.

And, you know, famous case always being tulip bulbs. I mean, tulips may have been more attractive than dandelions or something, so people paid a little more money for them.

But once a price history develops that causes people to start looking at an asset that they never looked at before and to get envious of the fact that their neighbor made a lot of money without any apparent effort because he saw this early and so on, that takes over.

And my guess is that we’re seeing some of that in the commodity area. And, of course, I think we’ve seen some of it in the housing area, too.

How far it goes, you never know. I mean, it just — some things go on to just unbelievable heights, and then, you know, silver went back and that was manipulation, to some extent, but it got up to $50 an ounce very briefly back in the early ’80s.

But the eyes of the world that never looked at silver when it was $1.60 or — or $1.30 back in the ’60s, you know, everybody in the world was looking at it. And some were shorting and some were buying, but it becomes a speculative football.

And my guess is that an awful lot of the activity in something like copper now is speculative on both sides of the market.

If — you know, if it goes to $5 a pound, who knows? But it — you are looking at a market that is responding more to speculative forces now than to fundamental forces, in my view.

Charlie?

CHARLIE MUNGER: Well, I think we’ve demonstrated how little we know about commodity prices by our very skillful operations in silver.

WARREN BUFFETT: I think you can change that from “our” to — it’s mine, actually.

I bought it very early. I sold it very early. Other than that, everything I did was perfect. (Laughter)

We managed to minimize things there with great efficiency, or I managed to. Charlie didn’t have anything to do with that. I was the silver king there for a while.

We did make a few dollars on it. But we’re not good at the game of, when it gets into the speculative area, figuring out how far a speculative boom will go.

If the fundamentals are attractive, we think we’re getting a lot for our money, buying equities or whatever it may be, we’ll make some money.

We will — we may not make as much money — remotely as much money — as somebody who is, you know, plays out the last 30 days or 30 weeks of a real wild orgy.

I mean, these things, they tend to be the wildest toward the end.

But that gets back to the question, you know, of Cinderella at the ball. I mean, you know, you’re there. You’re having a wonderful time. The punch bowl is flowing and the dance partners are getting prettier all the time.

And you know at midnight, it’s going to turn to pumpkins and mice.

And, you know, you look around the room and you think, “Just one more dance, one more good-looking guy,” you know, “one more glass of champagne.”

And you think you’re going to get out of there at midnight, and, of course, everybody else thinks they’re going to get out of there at midnight, too. And in the end, it does turn to pumpkins and mice.

And in this game, as I’ve said — you know, Adam Smith said it many years ago — a fellow named Jerry Goodman wrote under the pseudonym of Adam Smith — says the problem with that particular dance for Cinderella is that there are no clocks on the wall.

You know, and in the markets — if you’re talking copper now, if you’re talking Internet stocks in 1999, if you’re talking uranium stocks in the 1950s — there are no clocks on the wall.

And the party does get to be more fun, you know, minute after minute, hour after hour, and then it does turn to pumpkins and mice.

16. “Brazil would not be off limits”

WARREN BUFFETT: Number 10?

AUDIENCE MEMBER: My name is Luisa Loredo (PH). I’m a student at University of Kansas, and I’m originally from Brasilia, Brazil.

My question is for both Mr. Buffett and Mr. Munger.

The stock market in South America has been growing quickly in the last few years. What do you think about investment opportunities in South America, given the political environment and underlying risks?

WARREN BUFFETT: Yeah. We would — our problem in many markets is that we have to put a lot of money to work to move the needle at Berkshire. We’ve got a market value of 135 billion or something like that.

So we are looking to put out hundreds and hundreds of millions of dollars at a minimum when we look at marketable securities. And that really narrows the field in terms of countries or in terms of businesses within those countries.

But, you know, we made an investment about three years ago in PetroChina. Now, PetroChina is one — probably one of the — well, it is one of the five largest oil companies in the world — and, yet, we were only able to — even there — to get 400 and some million dollars into it, which fortunately is worth a couple of billion now.

But here it’s a country the size of China, largest company in that country, and even there we only got 400-and-some million dollars in, although we would have liked to have gotten more.

But we weren’t afraid to go into China. We wanted to get paid more for going into China, and we did, because we don’t know the game as well there. We would feel the same way in Brazil.

I mean, we — a great beer company down there that a friend of mine ran, and, you know, we should have been in that. We knew he was a great manager, and he was going to do a great job with it.

So, Brazil would not be off limits at all, but we’d have to be able to get a lot of money into a business we understood at an attractive price.

We would want it to be cheaper than if it were in the United States. We wouldn’t understand the tax laws as well, the nuances of governance, a whole bunch of things. But after allowing for that, at a price, we would do it.

We’re unlikely to put a lot of money into — Brazil is a big country, but we’re unlikely to put a lot of money into really small economies because we can’t get enough money into them. Charlie?

CHARLIE MUNGER: No more.

17. Outlook for Clayton and manufactured homes

WARREN BUFFETT: Number 11?

AUDIENCE MEMBER: My name is Jeff Bingham (PH). I’m from Chicago, Illinois.

I have a question regarding the manufactured housing industry. What is your outlook on demand for the industry? And, correspondingly, in your opinion, will lending increase in a meaningful way over the next few years?

And are the homes priced attractively relative to competitive products, like stick-built housing and apartments, in the face of continued site rent increases at the community level and, in some cases, lenders requiring shorter maturities on mortgages?

WARREN BUFFETT: It’s been kind of an interesting history on manufactured housing. If you go back — you have to go back 30 or 40 years — 40 years, I think, almost, to have — find volume as low as it’s been in the last couple of years. And the houses are better than — by far better — than they were then.

There have been years when 20 percent of the housing — the new housing product in the United States — was manufactured housing. One out of every five.

Last year, leaving out FEMA demand, you know, we were bumping along for the third year, I believe, just a tiny bit over the 130,000 level, you know, which is like 6 or 7 percent — probably 7 percent — of new housing starts.

So, the percentage of the total new housing stock that has been manufactured housing in recent years has really been very low, while the houses are better — considerably better — quality than in the earlier years.

You can look at the house. We’ve got two houses out there on the exhibition floor, around $45 a square foot. You know, that’s good value.

There’s a lot of resistance, through local zoning laws and that sort of thing by the local builders, to the influx of manufactured housing. We’ve made progress on that in some areas. We’re actually developing subdivisions in that business.

The houses were mis-sold four or five years ago in huge quantity because you had manufactured housing retailers selling the properties, getting any kind of a down payment, taking the loans — selling to people that shouldn’t be buying them — taking the loans, securitizing them, so somebody in some insurance company someplace lost significant sums of money.

So you had, really, an abuse of credit in the field. And there’s a hangover from that, and it’s taken a long time for that hangover to work its way through.

I think Clayton Homes, which we own, has done a terrific job in both the financing — they should be financed on shorter terms, incidentally.

I’m — if you put them on owned land, that’s one thing, but financing them for 30 years, in my view, was a mistake.

But the terms got very lax for a while, and, you know, we’re bearing the consequences of that now.

But I think the market will get bigger, but I do not think it will get bigger this year. I see a year that, counting some FEMA demand and some hurricane-induced demand, maybe 150,000 units, 145,000 units. And by industry standards, that’s down a lot.

Now, the number of plants is down a lot and the number of retailers are down a lot.

Clayton’s position is very strong. And their record is so much better than anybody in the industry that you have to look very hard to find number two.

Charlie?

CHARLIE MUNGER: Yeah. You asked about stick-built housing and how competitive it was. That’s been one of the troubles of the manufactured housing game is that the stick-built housing has gotten so efficient.

But there the system is aided greatly by Berkshire’s subsidiary MiTek. So — and stick-built housing is amazingly efficient when it’s done in big quantity with systems like MiTek provides.

And if it weren’t for that, there would be a lot more manufactured housing.

Personally, I think manufactured housing is going to get a lot better and take a lot more of the market. It may take a considerable period, but that is so logical that I think it will eventually happen.

WARREN BUFFETT: Yeah. Somewhere down the road, you would expect 200,000-plus units for the industry. But I don’t think you’ll see it in the next year or two.

The industry has to think through — and they have, they’ve made a lot of progress on this — but they have to think through what’s the logical way of financing these things, and what’s the way to make sure that the person who buys it really has an asset that’s in excess of their loan value five and ten years down the road.

And, really, very little consideration was given to that five years ago. It was just a question of put together the papers, sell it on Wall Street, and let somebody else worry about it later on.

Clayton did a way better job than other companies in that respect, but those were the industry conditions that existed then.

But I think Clayton will be — Clayton could easily be — the largest homebuilder in the United States in future years because we will be a big part of an industry that, as Charlie says, should be doing more volume.

CHARLIE MUNGER: I also think that some of the sin that was in the manufactured housing finance a few years ago has shifted into the finance of the stick-built houses.

There is a lot of ridiculous credit being extended in America in the housing field. And it had a horrible aftermath in the manufactured housing sector, and my guess is there will be some trouble in the stick-built sector in due course.

WARREN BUFFETT: Well, dumb lending always has its consequences and usually on a big scale, but you don’t see it for quite a while. So, therefore, it’s like a disease that doesn’t manifest itself for, you know, a few weeks.

And you can have an epidemic of something like that, and by the time you know you have an epidemic, you’re very well into it. Well, that’s what happens in dumb financing.

And you had that — you periodically — you certainly had it in commercial financing in the ’80s, and you had the RTC and the savings and loan crisis and all of that because, literally, one dumb project was put up after another.

A developer will develop anything he can borrow the money against. It’s that simple. And when the lending institutions pour the money out for something, it will get built.

And that happened in manufacturing housing. It happened in commercial real estate in the ’80s. I think it’s happened in conventional housing here in recent years.

And if you look at the 10-Qs that are getting filed for the first quarter of some lending institutions, and 10-Ks that were last year, and you look at the balances increasing on loans for interest that’s accrued but was not paid because people had adjustable mortgages, but they’re only adjustable so far, but the lending institutions are taking in the income as if it were paid, you’ll see some very interesting statistics.

CHARLIE MUNGER: Yes. And some of this dumb lending is being facilitated by contemptible accounting. The accounting profession has not stopped compromising its way into terrible behavior.

WARREN BUFFETT: Our auditing bill just went up.

18. No interest in investing in Russia

WARREN BUFFETT: Number 12? (Laughter)

AUDIENCE MEMBER: My name is Elliott Samuels (PH). I’m from New York City.

Thanks to high energy prices and other factors, Russia has been one of the best performing markets recently. The country’s financial condition has stabilized since the 1990s.

A fledging middle class is taking shape as personal incomes grow. And there are also risks — political, legal — risks to minority investors.

But there are also potentially great values among second tier companies there.

I was wondering, what needs to happen in Russia for you to invest there, whether for Berkshire or for yourself, and what kind of companies would interest you there?

WARREN BUFFETT: Sounds like you may own a few Russian stocks yourself. The — I would — as you know, in 1998, Walter Wriston said sovereign governments don’t default.

In 1998, in Russia, at least, he was proven wrong. And Charlie and I were — inherited a business at Salomon that was in the oil business big time-out in the — in Siberia.

And there came a time when — we got to dig the holes. We sent the money in. And as long as we were drilling, we were welcome. And then when we wanted to start taking the oil out, after our money had been used to drill the holes, they weren’t quite as friendly. In fact, it was really kind of extreme what took place with us.

So, having had a few experiences like that, it might take us quite a while before we wanted to sink a lot of money into Russia. It may be different now, but I don’t think it’s any certainty.

I had breakfast in Sun Valley three years ago this July, I believe it was, with [Mikhail] Khodorkovsky, and we had a translator there. And he talked to me about whether — he was thinking about listing Yukos on the New York Stock Exchange, but he said, you know, it would require registering with the SEC or something, and he wasn’t sure whether that would be too dangerous.

Well, I don’t think he listed it there, but he went back to Russia, and he’s been in jail now for — well, just about ever since.

And Yukos was put into bankruptcy with tax claims, and, you know, it — I don’t — I just think it’s a little hard to develop a lot of confidence that the world has changed permanently there in terms of its attitude toward capital, and particularly toward outside capital.

Charlie, what are your thoughts?

CHARLIE MUNGER: Yeah. The situation reminds me a little of POLY Petroleum, which, years ago, was much traded in Los Angeles.

The saying always was, “If they ever do find any oil, that old man will steal it.” And I’m afraid we have some of that problem in many of the countries in which we’re seeking for oil.

WARREN BUFFETT: Didn’t we really have the livelihood of our guys threatened over there, Charlie?

I think we sent in some people to get out the equipment, and they said if we sent in the people to get out the equipment, not only would the equipment not get out, but the people wouldn’t get out.

So we understood the situation. That was not that long ago.

CHARLIE MUNGER: No.

19. Hottest real estate markets are cooling off

WARREN BUFFETT: Number 1 again.

AUDIENCE MEMBER: I’m Lori Gold (PH) from San Francisco, California.

My question is, what are your thoughts about the residential real estate market in the U.S., where it’s headed? And how is California different, if so?

WARREN BUFFETT: Well, Charlie is our California expert. We’ve managed one time to develop a great piece of property in California. We spent about 20 years or so developing it, Charlie, or —

CHARLIE MUNGER: Yes. And we got our money back with interest.

WARREN BUFFETT: Barely. (Laughter)

CHARLIE MUNGER: Barely, yeah.

WARREN BUFFETT: We finished it at just the wrong time. We — the land value that we nurtured — that was a terrific piece of land. Charlie lives there. And I don’t think it’s an exaggeration to say we spent 20 years —

CHARLIE MUNGER: No.

WARREN BUFFETT: — working on developing the land. And the land value, which, in effect, we cashed out for, what, 5 or $6 million, now would have an — the implicit land value — would be what?

CHARLIE MUNGER: Maybe a hundred million dollars.

WARREN BUFFETT: Yeah. But we finished it at the wrong time.

So, you know, it’s a wonderful — the climate is wonderful. Everything is wonderful about this property.

It’s just that, from time to time, even in great localities — you’ve seen it happen in New York a couple of times, you know, in the last 30 years, where the swing in property values has just been huge.

And what we see in our residential brokerage business — and we’re in, I don’t know how many different states — is we see a slowdown every place.

Now, we see it most dramatically in some of the — what have been the hottest markets.

In the markets where you’re going to — in my view — you’re likely to see the greatest fall-off and where you’ve had the biggest bubble are the ones — they tend to be the high-end market, and they tend to be ones where people have bought for investment or speculation, rather than use.

People will pay $300,000 for a house and mortgage it for 270,000, and if the value goes to 250, if they have a job and everything, they won’t move out.

I mean, you don’t lose a lot of money even though the market value on a given day is less than the loan value when families stay together and employment is present and all that.

But when you have investment-type holdings, speculation-type holdings, when you, in effect, have had the day traders, you know, of the Internet move into the day trading of condos, then you — then you get — then you get a market that can move in a big way.

First it sort of stops, and then it kind of reopens. Real estate is different than stocks. If you own a hundred shares of General Motors, it’s going to trade on Monday and that’s what it’s worth and you can’t kid yourself about it.

But if you own real estate, you know, there’s a great tendency to think about the one that sold down the street a few months ago. And there’s a great tendency to think, you know, you only need one buyer who hasn’t gotten the word that things have slowed down and you’ll make your sale.

I can tell you that in Dade and Broward County, for example, in Florida, where the average condo is about 500,000, if you go back to December of 2004, there were less than 9,000 condos listed for sale, and I think 2,900 of them sold in the month so you were — turnover one every three months, less than that.

Now, the listings are up to 30,000, and the sales are down to under 2,000 a month. Well, 30,000 is $15 billion worth of properties. And you are — very likely, you can get real discontinuities in a market like that, where all of a sudden people realize that the whole supply-demand situation has changed.

So I think we’ve had a bubble, to some degree, and it’s very hard to measure that degree until after it’s all over.

But I would be surprised if there aren’t some significant downward adjustments from the peak, particularly in the higher-end properties.

CHARLIE MUNGER: Yeah. The man is right that the bubbles came in Manhattan and in certain places in California. In Omaha, housing prices are quite reasonable. So it’s — the country is not all the same, at all.

20. Attendance estimate and Furniture Mart sales

WARREN BUFFETT: We just got an estimate of the attendance at 24,000, which was about what it looked like from the tickets we had gotten. I thank you all for coming, on that note. (Applause)

Even better, the Furniture Mart, which had sales in 1997 of 5-and-a-fraction million, 2003 sales of 17 million, sales last year of 27 million, is up so far 2 1/2 million, with the best yet to come.

So we’re — I would say we’re likely to do over 30 million at the Furniture Mart. And that, incidentally, is about equal to a normal monthly volume for the store. So you’re doing your part. Thank you. (Applause)

21. Don’t like excess cash, but we hate dumb deals

WARREN BUFFETT: Number 2?

But you can do more. (Laughter)

AUDIENCE MEMBER: Good morning. My name is John Norwood (PH) from Des Moines, Iowa.

I have a two-year rule for my closet. If I don’t wear a particular pair of pants or a shirt within two years, I give it away to Goodwill so that someone else can put it to better use.

With 40 billion in cash, I’m wondering whether Berkshire Hathaway should have a similar closet rule for deployment of surplus shareholder cash.

WARREN BUFFETT: It won’t go to Goodwill, I promise you that. (Laughter)

AUDIENCE MEMBER: Thank you. And wouldn’t it be better if you had a smaller budget and fewer gifts you needed to — you and Charlie needed to shop for? Wouldn’t you have more time for the beach and a better chance of hitting some home runs?

WARREN BUFFETT: Yeah. I don’t think we’ll hit any home runs, under any circumstances. But the — you might consider a normal level of cash at Berkshire as being about 10 billion, although we — you know, there could be circumstances where we’d go below that.

But because of the catastrophe insurance business we’re in and all of that, we do not — you know, we do not scrape the bottom of the barrel, but we don’t need anything like 40 billion.

I think you’ll see in the 10-Q that we have — I think it was about 37 billion at the end of March — double check that — and I’m not counting the cash and the finance business — yeah, 37-something — and we’re spending 4 billion on ISCAR.

We’ve spent — we’re spending some money on some other things as well.

But we would be happier — much happier — if we had 10 billion of cash and all the balance in things that we liked very much.

And we work toward that end at all times. But there is nothing even about the way businesses come to us.

We’ve got one idea at present, low probability, but that would take — could take — as much as 15 billion or close to 15 billion of cash. And whether it comes to fruition or not, who knows, but we do work on them.

And, what we care more — we don’t like having excess cash around. We like even less doing dumb deals because we do them forever.

I mean, if we make a dumb deal, it just sits there. We don’t resell it three months later by having an IPO of it or something of the sort.

So you’re right to say that we should be very uncomfortable about the fact that we’ve got the cash. But it’s also important that we not be so uncomfortable that we go out and do something just to be doing something.

I would say it’s likely, but far from certain, that three years from now we have significantly less cash and, I hope, significantly more earning power. But the goal of that cash is to be translated into permanent earning power over time.

Like I say, with the 4 billion that we’ve just committed on ISCAR, you know, we love having that 4 billion employed there instead of sitting around in short-term securities.

And that’s our job. Charlie and I don’t do anything else, except appear in movies and that sort of thing.

But the — you know, you’re right to keep jabbing us on that because — but we jab ourselves. You know, we — neither one of us is — basically likes cash.

We always want to have adequate cash and we always will have adequate cash. And we are the biggest player in the world in cat insurance, and people come to us because they know we’re going to run a place that’s very strong financially. But it doesn’t have to be as liquid as we are now.

We spent 5 billion — well, we didn’t spend that much. At the Berkshire level, we spent about 3 1/2 billion on PacifiCorp.

You know, we contracted (inaudible) earlier, but we will get more chances, I think, in that field, but you never can tell when they’ll come.

So come back next year, and I hope we have less cash.

OK. We’ll go to 13 now.

OK. Charlie, would you like to add anything on that?

CHARLIE MUNGER: Yeah. I think you may get some perspective on what bothers you if you go back to the annual report of Berkshire ten years ago and then compare that report with the last one.

Despite the great difficulties of deploying cash, we managed to put an awful lot of wonderful stuff into Berkshire in the last ten years. So, we aren’t altogether gloomy about that process continuing. (Applause)

22. Should have sold Coca-Cola at “silly” price

WARREN BUFFETT: I neglected to go to the adjacent room, which has a number of people in it as well. So I’m going to go to No. 13 now, which will come from the ballroom.

AUDIENCE MEMBER: This is Phil McCaw (PH) from Connecticut.

I wonder — it’s been some time since you’ve commented on Coca-Cola. And now that you’re off the board, I wonder if you feel free to comment on it?

WARREN BUFFETT: Yeah. Well, I won’t make particularly different comments than from when I was on the board.

But Coca-Cola is a fabulous company. Coca-Cola will sell over 21 billion cases of various products — more Coke than anything else — around the world this year, and it goes up every year.

It’s interesting. The stock in, what, 1997 or ’98, whenever it was, sold over $80 a share when the earnings were — I don’t remember whether they were $1.50 a share, or something like that — and the earnings then were not as good quality as the earnings are now when, you know, they were $2.17 or something like that.

And every year the — you know, they have — they account for a little greater share of the liquids consumed by people in the world.

They make fabulous returns on invested capital. You know, it’s a business that has — exclude the bottling part of it — has 5 or 6 billion of tangible assets and makes a similar amount.

So, there are not lots of big businesses in the world that earn 100 percent pretax on tangible assets.

And it will be a great business, and it’s been a great business.

The stock got to what, in retrospect, clearly was a ridiculous level, but you can’t hold the present management, Neville Isdell, responsible for that.

And he — you know, if the company sells 4 or 5 percent more units this year than last year, and the population of the world goes up 2 percent, it just means that more people are putting that particular source of liquid down their throats than the year before, and that’s been going on ever since 1886.

So it strikes us as a really wonderful business that sold at a very silly price some years back.

And you can definitely fault me for not selling the stock. I always thought it was a wonderful business, but clearly, at 50 times earnings, it was a silly price on the stock.

So we like it. We’ll own it ten years from now, in my view. Charlie?

CHARLIE MUNGER: No more.

WARREN BUFFETT: This peanut brittle gets caught occasionally, but it’s worth it. It’s worth it, definitely.

CHARLIE MUNGER: Why don’t you share with me?

WARREN BUFFETT: What? Oh, you want some, huh? Get your own box next time. (Laughter)

23. Reinsurance rate variations

WARREN BUFFETT: Now, do you want us to go to 14 or not? Yes. OK. Number 14.

AUDIENCE MEMBER: My name is John Gosh (PH) from Key West.

Have insurance rates hardened as much as you anticipated, and have you seen a significant flight to quality in the last few years?

WARREN BUFFETT: Yeah. I think you’re probably asking more about reinsurance rates.

Actually, in auto insurance, you can figure it out. Our policies are up more than our premium volume. So the average premium in auto insurance, which, after all, is close to 40 percent of the whole market for insurance — the average premium in auto insurance is actually down a little bit.

But in reinsurance, in which we are a big player, you will — there’s great variances.

If you take insurance for marine risks in the Gulf Coast — drilling rigs and offshore platforms and that sort of thing — those prices are up very dramatically, but they should be.

I think in the last couple of years, there’s been, like, 2 1/2 billion of premium in the Gulf Coast and 15 billion in losses. So if you paid out 15 billion and took in 2 1/2 billion, the more astute of you would figure that you needed a little more money for that particular risk.

We have been, historically — at least in recent years — the largest writer of cat — catastrophe — mega catastrophe insurance in world, and I think we will be this year. In fact, I’m almost sure we will be this year.

Our mix has changed some. Prices are up a lot, but what we don’t know is whether exposures are up even more.

We don’t know whether the experience of the last two years, we’ll say, with hurricanes in this hemisphere, is more to be relied upon than the experience of the last hundred years.

You can take the hundred-year experience and it tells you one thing, and you can take the last couple years and it tells you something else. And which is more meaningful? We don’t know the answer to that.

We do know that it would be kind of silly to assume that the 100-year experience is the relevant criteria when conditions — we know certain atmospheric conditions have changed. We know water temperature’s changed.

But we do not know all of the variables that are into the propensity of hurricanes to occur and the degree to how intense they may be if they do occur. We don’t know the answer to that. We don’t think anybody else knows the answer to it, either.

So we are getting more money for hurricane insurance. We’re getting appreciably more money.

If the last two years are the relevant years, we’re not getting enough. If the last hundred years are the relevant years, we’re getting plenty. And we will know more as time unfolds.

The really scary possibility is that variables are changing in some way so that the change is continuous and that what we’ve seen the last two years is not a worst-case example at all.

And, of course, you get into chaos-type theory with some of these variables where the outcome is not a linear relationship to the input, and you can dream up some pretty scary scenarios on this.

I don’t know whether they’re true and nobody knows.

We are willing to write certain areas, certain coverages, because we believe the prices are adequate, and we can sustain the losses.

We’re willing to lose many billions of dollars in a given catastrophe if we think we’ve been paid appropriately for it.

But it is not like figuring out the odds on flipping coins or rolling dice or something like that. You are dealing with changing variables, and you — the worst thing you could have would be a 100-year history book in making those judgments.

The third quarter, we will have a lot of exposure for wind. We don’t have as much exposure now — well, we may. I’d say we’re getting there. But we don’t have as much — certainly as much as we had a couple of years ago.

Prices — question about prices hardening. Prices are getting — are hardening — in that particular area. And if they get to what the — where we really feel they’re appropriate — you know, we might take on a fair — we will take on — a fair amount more risk.

If they don’t get there, even though they’re higher than last year, we won’t write — you know, we’re not interested in writing it, because it’s a dangerous business.

And we don’t believe in modelers at all. I read all this stuff about modeling. I wrote about that a few years ago. It’s silly. You know, the modelers don’t know a thing, in my view, about what’s going to happen.

And we get paid for making guesses on it. If, over a lifetime, the guesses are decent, we will know that, you know, we were doing the right thing.

But if this year goes by and nothing happens, we still don’t know whether we were right on the prices.

Because if you get a 25 percent rate for something and it doesn’t happen in a year, that does not mean that you didn’t need 40 percent or 50 percent. It just means that if you do it enough times, you will find out whether, overall, your judgments are any good.

It’s still a business we like. We bring a lot to the party. Everybody knows we can pay. You get into the question of creditworthiness.

If there is some super, super catastrophe — and I regard, sort of, the outer limits of that being a $250 billion insured loss — for reference, Katrina was a — presently estimated — was about a $60 billion loss.

So, if something comes along that’s four times Katrina, which could happen, you know, we can pay, and we can comfortably pay. We would probably have about 4 percent of that, maybe 10 billion.

A very large percent of the industry would be in very, very serious trouble.

So, we can play bigger than others, and we can survive better than others if something bad comes along. And we will see, over a five- or ten-year period, how we do. You can’t judge it by any one year.

Charlie?

CHARLIE MUNGER: The record of the past, if you average it out, has been quite respectable.

And why shouldn’t we use our capital strength to get into volatile stuff that makes other people frightened?

24. NetJets losses and retroactive policies

WARREN BUFFETT: Do we go back to number — to here? One more. Number 15?

AUDIENCE MEMBER: Hello?

WARREN BUFFETT: Yeah.

AUDIENCE MEMBER: I’m Marc Rabinov from Melbourne, Australia. I had a two-part question on the 2005 annual report.

Firstly, NetJets is a substantial part of our operations. Unfortunately, its value is obscured by losses in recent years, and I can’t estimate its value from the report. I was hoping you might be able to help me on that.

The second thing, how do I value the Berkshire Hathaway reinsurance group in light of the deferred charges on retroactive policies? Thank you.

WARREN BUFFETT: The second question, that — about the — we have an item that’s about $2 billion on the asset side.

I think I’m addressing the question of deferred charges on retroactive policies. That reflects the fact that those retroactive policies, where we insure — we reinsure, in effect — the losses that somebody has already incurred, although they may not know how much they’ve incurred, and we have limits on these.

But we set up a factor that, essentially, recognizes the fact that we will have that money for a considerable period of time. We set up an asset, and that gets amortized over the length of time we have that asset.

That number, which I think has gotten as high as 3 billion over the years, since we haven’t done any of those — any big contracts recently, is down around 2 billion.

There’s nothing magic about that. It means that we’re going to amortize that 2 billion over the lifetime of the use of the funds, and we think we’ll make money, net, during that time.

But we misguessed on one a couple years ago and took a $100 million charge, for example, in the first quarter of — I think it was the year before last.

The other question was about NetJets, wasn’t it, Charlie?

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: And I didn’t get it all. I love the Australian accent of our gecko, but I didn’t pick up the exact nuances of what you asked.

But my guess is you asked about the earnings and operation of NetJets.

And NetJets has grown rapidly, and so far, our expenses have grown faster than our revenue.

We’ve got the top service in the world. We’ve got, really, the only worldwide service. We have a very strong position, particularly in larger airplanes.

But I’d have to tell you that I did not anticipate — I thought we would have economies of scale, to some degree, and so far you can almost argue that we’ve had diseconomies of scale.

And our expenses, particularly last year, you know, basically got out of hand. And there are various reasons I could give you for that. All I can tell you is, it’s being addressed.

Rich Santulli, who runs that operation, you could not have a better operator. He loves NetJets. He works at it 16 hours a day. He’s — there’s nobody in the world I would have run that except for Rich.

I think it’s an important service. It’s tough to make money with airplanes. They’re capital-intensive. We’ve had fuel do what it has, although that’s a pass-through to people, but it still affects the business.

And I would — I had expected we would be profitable last year, and as I put in the annual report, I was dead wrong.

I think we will be profitable before long, but you should take my prediction there with — probably with — a certain amount of skepticism until it actually happens because I, like I say, I’ve been wrong.

We’ve got a good business in that almost anybody looking for a large plane on a fractional jet program comes to us. We are able to get full price for our service. But there were a variety of inefficiencies last year which added up to a lot of dollars.

And you know, you’re entitled to hold me accountable for the fact that we paid a lot of money for the business many years ago, and we haven’t earned any money since.

And we’ve got a much bigger business now, probably five times or so the size of the business we bought. That may be some solace to — I looked at Raytheon’s figures the other day. They lost a lot of money, and they have the second largest operation.

They sell their — they sell airplanes too, so they may not feel it the way I do.

But if I had to bet one way or the other, I would bet we will be making money before long, but I’ve lost that bet in the past.

Charlie?

CHARLIE MUNGER: Yeah. The product integrity is so extreme between flight safety and NetJets. The pilots are subjected to real oxygen withdrawal in the course of the safety training so they will recognize the subtle sensation that you get, and not everybody does that. It’s an expensive, difficult thing to do.

In place after place after place, that system is very obsessive about product integrity, and it’s my guess that that obsession, in due course, will be rewarded.

25. Why Buffett bought, and sold, silver

WARREN BUFFETT: OK. We’ll go to Number 3.

AUDIENCE MEMBER: Dear Warren and Charlie, I’m Oliver Couchet (PH) from Frankfurt in Germany.

Here’s a question to the Silver King: Some commodity investors give you as a reference as one of the largest owner of physical silver. Could you please clarify what kind of exposure you or Berkshire currently have in silver?

And, further, could you please help us to understand how you determine the value of a noninterest-bearing precious metal?

WARREN BUFFETT: Do you have any silver on you, Charlie? We had a lot of silver at one time, but we don’t have it now.

The original decision — my decision — was that the production of silver and the reclamation of silver — I don’t remember the numbers exactly now — but they were running, perhaps, 100 million ounces or thereabouts, less than the consumption.

And, now, a lot of consumption has gone down in photography, but that’s where the reclamation was, too, so that those tended more to balance each other out.

I haven’t looked at the figures for the last year or so, but silver was out of balance.

Now, on the other hand, there were enormous quantities of silver aboveground, and there were huge quantities of silver that could possibly be removed from other uses, perhaps, you know, in jewelry and all kinds of things, that could conceivably add to supply as they did in the early 1980s when the Hunt Brothers thing took place.

But, overall, silver was being produced and reclaimed at a lesser rate than it was being consumed.

And added to that was the fact that there are relatively few pure silver mines. Silver is largely produced as a by-product of copper and lead and zinc, and so that it was not easy to bring on added production.

So, all of that added up to the fact that I thought that silver would get tight at some point.

And, as I said, I was very — I was early in that conclusion, and I was early in selling.

So we have no silver now, and we did not make much money on it.

And you’re right that it doesn’t earn anything. So you sit with it. It’s not like sitting with a stock where, in most cases, earnings are piling up for you.

You have to hope that it — you have to hope that a commodity moves in price, because it is not producing anything as it sits there looking at you. And that’s one of the drawbacks of commodities.

Charlie?

CHARLIE MUNGER: We didn’t get where we are by owning noninterest-bearing commodities. I don’t think it’s a big issue around here.

WARREN BUFFETT: We actually owned oil at one time too, didn’t we? But we didn’t make much money on it. We made a little money.

CHARLIE MUNGER: No. You made quite a bit out of oil.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: But, you know, it’s a good habit to trumpet your failures and be quiet about your successes. (Laughter)

WARREN BUFFETT: Yeah. We have more to trumpet than we have to be quiet about. (Laughter)

26. “We don’t play big trends”

WARREN BUFFETT: How about number 4?

AUDIENCE MEMBER: Good morning. My name is Bill Gurn (PH). I’ve traveled from the United Kingdom.

And I would like to ask if you think it’s a good investment strategy to invest in regions of high resources per capita?

In particular, I should like to ask if you think that the analysis per capita should lead to higher growth for businesses in that region, plus the bonus of a relative exchange rate growth? Thank you.

WARREN BUFFETT: I’m not sure about the per capita part, Charlie.

CHARLIE MUNGER: My understanding is he was talking about investing in a region with high resources per capita. I think he means natural resources.

WARREN BUFFETT: Yeah. Are you thinking of places like Canada or something of the sort where the —

AUDIENCE MEMBER: I can clarify. Yes, high natural resources, but also good infrastructure. Thank you.

WARREN BUFFETT: And whether there would be relative currency strength in those as well and —

CHARLIE MUNGER: No. Whether it’s a good area for us to be operating in.

WARREN BUFFETT: Well, that would be a little macro for us. We really just zero in on, you know, whether people will keep eating candy and whether we can charge a little more for it next year.

We don’t play big trends. You know, we don’t think about demographic trends or anything of the sort. We think about our own age as getting older.

But other — big trends, they just don’t mean that much. There’s too much money to be made from year to year to think about things that take decades to manifest themselves.

So I can’t recall of a decision we’ve ever made on a purchase of a business or a stock or a junk bond or a currency or anything else based on a macro.

CHARLIE MUNGER: Not only that, we’ve recently failed to profit much from one of the biggest commodity booms in history.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: And we’ll probably continue to fail in the same way. (Laughter)

WARREN BUFFETT: But we’ll search for new ways to fail. I mean, we’re not trying to limit ourselves. (Laughter)

It’s probably true, incidentally, in a country like Canada, where you’ve got, probably, millions of barrels of oil of — millions of barrels a day — of oil production coming on and where there’s, you know, relatively few people and where there’s already a surplus.

When they’re running a significant current account surplus, that — you know, it’s not strange that their currency should be strong relative to a country like ours where we’re running a huge current account deficit and we don’t have that same natural — the gain in natural exports coming on that they do.

But that — there’s so many more important factors that are going to hit us immediately that that’s what we really think about day-to-day.

27. Nuclear threat is “ultimate problem of mankind”

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: Good morning. My name is Glen Strong (PH). I’m from Canton, Ohio.

I’m an optimistic person, and I’m sure it would be more enjoyable to discuss the Chicago Cubs’ march to the World Series.

WARREN BUFFETT: You are optimistic. (Laughter)

But everybody has a bad century now and then, as somebody said about the Cubs. (Laughter)

AUDIENCE MEMBER: However — (Laughter) — I have an information deficit on a certain topic that I hope you can fix. Please gaze into your crystal ball.

As an investor, I want to know how to address the risk of nuclear terrorism in the United States.

Consider a scenario where terrorists have detonated a nuclear device in a major U.S. city. I know there would be a terrible cost in human lives.

Gentlemen, what would happen to our economy? How would it respond? How resilient would it be? Thank you.

WARREN BUFFETT: Well, it would certainly depend on the extent of it.

But, if you’re asking how to profit from that, there’s probably some dealer that will sell you mortality derivatives. But I’m not sure that’s what we would be thinking about then.

No. I agree with you. I couldn’t agree with you more about that being the ultimate problem of mankind, not necessarily a terrorist-type usage, but a state-sponsored usage of weapons of mass destruction.

And it will happen someday. The extent to which it will happen, where it will happen, who knows. But we’ve always had evil people. We’ve always had people who wish evil on others.

And, you know, thousands of years ago, if you were psychotic or a religious fanatic or a malcontent and you wished evil on your neighbor, you picked up a rock and threw it at them, and that was about the damage you could do. But we went on to bows and arrows and cannons and a few things.

But since 1945, it’s — the potential for inflicting enormous harm on incredible numbers of people has increased, you know, at a geometric pace.

So it is the problem of mankind. It may happen here. It may happen someplace else.

People say it’s a — sometimes they say, “Well, you know, if we’d solve poverty, we’d solve this.” Well, I will just remind you that nuclear weapons have only been used twice, and those were by the richest country in the world, the United States, in 1945.

So, people will justify their use under some circumstances, if they feel threatened. They will justify them for religious reasons. They will do all kinds of crazy things.

And the — what holds it in check is the degree to which the lack of knowledge of how to do it is controlled, and the degree to which the materials are controlled, and which the deliverability is circumscribed.

And we’re losing ground on all of those fronts. The knowledge is more widespread. The possibility of getting your hands on materials — you know, the Dr. Khans [Pakistani nuclear scientist] of the world and so on, has increased.

And it will be a — it’s a real problem, but we won’t be thinking about what Berkshire did that day in the stock market.

And I don’t know how money attacks that. I mean, I’ve always saw that as the top priority, I think should be the top priority for philanthropy, in my particular case.

But it’s a difficult — it’s a very difficult — it’s a worst-case problem. You know, you have 6 billion people in the world, and you have a certain percentage of them who are, one way or another, a little crazy, or very crazy, and some of whom in that craziness would manifest itself by trying to do great harm to a lot of people.

And it’s — only one of them has to succeed.

I don’t know how many we’ve intercepted over the years. I’m sure we’ve intercepted a lot of incipient ones.

But it is a worst-case problem, and one will succeed at some point. And it may be state-sponsored; it may be terrorists.

But, you know, Berkshire is better set to survive than anybody else, but it won’t make much difference.

Charlie?

CHARLIE MUNGER: Well, I think that the chances we’ll have another 60 or 70 years with no nuclear devices used on purpose is pretty close to zero.

So, I think you’re right to worry about it, but I don’t, myself, think there’s much that any of us can do about it, except be as sensible as we can and take the consequences as they come.

WARREN BUFFETT: The only thing you can do about it — but you only have one vote — is to elect leaders who are terribly conscious of the product — problem — and who devote a significant part, you know, of their thought and energy into minimizing it.

You can’t eliminate it. You know, the genie is out of the bottle. And you would like to have the leading — the leaders — of the major countries of the world regarding it as their primary — as a primary — focus.

Actually, in the 2004 campaign, I think that both candidates said it was the major problem of our time. But, you know, they probably suffer from the same feeling that I do, that it’s very hard to address.

28. A Berkshire stock buyback won’t be a secret

WARREN BUFFETT: Number 6?

AUDIENCE MEMBER: Hello, Mr. Buffett, Mr. Munger. My name is William Schooler (PH), and I’m a shareholder visiting from Spicewood, Texas.

I would like to thank you both for being so generous to the public with your ideas.

Last year, I read “Poor Charlie’s Almanack” and came across a passage on share repurchases.

It reads, quote: “When Berkshire has gotten cheap, we’ve found other even cheaper stocks to buy. I’d always prefer this. It’s no fun to have the company so lacking in repute that we can make money for some shareholders by buying out others,” end quote.

Last year, you bought stock in some great businesses trading at fair prices, such as Walmart and Budweiser, but did not attempt to buy our own shares.

Would shareholders be correct to infer from this decision that you both felt Walmart and Budweiser were trading at a deeper discount to their intrinsic values than Berkshire was?

And would it be possible to buy as much Berkshire in the open market as you did Walmart without running up the share price?

WARREN BUFFETT: Most of the time, we would not be able to buy an amount that would be material, in terms of increasing the value of the remaining Berkshire shares. But that doesn’t mean it would never happen.

But it — if you look at the trading volume on Berkshire — and, [CFO] Marc [Hamburg], you might put that up, if we can, in a second — we probably have less opportunity than most companies if our stock is selling — should be selling — below intrinsic value to have anything meaningful happen.

We would also have — if we regarded some other company as worth X, a good business, and we could buy it at 90 percent of X, we might be doing that now, whereas we wouldn’t have done it many years ago.

But we might require a somewhat greater margin, in terms of buying Berkshire shares, simply because our view on that might be less — we probably have more knowledge on it, but we might be less objective than on some other things.

We think that when we buy — if we were to buy in Berkshire shares — and, if you remember, four or five years ago I announced we would if the price stayed the same — that the case ought to really be compelling, and if it’s compelling, we ought to do it. It was compelling at that time.

But simply the act of writing about it — you know, a little bit of a Heisenberg principle — the act of writing about it, in effect, eliminated the opportunity to do it, which is fine.

Because we do not — we are not looking to make money off of buying from shareholders at a depressed price.

On the other hand, if the price is sufficiently depressed, we will announce again that we intend to do it, and then we’ll see whether we actually get a chance to do it. Charlie?

CHARLIE MUNGER: Yeah. The whole climate in the country is different now.

It used to be that almost every company that bought in shares was buying them in at an obvious bargain price. Now I think a lot of share buying is designed to, sort of, prop the stock price.

In other words, it’s not bargain-seeking. It’s more like Sam Insull.

WARREN BUFFETT: Yeah. Forty years ago, 30 years ago, it was a very fertile field for making money to look at companies that were aggressively buying in their shares, the most extreme case probably being Teledyne.

But those people were buying overwhelmingly — Gurdon Wattles was doing it at the companies he controlled — those people were motivated simply by the fact they wanted to buy the stock below what it was really worth and — significantly below — and you could make money with that group, and we did a little of that at the time.

I would say in recent years, that motivation has been swamped by people who either think it’s fashionable to buy in shares, or by people who really like the idea of trying to prop their stock up somewhat.

And the SEC has certain rules, in terms of the way you conduct your repurchases to prevent daily, sort of, propping up.

But I think there’s a lot of motivation that our stock has got to be cheaper than other people’s stock, and we’ve got a wonderful company, and we’re just going to buy the stock come hell or high water, and that is not the way we would go about repurchasing shares.

We’ve got — well, we had up there, I think — some figures that showed the turnover of Berkshire shares compared — in a year — compared with a few others I picked out.

I think Berkshire has the lowest turnover, by some margin, of any major company in the United States.

And I put Walmart up there because the Walton family owns about the same — in fact, they own more — of Walmart than I do of Berkshire.

So, this is not a function of simply the fact that we’ve got concentrated holdings with the Buffett family.

This is a reflection of the fact that we’ve got a really unusual shareholder body in that they think of themselves as owners and not as people who are moving around with little pieces of paper every week or month.

We have the most — in my view — we have the most what I would call honest-to-God ownership attitude among our 400,000 or so shareholders of any company — of any big traded company — in the United States.

People buy Berkshire to own it, and hold it, and that’s reflected in our turnover. That does mean if, for some reason, the stock gets cheap — real cheap — that we would not be able to buy a lot of stock in.

But we don’t want — we are not looking to buy out our partners at a discount. If it sells there and we tell them we’re going to buy it, we’ll buy it. But that’s not a way that we’re trying to make money.

Charlie, any more?

CHARLIE MUNGER: No. I’ve said my piece.

29. Advice to young investment professionals

WARREN BUFFETT: Number 7?

AUDIENCE MEMBER: Good morning. My name is David Saber (PH), shareholder from Minneapolis, Minnesota. Looking for some advice you might give the young professionals here.

I could be classified as one of those helpers you describe in your annual report. In fact, most of my friends are helpers, and some could be classified as super helpers.

Most would love to step out and explore some of their more innovative ideas, innovative business models, strategies, and things of that nature.

But the risk of giving up a significant salary, health insurance, flights, other ridiculous corporate perks some of us young professionals earn.

What advice would you have for us in pursuing those dreams?

WARREN BUFFETT: Charlie, what do you think?

CHARLIE MUNGER: Well, there’s certainly a lot more helpers in the economy than there used to be, and the ones that come here tend to be the very best of the helper class.

So, I don’t think you should judge the helper class by those you meet here. We get the best of them.

And as to what the young helpers ought to do so that they’ll eventually be like Warren Buffett, I would say the best thing you can do is reduce your expectations. (Laughter and applause)

WARREN BUFFETT: I think I’ve heard that before.

Well, you know, as I wrote about — and I — trying to tweak the system a little bit — but it is an interesting business in that the activities of the professionals are self-neutralizing.

And if you’re going to — if your wife is going to have a baby — you’re going to be better off if you call an obstetrician, probably, than if you do it yourself. You know, and if your plumbing pipes are clogged or something, you’re probably better off calling a plumber.

Most professions have value added to them above what the laymen can accomplish themselves. In aggregate, the investment profession does not do that.

So you have a huge group of people making — I put the estimate as $140 billion a year — that, in aggregate, are, and can, only accomplish what somebody can do, you know, in ten minutes a year by themselves.

And it’s hard to think of another business like that, Charlie.

CHARLIE MUNGER: I can’t think of any.

WARREN BUFFETT: No.

But it’s become a bigger and bigger business.

And, as I’ve pointed out in the report, the main thing that’s been learned is that the more you charge, at least temporarily, the more money you bring in, that people have this idea that price equals value.

It’s useful to get into a business like that.

Sometimes, if I’m talking to the people at a business school and I ask them what the — what a great — to name me a great business — and, of course, one of the great businesses is a business school because, basically, the more you charge, the more your prestige is, to some extent.

And people think that a business school that charges 50,000 a year tuition is going to be better than one that charges 10,000 a year of tuition.

So there’s some of that that — well, there’s a lot of that that’s gotten into the investment field recently, and you now have large — certain large — portions of investment management that are charging fees that, in aggregate, cannot work out for investors.

Now, obviously some do, you know. But you cannot be paying people 2 percent and 20 percent where they get up it in the good years, and they fold their partnerships and start another one if they have a bad year and that sort of thing.

You can’t have that coming out of an economy that’s only going to produce, we’ll say, you know, 7 percent or something like that a year for investors, and have people net better off. It isn’t going to work.

And then the question that you will have is, “How do I pick out the few exceptions?” And everyone that calls upon you to sell you this will tell you that they are an exception.

And, I am willing to bet a significant sum of money, we’ll put it up, to anybody who wants to name ten partnerships that are $500 million or more of management and pit those, after fees, against the S&P over a ten-year period.

It — you know, it gets away from the survivorship bias and all that kind of a thing. And it isn’t going to happen.

But a few will do well. They’re bound to do well.

And, actually, I think I do know how to pick a few that will do well. I mean, I did it in the past.

When I wound up my own partnership in 1969, I told people to go to either Bill Ruane or Sandy Gottesman, and that would have been a very good decision, whichever place they went.

So, if you know enough about the person, know enough how they’ve done it in the past, know enough about their personality, honesty, and a whole bunch of things, I think that occasionally you can make a very intelligent choice in picking an investment manager.

But I don’t think you can do it if you’re sitting running a pension fund in some state and you have 50 people calling on you.

You’re going to go with the ones that are the best salespeople and not the ones that are the best investors. Charlie?

CHARLIE MUNGER: Yeah. On that state pension fund investment subject, I think it ought to be a crime to entertain, in any way, a state pension fund official, and I think it ought to be a crime, if you are a state pension fund official, to accept the entertainment.

It’s not a pretty scene, a lot of investment management, in America now. And, human nature being what it is and the amounts of money being what they are, I don’t think much is going to be improved.

30. Break for lunch

WARREN BUFFETT: Well, we wanted to leave you in a good mood for lunch. So — (laughter) — we will break now, and we’ll come back in about 45 minutes or so.

And those of you who are in the other rooms, by then the crowd thins, for some explainable reason, and you can all join us here in the main room. And we’ll be back in about 45 minutes.

Afternoon session

1. Buffett favors path to citizenship for some illegal immigrants

WARREN BUFFETT: OK. We’ll go to zone 8.

AUDIENCE MEMBER: Where’s the light?

Good afternoon, Mr. Buffett. First of all, I want to thank you for responding to all my letters throughout the years. I will always treasure them.

Last week, demonstrations in many cities across the United States took place on the subject of illegal immigration. Many companies want to stay in the U.S. but have grown dependent on cheap, illegal labor as a way to remain globally competitive.

A recent Businessweek article describes Shaw’s competitor, Mohawk Carpets, and their employment of illegal immigrants. If illegal immigration reform were to occur, how would you see this affecting Shaw, Clayton, and other Berkshire subsidiaries?

WARREN BUFFETT: Yeah. I didn’t read that, and I don’t know much about the Mohawk situation. I don’t — I don’t know anything about it.

I’m sure in Nebraska, you know, there are very substantial numbers of illegal immigrants employed. Meatpacking has been an area that a number have gone into.

And I actually was down at the Omaha airport about 2 years ago, and there was a very large plane there, and I saw these — well over 100 people that were in shackles that were being put on that plane.

I kind of wondered what they did, if they ever had some kind of emergency on the plane. But they were being deported. So there’s a lot of it goes on in Nebraska.

You know, I think it’s a problem that should be addressed and addressed promptly. I don’t believe in shipping 11 million people back away from the United States. Whatever acceptable way that the country can handle giving those people citizenship, I, basically, would support.

I think we ought to enforce the rules in the future. I think they ought to be liberal rules, but I think they ought to be enforced.

But I don’t think it would make dramatic differences. I mean, if one meatpacking plant employs people at subpar wages, you know, the rest of them are going to do the same thing.

You may end up paying a little bit more for meat in the end, but I do not think it would have a dramatic effect on the economy or even on specific industries, except to change, maybe, relative prices a bit.

But I don’t think it would have a dramatic effect on the economy if the people that are here illegally became legal in some manner.

You know, who’s to say if Charlie and I had been born into some terrible situation in some other country, we wouldn’t have tried to get into this place ourselves.

So it’s a — I’m pretty empathetic with it, but I believe that we do need to have laws that are enforced in the future. I don’t think we should send 11 million people back.

Charlie?

CHARLIE MUNGER: If you don’t like the results, I think you should get used to it because we never seem to have the will to enforce the immigration laws. I just think that what you’ve seen is what you’re going to get.

WARREN BUFFETT: I don’t — in terms of the carpet industry specifically — you mentioned Clayton Homes. I wouldn’t — I would think the mobile manufactured housing industry — I’d be surprised if there was any unusual number at all of illegal immigrants, but I — the answer is, I don’t know that for sure.

But I don’t see any change in those industries.

2. Business schools have improved “considerably”

WARREN BUFFETT: Number 9?

AUDIENCE MEMBER: Hi, Warren. Hi, Charlie. My name is Jeremy Cleaver (PH), and I come from Lawrence, Kansas. I’m a Jayhawk.

And what do believe is the best finance program in the U.S.? (Buffett laughs)

Also, I will be graduating in a year. Could you compare and contrast the financing opportunities now and when you graduated college?

WARREN BUFFETT: He comes from a school that has set some classes up in the last couple years that are absolutely terrific.

I’ve had — I will have in this school year, probably close to 40 schools where the students come out. And now I usually double up schools, because 20 of these a year is about all I can handle.

And we’ve had some terrific groups come out. And I would say that the teaching in finance departments, based on what I’ve seen, has improved quite a bit over 20 years ago. But that was from a very, very low base.

The orthodoxy of 20 or so years ago where, really, you know, the flat Earth was being embraced, has improved considerably.

And one particular place is KU. Professor Hirschey has done a great job. (Applause)

Missouri, Florida, Columbia, a lot of good schools — Stanford — have got people in those departments that are doing a very good job.

And 25 years ago, you’d have had a tough job getting a position at a finance department, and you certainly would have had your advancement stifled, unless you went along with the orthodoxy: efficient markets and modern portfolio theory and a lot of stuff that, not only wouldn’t do you any good, but might get you in trouble.

And that has — that’s improved a lot. And I enjoy seeing these groups of students as they come out, because it’s quite encouraging. Now, they all think they’re going to get rich by, sort of, copying what Charlie and I did many, many years ago. I wish them well.

It’s — the amount of brain power going into money management gets a little distressing, particularly to Charlie. But I would — you know, it’s a great time to be 22 or 23 or 25 and getting out of school.

So, you can look ahead to a very — I think a very interesting future in this country, even though you may find that the method of using the talents you have in investing get used in a somewhat different manner than where they — where they’re used presently.

I mean, right now an awful lot of the students that come to visit Omaha say private equity or hedge fund, and it’s hard to imagine a world where everybody is running a hedge fund. I’m not sure exactly what we would do for food and clothing, and a few things like that.

But I am encouraged by the kind of students I meet. When the KU group comes up — we had a great time. They put on various skits. They tried to sell me companies. I’m hoping they succeed.

We haven’t had any luck yet, but they keep coming up with good ideas, and I’ll keep pursuing them. And one of these days, every one of those students will get — I’ve offered them two B shares, and that’s a limited-time offer to try to spur extra activity.

And I hear from a lot of students later, and I think a lot of them have their heads screwed on right. Charlie?

CHARLIE MUNGER: Well, I’ve heard that something like half of the business school graduates in the elite eastern schools want to go into private equity or hedge funds.

And those whom I bump into seem to judge their progress in life as to whether or not they’re keeping up with their age cohort at Goldman Sachs. That appears to be the minimum standard by which progress of life is measured, and this can’t possibly end well. (Laughter)

WARREN BUFFETT: You can see why they come —

CHARLIE MUNGER: — in terms of satisfying all these expectations.

WARREN BUFFETT: That’s why they come to see me instead of Charlie. (Laughter)

He’d give them better advice, don’t misunderstand me, but go away with very long faces.

3. New CEO will go through a “media probation-type affair”

WARREN BUFFETT: Number 10?

AUDIENCE MEMBER: My namaste and good afternoon to Swamiji and respected Charlie Munger. Yes, I did say “Swamiji.” I see your inner dress crowned by your truth, by your humbleness, by your simplicity.

But your outer dress — I mean your wealth — is for the needy, at large. So you look upon us, your children, your friends, and your partners.

My name is Shekhar Agarwal. I’m from Sugarland, Texas, suburb of Houston.

Since May ’99, I got interested in Berkshire Hathaway. And I have read a lot of what you have written. So, I can judge a little about you.

By the way, I bought B shares March 3, 2000, at 1410 before they hit the low on March 10, and it became at that time 40 percent of my portfolio, and I still own all those shares and many more.

As you tell the students who come to Omaha to run a portfolio with real money to have a real feeling and real learning, I had the same experience with you.

You know, three years back, I had a chance, with my wife, my daughter, and my 6-year-old son, who is with me today, to spend a few minutes with you when you came to Houston during the opening of a new Star Furniture store.

As we were posing for a family picture with you, my 6-year little one was standing just beside you, while you were sitting on a high-bar chair. And you said to this stranger, “Son” — you said — “Son, you come and sit in my lap.” Sir, Swamiji, that is your simplicity. That is your humbleness.

And you talk about the contribution of Ajit Jain and ask us to bend really down if we see him, or name our children Tony to honor his contribution. Well, 40 years of selfless services to this corporation and to the humanity, you rightly deserve this distinction or this title of ”Swamiji.”

There is a beautiful, beautiful — (Applause) — beautiful prayer in the Holy Vedas that says “tvam jīvehiṁ śaddhā-śataṁ.” It means, “The Almighty God says, ‘Oh, my child, may you live hundred and longer peacefully.’”

So that’s my wish. That’s my prayer on your 75th birthday. And, Swamiji, I’m waiting for my chance to touch your feet and get your blessings. (Applause)

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: Let me finish, please. Swamiji, I have a question anyway. (Laughter)

A lot of business people have a great amount of respect and trust for this 75-years-young teenager girl who is sitting by the phone waiting for it to ring, and now and then that phone rings.

I have no concern about the next CEO of Berkshire Hathaway to take this company forward, but I do wonder about this phone. It may not ring as often as it does now, until the new CEO earns the respect and the trust of these phone dialers.

Do you see that a concern? And do you think it is a good idea that you may become the only chairman, and let someone else become the CEO, and let him earn the respect and trust under your umbrella while you are still young and healthy? Thank you very much.

WARREN BUFFETT: Yeah. Thank you. (Applause)

I don’t think there’s any question, but — that my successor, you know, will go through, sort of, a media probation-type affair for a year or so.

And people will, understandably, wonder whether the culture is going to be different under the successor than it’s been at this point.

That’s going to happen. It won’t be the end of the world. It will mean that the phone will — it — the phone probably won’t ring less, it will just be a different kind of suitor that is calling.

The investment bankers will all try out this guy to see if he’s softer than I am and wants to participate in auctions and all of that sort of thing.

But I think it will become evident — and it will take a year, two years, maybe — I think it will become evident that the culture is the same, that the yardsticks, the metrics, the attitude towards shareholders, the whole thing, will not change, the board will not change.

But I think there will be a hiatus of sorts where people do not have the same feeling immediately that joining Berkshire is going to be the same experience as it — with our companies — as its been in the past. But it won’t last long.

I can tell you that the successors that the board has in mind — you know, they’re very smart. They understand. They’ve bought into the whole corporate personality we have.

And they will develop — be somewhat different in style, but they will — they will develop the confidence of the world that — and to possible sellers of businesses — they will develop the confidence that it’s going to be the same Berkshire going forward.

But it’s a good question. And there will be — there will be a period when the phone won’t ring for a while until people realize that Berkshire is, sort of, one-of-a-kind, and it’s continuing to be one-of-a-kind.

I don’t think it would work well, you know — but it’s the kind of the thing we talk over with the board, though — but I don’t think it works well to have, sort of, a half-and-half arrangement.

I mean, you could say that I could handle, or encourage the handling, of the deals and somebody else could, sort of, be the operating guy. But the truth is, we don’t need an operating guy.

You know, we’ve got people running the businesses that are running them, and they’re very good at it. And the main thing to do is to not destroy or damage the spirit they bring to it and the fact that they like this method of operation.

So it would — I’m not sure what a chief operating officer would do at Berkshire except expose the fact that I wasn’t doing anything. (Laughter)

And as long as I’m around, they’re not going to get the calls on the deals. I mean, people are going to want to talk to me. I mean, that’s not a handoff that would work.

So I think we’ll go along in this mode. And, you know, you will have a period, everybody — there will be stories a year after I die that, you know, says one year later and what’s happened and all that sort of thing, but that will fade out.

And my successor will put his own particular stamp on the place, but he won’t mess with the culture. They’re too smart. They’ve seen it work too well. So that — the calls will start coming in again after a while.

We will still represent, sort of, a one-of-a-kind place for the owner that really cares about the future of his business.

For one reason or another — tax reasons, family division of shares or something — you know, they have to — they have to solve the ownership problem.

But they want to solve it in a way that really doesn’t change the psychic ownership of the place and the management of the place. And they can’t find that elsewhere, and they’ll continue to find it at Berkshire.

Charlie?

CHARLIE MUNGER: Well, speaking for the Munger heirs, I would rather the current method of operation continue to wring the last drop of good out of Warren. (Laughter)

WARREN BUFFETT: At low pay.

CHARLIE MUNGER: Yes, yes.

WARREN BUFFETT: Part of Charlie’s instructions under all circumstances.

No, if we — if we thought there was some better way to make this place function better or to even make the transition easier to the next person, you know, we’d be delighted.

But I really think it’s going to work pretty darn well. If I die tonight, the person who will take over tomorrow will not get as many phone calls for a while, perhaps, but very, very smart people. Know the business. You know, they know a lot about all businesses. They’ve got a general business knowledge.

I use “they” because there’s three candidates, but there would be one specific one in mind. They know how to make deals. These people are plenty deal-savvy, and they know how to avoid other kinds of deals, which is equally important.

And the world would not fully grasp that for a year, maybe even two years. But once it happened, you can argue that it would be even stronger than before because at that point people would realize that it was institutionalized and not just a person.

You’ve got a — kind of a hat — I mean, I don’t want to compare myself because it’s not in the same league, but, you know, everybody, when Sam Walton died in, I think, 1991 or something, wondered whether Walmart would continue in the same tradition.

Well, the fact that it did has made that place a lot stronger than if it had just depended on the guy in the pickup truck. I mean, it was not — it was the creation of one person at Walmart, but it was not required for the continuation at all. And we’re not in the same league, but it’s the same idea.

4. Go with your gut when picking a charity

WARREN BUFFETT: Number 11.

AUDIENCE MEMBER: My name is Martin Wiegand from Chevy Chase, Maryland. Mr. Buffett and Mr. Munger, on behalf of the assembled shareholders, we thank you and all the Berkshire staff who put so much work and thought into making this weekend such a wonderful community-building event. (Applause)

WARREN BUFFETT: Martin, is Janie (PH) with you?

AUDIENCE MEMBER: Yes, sir.

WARREN BUFFETT: OK. Well, she sent me some great sweetbreads the other day. I love them. Keep them coming. Thank you. (Laughter)

AUDIENCE MEMBER: Through the years, you have generously helped us thinking through capital allocation decisions for funding our businesses and feeding our families.

Would you please help us think through the capital allocation decisions we face when it comes to charitable giving, particularly as it concerns how we pick effective charities? Thank you.

WARREN BUFFETT: You know, it’s tough to give other people advice on that. But, you know, you have to pick the things that are important to you. And, you know, many people — majority in the United States — it’s their church. You know, there’s more money given to churches than anything else.

Many people — very many people — it’s their school, or schools generally. You know, I think, to a great extent, you should pick whatever gives you the most satisfaction, and that will probably be something that you know, something you’ve, maybe, benefited from yourself.

I look at it a little differently. The amount of funds are different, too, but I like to think of things that are important but that don’t have natural funding constituencies.

But that isn’t something, you know, for millions of people to be following as an example or something. Nothing wrong with doing something that gives you plenty of personal satisfaction and does some good for other people in the process.

So I would not be reluctant — I would not feel I had to be as objective about that, necessarily, as I was about buying securities or something of the sort. I would, kind of, go where my gut led me and make it something you participate in.

And, like I say, I think if you’re doing it with large sums, you may have some reason, maybe even some obligation, to try and think about where really large sums can have an important impact on a societal problem that might not get attention otherwise. And, you know, that’s, sort of, where my own thinking leads me.

But I would — I would go with something where I felt I knew where the money was going to go and I knew some good was going to come out of it. And maybe, by observing what took place, I could make the next gift more efficient than the last gift and more beneficial.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add. But I have a question: would you pour me a cup of coffee? (Laughter)

WARREN BUFFETT: We don’t sell coffee, Charlie. We sell Coke. (Laughter)

We get the profit on one out of every 12 Cokes. So I don’t care whether you drink them, just open the can. (Laughter)

5. We like the regulated utility business the way it is

WARREN BUFFETT: Number 12.

AUDIENCE MEMBER: Good afternoon. My name is Robert Piton (PH) from Chicago, Illinois.

And my question is, did the possible future deployment of telecommunications services over power lines factor into Berkshire’s decision to invest in the utility space? Thank you.

WARREN BUFFETT: Yeah. The answer is no. We’re in the utility business — the regulated utility business — because we like the business as is.

Where it leads, you know, will be determined — well, in specific states — by what they want us to do and maybe by technological changes, generally.

But we’re going to earn a return on capital employed if we do an efficient job, keep consumers happy, whether we transmit it the old way or, you know, some new processes come along.

So it’s a business where we’re trying to be efficient, which means serving our customers while keeping their costs down as much as possible. And we will — even in terms of what generating sources we use — we are following the will of the people in the states in which we operate.

There are different costs associated with different forms of generation. And we feel that if people want to elect a more expensive way to generate electricity but one that they’re more comfortable with in terms of the environment, you know, that’s the decision of the people whose state in which we operate.

And we — so I do not see us — I don’t see any large developments that change the economics of what we’re doing. And we’re certainly not going in — we’re not buying an electric utility because we expect it to generate revenues from activities other than that.

Charlie?

CHARLIE MUNGER: Nothing to add.

6. “Media businesses do not have a great outlook”

WARREN BUFFETT: Number 1.

AUDIENCE MEMBER: OK. First, my name is Egil Dahl. I’m a retailer from Norway. I would like first to thank you gentlemen for the opportunity to come here and ask two of the best businessmen in the world a question.

My question is regarding the media and entertainment business. Do you think that the nature of newspapers, magazine, television, and maybe movie and music business as well, are about to change permanently and become less predictable because of new technology and internet?

And the second part is, if not so, do you think that some of these businesses represent good purchases at the moment because the market thinks so? Thank you.

WARREN BUFFETT: Well, people are always going to want to be entertained and they’re going to want to be informed and some mix thereof. But, you know, we only have two eyeballs, and we only have 24 hours a day.

So if you go back 50 or 60 years and think about how people got informed or entertained then, the choices were far fewer. You had the local movie theater, and you had the radio, and you had newspapers.

And as the years have gone by, what technology has done is opened up a huge variety of ways of being informed faster, certainly. And whether it’s better or not depends on who you ask.

And certainly entertained in way many more forms, many that are free. And it hasn’t expanded the time you have for entertainment or for acquiring knowledge.

And any time you get more and more people competing in any given area, generally, the economics deteriorate.

And the economics have deteriorated for newspapers, although they’re still enormously profitable in relation to tangible equity employed, but they do not have the same economic prospects, if you look at the future stream of earnings, that it looked like they had 20 or 30 or 40 years ago.

And television, again, the margins have been maintained surprisingly well, but the audience keeps going down and — for any given means of distribution.

So, that has to erode economics over time. Cable was thought to operate pretty much all by itself, and the telecoms come in.

And very few businesses get better because of more competition. They like to talk about it, you know, but it — you know, the idea —

I had one friend in the newspaper business. And I think Charlie used to tease her a bit by saying that her idea of a competitor was a corpse laid out on a slab with a toe twitching, you know. And the — it is not a better business when more people compete.

So I think that, generally speaking, the economics of media businesses do not have a great outlook, I mean, compared to — like I say, they’re enormously profitable now, in returns on tangible assets.

I mean, it’s a business — you know, a license from the federal government became a royalty stream on huge amounts of money.

I mean, there were only three highways between — electronic highways — between Procter & Gamble and Ford Motor and the eyeballs of several hundred million people, and those three highways could make a lot of money when there were only three highways.

But you keep building more ways to — for the P&Gs, or the Gillettes, or whomever it might be, or Ford Motor, or General Motors — to get to those eyeballs, and you decrease the value of the highways. It’s not complicated.

So, I think you will see — it’s hard to imagine those businesses having great prospects in aggregate.

We owned the World Book. We still own the World Book. We were selling 300,000 sets a year or something like that in the mid ’80s. It’s a very valuable product. It sold for $600 or thereabouts, and it was worth it.

But the problem became that you could get that same information, or a good bit of the same information, you know, very, very cheap through the internet.

And you didn’t have to cut down trees. And you didn’t have to run paper mills. And you didn’t have to hire United Parcel Service to deliver a very bulky package.

And it isn’t that the product we have isn’t worth the money; it’s that people have lots of other alternatives. And that’s true in information and entertainment in a big, big way, and it won’t stop, in my view.

Charlie?

CHARLIE MUNGER: Yeah. It’s simplicity itself. It will be a rare business that doesn’t have a way worse future than it had a past.

WARREN BUFFETT: Give them the bad news, Charlie. (Laughter)

The thing to do was to buy the NFL originally or something like that.

I mean, you know, there still is only — you know, there are certain primary events, but it’s the people who transmit them — there’s more ways to transmit those events, and so the value gets extracted in a much different way.

7. “Significant consequences” from U.S. trade imbalance

WARREN BUFFETT: Area 2?

AUDIENCE MEMBER: Good afternoon. My name is Yuji Siamoto (PH) from New York City.

I would like to ask Mr. Buffett regarding your views in respect to currency: the renminbi, the yen, and the euro, in particular.

During the visit by Hu Jintao, this issue of the currency level had become a big issue. And increasingly, this is becoming a very, very important issue for economic health of this country.

United States is becoming highly dependent on very cheap, underpriced Chinese exports in all consumer goods. You go to Walmart, and most of the high product — high-end product electronics — or most of the — any value-added products — are manufactured in China.

U.S. is almost addicted to very low-priced Chinese goods, thanks to artificially maintained currency level. At the same time, U.S. is becoming addicted to very cheap capital from China and Japan, as they provide infusion of capital to U.S. Treasury markets, thus keeping the interest rate low for mortgage rates.

I see a great danger if this is maintained for long time, as U.S. becomes addicted to this cheap Chinese or Asian exports for all our consumption, and also for all of our cheap mortgage rates.

And this is almost like being addicted to opium, as Chinese were addicted to opium during Opium Wars.

And should government try harder to break this vicious cycle? And, if so, what would you think about the currency level?

And you have — previously, you have held very strong views about the dollar, but what are your views now, and are you capitalizing on your views on the currency?

WARREN BUFFETT: Yeah. Well, my views — and Charlie may disagree — but my views are strong as ever, perhaps a bit stronger. The — we are doing less directly in currency futures because the — as I explained in the annual report — the carry cost has gone from being positive to quite negative.

So there are better ways, in my view — considerably better ways — of mitigating the consequences of the dollar becoming a lot weaker in the future.

We like the idea of developing earning power in other currencies around the world, and, in effect, in ISCAR itself, the — a large portion of the earnings are not in dollars, and we’re doing it in other areas as well. We will hold less in currency futures unless the carry picture changes.

But the fundamental picture, what, in my view, is almost — you never say “certain,” but a very high probability of happening, is that the U.S. currency weakens over time.

No idea about the next 6 months or year or anything, but over a long period of time, weakens against other currencies because we are following policies that don’t seem much — don’t seem to leave much alternative.

Here is a quote referring to running a large current account deficit that was given on February 28, 2002. The quote is, “Countries that have gone down this path invariably have run into trouble, and so would we. Eventually the current account deficit will have to be restrained.”

Now, that was said by a very smart fellow whose name was Alan Greenspan. And at that time, the current account deficit was 385 billion, and it will be more than double that now.

So here, 4 years later, we have gone down that path, which he talked about, and we’ve gone faster and faster down the path. And he says, invariably, it runs into trouble.

Now, in his later years as Fed chairman, he did not emphasize this view as much. He never repudiated it, but he sort of talked about other things more.

But it — it’s going to lead to something, and it — in my view, it’s likely to be something significant. And people talk about a soft landing, but they never explain to me exactly how it’s going to take place.

And Chairman Bernanke recently gave a talk where he said the probabilities were that the ending would be good but that he couldn’t rule out the possibility otherwise.

I think you will see significant consequences at some point. We will have, at Berkshire, a fair amount of our earning power coming from other countries with other currencies, but we will always be primarily in the United States.

And, you know, we may — one consequence certainly seems possible is significantly higher inflation as the years go by.

Because as you owe more and more money as a country, it gets more and more tempting to devalue what you owe by paying in a cheaper currency than in the one in which the debts were incurred.

Charlie, what do you have to say on this?

CHARLIE MUNGER: Well, I don’t feel I have any special capacity to predict whether the euro was exactly priced right, right now. I don’t consider it a big deal that Berkshire has had the position it’s had.

In effect, about half of our surplus cash was stashed short-term in currencies other than the dollar. I regard that as almost a nonevent. Now, as it happened —

WARREN BUFFETT: Well, we made a couple billion dollars off it. (Laughter)

CHARLIE MUNGER: Yeah. I was — as I was about to say, that as it’s happened so far, it’s been a very profitable nonevent, but... (Laughter) Generally —

WARREN BUFFETT: If it doesn’t mean anything to him, he can always give his share to me. (Laughs)

CHARLIE MUNGER: Yeah. Generally speaking, it can’t be good to be running a big current account deficit and a big fiscal deficit and have them both growing.

I mean, a great civilization may be able to stand something like that for a way longer period than you might have thought at the outset.

But you think that in the end, there would be a comeuppance and that we would have to change policies, perhaps painfully. In fact, I would say almost surely painfully. Wouldn’t you, Warren?

WARREN BUFFETT: Yeah, I would. And it’s interesting because I think almost everybody says it’s unsustainable, and then they never explain how it doesn’t keep being sustained until something comes — very unpleasant comes along.

But then they also say that there will be a soft landing, and I don’t always get from A to B to C when I listen to them. The —

Certainly the longer it goes on, the greater the credit — the greater the net debtor position the United States is in, the more people see that we are, sort of, addicted to this kind of behavior, the more chance there is at some point, probably brought about by some other extraneous affair, that currency doesn’t —

There aren’t some big adjustments that take place and, perhaps, some chaotic markets in which currency adjustments play a part. But knowing when or exactly how, it’s impossible to say that sort of thing — predict that sort of thing.

Charlie and I, in the 1980s, saw something called “portfolio insurance” — and that was a very popular term then — catch on with institutions.

And what happened was that a group was around selling the idea that this was a sophisticated, superior way for large institutions to manage money. And they charged appreciable sums for people — to people — to set up mechanistic procedures for dealing with stock market fluctuations.

They did this with pension funds and various big guys. And it was very popular, and the academic literature was full of it, and people were teaching about it in the schools.

And then October 19, 1987, came along, and a relatively small portion of American money invested — American investments — were being guided by this portfolio insurance doctrine.

But just that small amount of money was a leading factor in producing a 22 percent change in the value of American stocks in one day.

Every one of these people individually thought what they were doing was intelligent, but, when aggregated, and having to follow a given signal, in effect, you created a doomsday machine. It was out of control, and some really chaotic things happened then.

I would say the potential for that sort of thing — not that exact thing at all, but that sort of thing to happen in the world ahead is — it’s probably magnified quite a bit from what existed in the ’80s.

And currency enters into it, but it’s not — who knows where it starts or exactly why somebody yells “fire.” But when “fire” is yelled, there will be — the currency markets will play a part in the rush for the door.

8. “CPI has understated inflation”

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Hi, there. Alex Rubalcava from Los Angeles.

Warren, you just brought up the topic of inflation, and so I wanted to ask, do you believe — or do you believe that the Consumer Price Index is a good and true and accurate measure of inflation?

WARREN BUFFETT: Well, that’s a good question. Bill Gross has written a little bit about that in some of his PIMCO methods and — messages. And, you know, if you go out to the Furniture Mart and construct a price index, it hasn’t moved very much.

I mean, it makes it very tough for comparable store sales when you were selling DVD players at X few years ago, and now you’re selling them at a quarter of X. So there’s certain areas that there have been a huge — in effect, deflationary aspects.

But I do think the CPI — and, like I said, Gross has written about this — but the CPI is not particularly a good index.

I always get a kick out of when they talk about the core CPI, and then they — and they say that excludes food and energy.

You know, food and energy strike me as pretty core to anything, in terms of the average — I can’t think of anything that’s much more core.

The CPI, as you may or may not know, many, many years ago had housing figured in directly.

There is no — the CPI now has a rental — which is an imputed rental type computation. It’s still a large portion of the CPI, but it does not reflect the new housing prices, or —

And rentals — the rental factor has lagged, in my view, significantly below what housing costs really are for an American family. And since housing is a big portion, I don’t think it picks it up well.

So I would say that the CPI has understated inflation for a great many people.

Now, if you’re older and you own your own house — I mean, everybody has their own way of living.

And, I mean, if all you do is drink Coca-Cola all day, you know, Coca-Cola hasn’t gone up in price enough, in my view, and you — my CPI has not changed very much.

But for somebody buying a new house versus 6 or 8 years ago and driving 30 or 40 miles to work or having a lot of driving in the family, the CPI has gone up a lot more than the government figures would indicate.

Charlie?

CHARLIE MUNGER: Yeah. I see it at Costco where there’s been almost no inflation in the composite product that flows through Costco, and, yet, in other places you get these dramatic rising figures.

I don’t feel sorry for the people that pay $27 million for an 8,000-foot condo in Manhattan. You know, if they’ve had little inflation, I guess it doesn’t matter to the rest of us.

But it’s almost weird the way the situation works in terms of how it’s —

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: — it comes in just a few places.

WARREN BUFFETT: If you look at the Costco annual report or the Walmart annual report — these are huge enterprises — and you’ll see their LIFO adjustment is just peanuts.

CHARLIE MUNGER: Almost nothing.

WARREN BUFFETT: Yeah. Just peanuts — is Costco on LIFO for —

CHARLIE MUNGER: Sure.

WARREN BUFFETT: — for fuel? I know they’re on LIFO generally. Are they on it for gasoline or not?

CHARLIE MUNGER: I think so. I can’t imagine they’re not.

WARREN BUFFETT: Yeah. But they wouldn’t have a large inventory relative to —

CHARLIE MUNGER: No.

WARREN BUFFETT: — their sales volume. But they — at Walmart, it’s inconsequential. I just got through reading their annual report, and the LIFO adjustment isn’t worth a hiccup, you know, basically.

And you’re dealing with 300 billion — well, in the United States a little less than that — but $200-and-some billion worth of sales, and the LIFO adjustment would have picked up changes in prices of that mix overall relative to their inventory level.

So in jewelry, you know, because of gold and some things, we had some big LIFO adjustments last year.

Steel, we’ve had big LIFO adjustments. We have a steel service center in Chicago and we buy a lot of steel at MiTek and there’s a big LIFO adjustment. So it’s very uneven.

Carpet went no place for 20 years, but because it’s petrochemical-based, there have been substantial price changes in the carpet business in the last couple years.

And our LIFO — we had a LIFO net — a minus LIFO figure, in effect — 3 years ago, and now we have 100 million or so of LIFO adjustments. So there’s been a significant price change there.

I think overall, though, for a typical young family, that the CPI probably underestimates the burden they have faced, in terms of their own living situation.

9. Why we don’t “do deals” with investment banks

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Hi. I’m Mike Kelly (PH) from Iowa City.

We’ve heard a bit about ISCAR today. Could you tell us some things about some of the other acquisitions of the past year?

WARREN BUFFETT: What would you like to know, Mike? (Laughter)

AUDIENCE MEMBER: Um.

WARREN BUFFETT: I mean, we described it a bit in the annual report, but —

AUDIENCE MEMBER: Right. Well, I believe since the annual report, there have been a couple others. Russell, for instance.

WARREN BUFFETT: Yeah. Russell is in the works. There’s just been a proxy statement that isn’t out yet, but it’s been filed with the SEC. You can get a copy of the filing. But that is one in process and is probably a couple months off from actual completion.

You know, we — I described the Business Wire situation in the annual report where I got a letter from Cathy after reading — reading a Wall Street Journal article. And, you know, these — they just all sort of pop up.

Medical protective, I think I suggested to Jeff Immelt at GE, that if — I knew they were interested in doing things with their insurance assets, and I suggested that was one portion of their insurance assets that Berkshire would have an interest in. And he and I met one time and we made a deal on that one.

PacifiCorp — that originated with Dave Sokol and the people at Scottish Power. I’m not even exactly sure what the sequence was.

But the one thing we haven’t done is we haven’t participated in any auctions.

I get books occasionally on various businesses, and the projections are just plain silly in these books. I mean, it’s a — I would — maybe that’s why they don’t sign their names in the books, the people that write them, because they’d be embarrassed about the projections they put forth.

I would just love to meet the people that write those investment banking books and make them a bet on the earnings that they project four years out. I would win a lot of money over time. They wouldn’t be met.

But we get the calls, occasionally, from the people that care about where their businesses end up.

We’re going to close on Applied Underwriters in just probably a few days, and those are two terrific guys, built it up from absolutely nothing.

Actually, I bought a tiny business here in Omaha — as I explained in the report — that’s why it’s here.

But they wanted to come with Berkshire. They think their own — they’re keeping 19 percent of the company. They think their own future will be the best in many ways, including financially, I’m sure, of being associated with us. They feel it’s the best place for the people, have the most opportunity to grow. And, you know, they came to us directly.

You know, I don’t know how many stories you read about a $4 billion deal, as appeared today in connection with ISCAR, where it doesn’t say anything about an investment banker, on either side.

But you’ll see more of those, I think, with Berkshire over the years.

Charlie, do you have anything in particular to add on our acquisitions recently?

CHARLIE MUNGER: Well, the interesting thing about it to me is the mindset. With all of these new helpers in the world, they talk about doing deals. That is not the mindset at Berkshire. We are trying to welcome partners. It’s a total different mindset.

The guy who’s doing a deal, he wants to do the deal and unwind the deal and — not too far ahead and make a large profit, et cetera, and that’s not our mindset at all.

We like the things that we can buy and that never leave us, and we like the relationships that last and are fruitful, not just for us, but for the people working there and the customers and everybody else.

I think our system is going to work better, long term, than flipping a lot of deals. And we have so many new deal flippers in the game that I think they’re going to get in one another’s way.

In other words, I don’t think there’s enough money out there to have all this new class make all the money they expect to make on a permanent basis just flipping, flipping, flipping, flipping.

WARREN BUFFETT: They’ll make it on fees, fees, fees, fees. (Laughs)

CHARLIE MUNGER: Warren reminds me, once I asked a man who just left a large investment bank — and I said, “How does your firm make its money?” He said, “Off the top, off the bottom, off both sides, and in the middle.” (Laughter)

WARREN BUFFETT: I know which firm he’s talking about, too. (Laughter)

CHARLIE MUNGER: That’s not our culture. And a lot of you have been here so long, you can see that’s not our culture. But in the end, it may be that Omaha will do better than Wall Street.

10. Salomon’s 1991 reprieve prevented “absolute chaos”

WARREN BUFFETT: Number 5. (Applause)

AUDIENCE MEMBER: Hi. Steve Rosenberg (PH) from Michigan, originally. First, I’d just like to thank you both very much for continuing to serve as role models for integrity and common sense.

Can you describe a little bit more specifically — (Applause) — how a derivatives meltdown might progress and, ultimately, get resolved after it’s been precipitated, and is there a plausible way to resolve it without some sort of a major bailout that would exacerbate a too-big-to-fail moral hazard problem?

WARREN BUFFETT: It’s really hard to tell. I mean, it — you know, it — what will cause people to yell “fire,” what will — how many people will rush for the exits, what they’ll do when they get there — it happens occasionally.

You know, with LTCM — Long-Term Capital Management — in 1998, you know, it affected the financial world in a big way. It didn’t affect it in the biggest way. I mean, the feds stepped in. But there were some pretty — pretty strange things happened during that period, in markets.

What happened in the junk bond market in 2002? I mean, it closed for a while almost, and it was chaos. So it’s very hard to know exactly what would happen. I’ll give Charlie a question here.

In 1991, when we were in Salomon — it was in August, middle of August — and on a Sunday we were within, probably, a half an hour of seeking out a federal judge to turn over the keys to the place to him and go into bankruptcy.

And, fortunately, the Treasury reversed itself, and we got out of that particular predicament. But the law firm was drawing up the papers for bankruptcy.

Now, that was on a Sunday. What would have happened Monday — and we had a good — we had, for those days, a good-sized derivative book. It would be peanuts now, but it was — it looked big at the time. We had a lot of security settlements due the next day.

Now, it happened to be the same day that Gorbachev was spirited away, and the Dow opened down a couple hundred points the next day off of a much lower Dow.

Now, if you had superimposed upon that the fact that Salomon failed in Japan starting at 7 o’clock or so the previous night and that it was — if you were delivering securities to them against payment the next day, you weren’t going to get paid.

And if you were expecting securities from them, you weren’t going to get those securities. And, by the way, you had a — I think a 6- or $700 billion derivative book.

And people who had traded off those derivatives had to try and figure out where they stood and scrambled around and whether their counterparties were any good.

What do you think would’ve happened on that Monday, Charlie?

CHARLIE MUNGER: Well, it could have been absolute chaos. That was a very interesting story with an interesting moral. Nick Brady really prevented that bankruptcy.

And he knew about Berkshire Hathaway from having been a family shareholder with the Chaces way, way back. And that had caused him to follow the matter with interest, particularly since he’d sold his own stock and watched his relatives, the Chaces, hold theirs.

So he knew about us, and I think he trusted you, Warren. And I think that mattered that day. So these old-fashioned reputational —

WARREN BUFFETT: Well, what would have happened the next day? I —

CHARLIE MUNGER: Well —

WARREN BUFFETT: It was terrifying. I’ll put it that way.

CHARLIE MUNGER: Yeah, it was terrifying. And — but there was an element of personal reputation in the avoidance of finding out what would have happened that next day.

WARREN BUFFETT: Kim Chace, who I introduced you to earlier, his father actually introduced me to Nick Brady many, many years earlier, mid ’60s, when Nick was working — was at Dillon Read and Malcom Chace said, “I’d like you to meet” — I guess he was a nephew or grandnephew.

In any event, I went over to Dillon Read and — I would have been in my 30s then — and Nick was a few years older — and we had a good time talking.

And then in 1991, he was secretary of the Treasury. And the Treasury had issued a death sentence to us at 10 o’clock in the morning on Sunday, and, fortunately, Nick, reversed that about 2:30 in the afternoon.

And if he hadn’t, I don’t know what would have happened. But that would have been kind of a pilot case for a mild derivatives daisy-chain-type panic. But that would be nothing compared to something now.

If — now, there’s way more of the stuff that is collateralized these days than formerly, but it would not be a — it’s not an experiment you would want to voluntarily conduct, I’ll put it that way.

11. We love reading them, but newspapers are in trouble

WARREN BUFFETT: Number 6.

AUDIENCE MEMBER: Hi. My name is Jeremy from San Diego. And, first of all, I want to thank you all for the tremendous impact that you’ve had on my career as a professional investor.

My question is also about the newspaper industry that the gentleman earlier touched on.

And for some of those same points that you brought up, some of the largest newspaper stocks seem to earn incredible return on invested capital as compared to a lot of the businesses in the S&P 500.

My question is more specifically related to valuation. If either of you were looking at a newspaper stock today and watching them fall, as some people may categorize falling knives, what would you use to determine — or how would you determine a very comfortable margin of safety to protect yourself against the deteriorating aspects of the newspaper industry?

WARREN BUFFETT: Yeah. Well, the question is what multiple you — what multiple should you pay for a business that’s earning $100 million a year — call it pretax — whose earnings are going to go down 5 percent a year compared to what you should pay for a business with a — that’s earning $100 million a year whose earnings are going to go up 5 percent a year.

And I would say that — I’m not saying that those are percentages I predict on newspaper companies — but certainly newspaper companies face the prospect of their newspaper earnings eroding.

And we’ve seen some of it already. We see every trend pointing in that direction. We own a newspaper ourselves.

And, you know, I do not think the circulation of our paper will be larger in five years, and I don’t think the advertising pages will be greater.

And I think that’s true even of newspapers that operate in more prosperous — or, actually, more growing, I should say — areas of the country than we do.

So — but I don’t think — I don’t think most owners of papers still have quite gotten to the point where they start projecting out declining earnings.

Certainly multiples on newspaper stocks are unattractively high if you would see some decline, like 5 or 6 percent a year on earnings, occurring to this point. They just — they’re not cheap enough to compensate for that sort of erosion in earning power.

And then you face the added risk that they may have, sort of, a perception lag and that they may continue to use some of that money to buy other newspapers at prices which, again, don’t make much sense.

It’s pretty hard in a declining business to buy things cheap enough to compensate for the decline.

People in the business always tend to think that they’re seeing the first robin, you know, or something, and that it’s going to get better. And I would say in the newspaper business, the decline, if anything, is accelerated somewhat. I —

You know, when they take — when they take people out to the cemetery, they’re taking newspaper readers, and when people graduate from school, they’re not gaining newspaper readers.

And that may not change things overnight, but it goes in the wrong direction. And the less the readers, the less the readership, the less compelling argument to have to advertisers.

So that virtuous circle where everybody read a paper because every ad was in it, and every ad was in it because everybody read a paper, that virtuous cycle is going in the other direction now. And I don’t think present prices for papers compensate for that.

And you are now hearing from a couple of guys that just love newspapers.

We think newspapers are indispensable, but we don’t have a lot of — we have less company in that view. We love — I read five newspapers every day. Charlie probably does about the same.

CHARLIE MUNGER: Four.

WARREN BUFFETT: Yeah, he’s — well, it shows too. The — (Laughter)

The — we couldn’t live without them. But a lot of people can, and more people can every day. And though we started out — we love the idea of buying newspapers. We traveled to Cincinnati, cheap hotels, all kinds of things, to buy newspapers.

But — and we thought, incidentally, we loved them as products, and we thought they were the greatest of businesses, the ultimate bulletproof franchise. But it became apparent we were wrong.

You know, we still love them as news — as products, but we were wrong about the bulletproof franchise. And, you know, we’ve got to believe our eyes, in terms of what we’re seeing in that world.

Charlie?

CHARLIE MUNGER: Yeah. I have an even greater sin to admit to. I once thought General Motors was a bulletproof franchise. And — but we have a wonderful way of coping with a lot of these things. We have this “too hard” pile.

I don’t know if Warren is buying General Motors or not, but I have a good guess.

And it’s just too hard. If something is too hard to do, we look for something that isn’t too hard to do. (Laughter)

What could be more obvious than that? (Laughter)

WARREN BUFFETT: It may mean that we don’t do very much. (Laughter)

CHARLIE MUNGER: Yeah. Yeah.

WARREN BUFFETT: We won’t get into specifics. The news — it’s — I don’t think anybody has watched the newspaper business much more carefully than Charlie and I have for, really, 50 years.

We used to — we always talked about every paper in the country, and the potential for buying it and, all that sort of thing.

And it was a — it was easily understood. I mean, it was about as easy an economic — a business economics problem — as you could imagine. And we slowly woke up to the change on it.

Actually, I wrote in the 1991 annual report, the newspaper — the very — the preprints of the world, you know, started turning the newspaper into a wrapper. It contained a whole bunch of things that could have been contained in some other package.

Now, your newspaper wasn’t reproducible in some other package, but this thing was carrying around a bunch of preprints. Now, the question is there a bunch — is there — are there easier ways to carry around those preprints?

But there was nothing magical about the paper except it got inside the house and brought the preprints inside the house. And as the newspaper lost penetration, it became a somewhat less efficient way of getting things into the house and other ways became more efficient at getting things into the house.

So these things — it’s not a hard business to understand. And it has been interesting to me to watch both owners — direct owners — and investors in the business sort of resist seeing what’s right in front of them, you know?

It just — it went so long the other way that you couldn’t make a mistake buying a monopoly newspaper. Nobody ever made a mistake buying one, you know, until, what, 1975 or ’80 or something like that.

CHARLIE MUNGER: Yeah. If the technology had not changed, they’d still be impregnable franchises. But the technology did change. Fortunately, carbide cutting tools appear to have no good substitute. (Laughter)

WARREN BUFFETT: It’s a lot better business over time, if you have the right management. Now, it takes very good management. Nice thing about the newspaper business 30 or 40 years ago, it took no management at all.

I mean, if you had an idiot nephew, you know, you — that would be a perfect — or a network television station. I mean, they were going to make money no matter what happened.

They were going to make more money if they were under good management. I mean, if Tom Murphy was running your television stations, you were going to do much better than if you had your nephew doing it, but the nephew would have done all right. (Laughs)

12. Don’t let your fear overcome your logic

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Hello, Warren, Charlie. My name is Matt Peterson (PH). I’m a shareholder from Seattle, Washington, and it is a true pleasure being here today. My question for you is simple.

The two of you have had a — many great opportunities throughout your years to work with many fine mentors and teachers.

And I’m wondering if you could provide us with a few names of some present-day mentors that we may look to for advice and our own ways to approach problems and situations, people similar to the Grahams and the Fishers of the present day?

WARREN BUFFETT: Well, the interesting thing, you don’t have to look at the present-day ones, necessarily.

I mean, if you wanted to look at great business careers, you could look at Tom Murphy or Don Keough on our board.

And you can learn everything you could learn about being an outstanding businessperson by just studying them. And you don’t have to study somebody that is 55 and currently in some executive position. Their lessons are timeless.

And there’s going to be a study — I think the Harvard Business — somebody sent it to me from the Harvard Business School, you know, on Cap Cities.

But there’s been others in the past. And, you know, if you learn the lessons of Tom Murphy, you don’t need to learn any other lessons in terms of business.

And I would say if you learn the lessons of certain investors in the past, you know, you don’t need to worry about a contemporary example.

Charlie?

CHARLIE MUNGER: Well, I think it’s also true that Warren and I are not following very well the 40-year-old investment professionals. Isn’t that right? (Laughter) Are you hiding something from me?

WARREN BUFFETT: I didn’t know there were any 40-year-olds. (Laughs)

I thought they’re all 25 now.

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: The — investing is not that — is really not complicated. I mean, the basic framework for it is simple. Now, then, you — you have to work at it some to find the best pockets of undervaluation, maybe, or something.

But you didn’t have to have a — you didn’t have to have a high IQ. You didn’t have to have lots of investment smarts to buy junk bonds in 2002 or even to do some of the stuff that was available when LTCM got in trouble.

You really had to have, sort of, the courage of your convictions. You had to have the willingness to do something when everybody else was petrified.

And — but that was true in 1974 when, you know, we were buying stocks at very, very low multiples of earnings. It wasn’t that anybody didn’t know that they were cheap.

They were just paralyzed for one reason or another. And, you know, that — the lesson of following logic rather than emotion, you know, is something that — it’s obvious. And some people have great trouble with it, and others have less trouble.

Charlie, can you give them any more?

CHARLIE MUNGER: Well, I think this is different. When we were young, we had way less competition than you people have now.

There weren’t very many smart people in the investment management field. (Laughter) There really weren’t. And you should have seen the people who were in the bank trust departments. (Laughter)

I mean — so, now we’ve got armies of brilliant young people and all these private partnerships and all these proprietary desks in all the big investment banks. It’s a — and we’ve got a vast amount of talent in the investment management business.

So — and there’s a lot of competition. Now, if there were suddenly a crisis now, there would be 500 firms that would be studying it intensely, each having capital that they could commit on a hair trigger. In our day, we would frequently be all alone.

WARREN BUFFETT: But in 2002 —

CHARLIE MUNGER: We’d be the only buyer.

WARREN BUFFETT: But in 2002, Charlie, there were tons of people that had investment experience and high IQs and lots of money was around. It wasn’t a question about money, it’s just they were terrified of that particular arena.

CHARLIE MUNGER: Well, when you have a huge convulsion, which is like a big fire in this auditorium right now, you know, you get a lot of weird behavior. (Laughter) And if you — (Laughter) — and if you can —

WARREN BUFFETT: Particularly at the head table. (Laughter)

CHARLIE MUNGER: — and if you can be wise when everybody else is going crazy, sure, there will still be opportunities. But that may give you long, dull stretches, if that’s your strategy.

WARREN BUFFETT: Three years ago — two — three years ago you could find a number of securities in Korea, population 50 million, advanced society, strong balance sheets, strong industry positions, at three or so times earnings. Now —

CHARLIE MUNGER: But that took a convulsion to create that, a real — a big convulsion.

WARREN BUFFETT: Yeah. But the convulsion happened three or four years earlier —

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: — five years earlier. And plenty of smart people in Korea in the investment business, plenty of smart people here scouring — the information was all available.

You can go to the internet and get information about Korean companies that’s just as good as you get it from the SEC. And there they were, dozens of companies at very, very, very cheap prices. Now, where —

CHARLIE MUNGER: It did —

WARREN BUFFETT: — were all these smart people with all this money —

CHARLIE MUNGER: It did happen. But if I asked you to name 20 more like it, you would have great difficulty.

WARREN BUFFETT: Well, if I have 20 more like it, I’m not going to name them. (Laughter)

13. If we were starting out again …

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: My name is Simon Denison-Smith from the UK.

My question is this: if you were starting out today with a million dollars, with a vision of building a business with 20 percent average growth in value over 40 years, what type of investments and investment strategy would you look to make in the first five years?

WARREN BUFFETT: Well, it’s somewhat interesting that we formed the first partnership 50 years ago last — 2 days ago, Thursday, May 4, 1956, which was 105,000. (Applause) That’s my sister clapping. She was in the partnership. (Laughter)

The — we would — if Charlie and I were starting all over again and we were in this, Charlie would say we shouldn’t be doing this. (Laughter)

But if we were to succumb to Satan and engage in the same kind of activity, we would, I think, be doing something very similarly. If we were investing in securities, we would look around the world, and we would look at a Korea.

And Charlie says you can’t find 20 of them, but you don’t have to find 20 of them; you only have to find one, really. You do not have to have tons of good ideas in this business, you just have a good idea that’s worth a ton, occasionally.

And in securities, we would be doing the same thing, which would probably mean smaller stocks — it would mean smaller stocks — because we would find things that could have an impact on a small portfolio that will have no impact on a portfolio the size of Berkshire.

If we were trying to buy businesses, we’d have a tough time. We would have no reputation, so people would not be coming to us. We’d be too small a player, if you’re talking about a million dollars. So we would not have much success, I don’t think, with small amounts, buying businesses.

Charlie started out, you know, in real estate development because it took very, very little capital, and you could magnify brain power and energy — or, I should say, brain power and energy could magnify small amounts of capital in a huge way that was not true in securities.

You know, my natural inclination was to look at securities and just kind of do it one foot in front of the other over time. But the basic principles wouldn’t be different.

You know, I think if I’d been running a partnership a couple of years ago with a small amount of money, I think I’d have probably been 100 percent in Korea.

And, you know, I would be looking around for something that was very mispriced and which — and that I understood. And every now and then, that’s going to happen.

Charlie?

CHARLIE MUNGER: Well, I agree with that. The concept that you’re likely to find just one thing where it will make 20 percent per annum and you just sit back for the next 40 years, that tends to be dreamland.

And in the real world, you have to find something that you can understand that’s the best you have available. And once you’ve found the best thing, then you measure everything against that because it’s your opportunity cost.

That’s the way small sums of money should be invested. And the trick, of course, is getting enough expertise that your opportunity cost — meaning your default option, which is still pretty good — is very high.

And so, the game hasn’t changed at all in terms of its basic arithmetic. That’s why modern portfolio theory is so asinine. (Laughter)

WARREN BUFFETT: It really is, folks.

CHARLIE MUNGER: Yeah. When Warren said he would have been all in one country, that’s pretty close to right. He wouldn’t have quite done that when he had the partnership, but he would have been way more concentrated than is conventional if you listen to modern portfolio theory.

Most people aren’t going to find thousands of things that are equally good; they’re going to find a few things where one or two of them are way better than anything else they know. And the right way to think about investing is to act thinking about your best opportunity cost.

WARREN BUFFETT: Number 9.

CHARLIE MUNGER: By the way, that’s in the freshman course in economics everywhere in the basic textbook; it just hasn’t made its way into modern portfolio theory.

WARREN BUFFETT: We don’t get asked to do book reviews. (Laughter)

14. Munger thinks Prof. Jeremy Siegel is “demented”

AUDIENCE MEMBER: It’s Anvayas Vegar (PH) from Munich, Germany. Thank you very much for the open discussion that you had with us.

Actually, I’d like to ask a question on a book, so I’ll come back to the book review.

Jeremy Siegel had some ideas in his second book, and I would like to understand what — how this would impact your investment strategies, if there are any changes from his ideas, and how you react to these recommendations that he makes? Thank you.

WARREN BUFFETT: This is which book? Jeremy Spiegel?

AUDIENCE MEMBER: Jeremy Siegel, the second book, “Why the Tried and the True Triumph Over the Bold and the New.”

WARREN BUFFETT: That — it’s had no effect on us.

Charlie?

CHARLIE MUNGER: No, is that the fellow who’s very optimistic about common stock investment over long periods of time?

WARREN BUFFETT: The University of Pennsylvania. Yeah.

CHARLIE MUNGER: Yeah. Well, I think he’s demented. (Laughter)

WARREN BUFFETT: Well, he’s a very nice guy, Charlie. But — (Laughter)

CHARLIE MUNGER: Well, he may well be a very nice guy, but he’s comparing apples against elephants and trying to make accurate projections. (Laughter)

15. “Things are really screwed up if you’re getting calls on Sunday”

WARREN BUFFETT: Number 10. (Laughter)

AUDIENCE MEMBER: I’m Bob Klein (PH) from Los Angeles. You so eloquently stated that you can’t see who’s swimming naked until the tide goes out.

Could you discuss the issue of trying to employ a rational decision-making process in investing, or in business generally, as opposed to focusing on outcomes or results of just a few instances or over a short period of time?

For example, it may not be a good idea to underwrite some insurance policies if competition has lowered the premiums too far. And, likewise, in the stock market, momentum investors may get good results for a while. But buying high and trying to sell higher isn’t a good long-term strategy.

So I’d just like to hear you guys provide some detail on the importance of using an effective decision-making process, even though it may lead to some bad outcomes and underperformance in the short run.

WARREN BUFFETT: Yeah. Well, Ben Graham said long ago that you’re neither right nor wrong because people agree with you or disagree with you.

In other words, being contrarian has no special virtue over being a trend follower.

You’re right because your facts and reasoning are right. So all you do is you try to make sure that the facts you have are correct. And that’s usually pretty easy to do in this country. I mean, information is available on all kinds of things. Internet makes it even easier.

And then once you have the facts, you’ve got to think through what they mean. And you don’t take a public opinion survey. You don’t pay attention to things that are unimportant. I mean, what you’re looking for is something — things that are important and knowable.

If something’s important but unknowable, forget it. I mean, it may be important, you know, whether somebody’s going to drop a nuclear weapon tomorrow but it’s unknowable. It may be all kinds of things. So you — and there are all kinds of things are that knowable but are unimportant.

In focusing on business and investment decisions, you try to think — you narrow it down to the things that are knowable and important, and then you decide whether you have information of sufficient value that — you know, compared to price and all that — that will cause you to act.

What others are doing means nothing. It’s what Graham writes in Chapter 8 of “The Intelligent Investor,” that the market is there to serve you and not to instruct you. That’s of enormous importance.

When people talk about momentum in stocks or charting or any kind of things like that, they’re saying that the market is instructing you. The market doesn’t instruct us; the market is there to serve us.

If it does something silly, we get a chance to do something because it’s doing something silly. We do it. But it doesn’t tell us anything. It just tells us prices.

And if the price is out of line where the facts and reasoning lead you, then you — then action is called for. And if it doesn’t, you forget it and go play bridge that day and the next day, see whether there’s something new. And the nice thing is there always is something new.

I mentioned the LTCM crisis. We were getting calls on Sunday from people that had portfolios that were in trouble. Now, I will tell you that if — you can make a lot of money on Sunday.

You may not get a chance very often, but any calls you get on Sunday you’re probably going to make money on. (Laughter)

Things are really screwed up if you’re getting calls on Sunday. And all you have to do is make sure that you’re the callee and not the caller — (laughs) on Sunday.

But if you get those calls — you get a call on a Sunday and somebody says that the off-the-run is trading 30 basis points away from the on-the-run, you know, all you have to do is decide whether — how you handle that particular piece of information — whether it’s correct in the first place — but how you handle that piece of information, whether you can play out your hand.

You never get in a position, obviously, where the other fellow can call your tune. You have to be able to play out your hand under all circumstances. But if you can play out your hand, and you’ve got the right facts, and you reason by yourself, and you let the market serve you and not instruct you, you can’t miss.

Charlie?

CHARLIE MUNGER: Well, I would say some of you probably can miss. (Laughter)

WARREN BUFFETT: I would say Charlie can’t miss. I’ll put it that way. He’ll agree with that.

Do you have anything further to add?

CHARLIE MUNGER: No.

WARREN BUFFETT: OK. (Laughter) At least I’ve got him off that previous subject.

16. How to read Berkshire’s annual report

WARREN BUFFETT: Number 11. (Laughter)

AUDIENCE MEMBER: Hello. I’m Randall Bellows from Maryland. I would like to know how you would look at the Berkshire annual report.

What numbers in the balance sheet or the cash flows would tell you that Berkshire is underpriced? And what numbers would you look at to determine if Berkshire is overpriced? Thank you.

WARREN BUFFETT: We try to — and we take it very seriously — we try to put everything in that report that we would want to know if the positions were reversed.

If I were sitting with all of my net worth in Berkshire and had been on a desert island for a year and I — and the manager was reporting to me about the business, we’d try to have that same information that I would want from him. And we would try to present it to you in a way that’s understandable.

And we don’t leave out things that we think are important. We try not to put — I mean, there’s — it runs about 76, I think, or maybe even 80 pages this year. I mean, there’s — you can drown people in information that really doesn’t make much difference.

But we’ve tried to organize it in a way by talking about these different groups of businesses. We try to explain how we think about it, in terms of things like the amount of operating earnings we’ve generated and the investments we have.

It’s really as if it’s a report that I was making to Charlie or Charlie would be making to me if one of us were inactive in the business and the other was running it.

And so I think — I mean, it may take a few hours to do it, but I think if you regard yourself as a serious owner of Berkshire, it’s really worth reading the whole report.

Thinking about: what is there? What are these guys going to do with it? What are they trying to attempt? What are the odds they’re going to be successful in that attempt? What are they —?

You know, what is it worth if they don’t succeed very well in deploying additional capital? What might be the case if they were successful in deploying excess capital and incremental capital?

But I can tell you that, obviously, we think it’s very important.

What counts is the kind of businesses we have, the kind of managers we have running those businesses, what those businesses are likely to earn over time — and we’ve expressed ourselves a little on that —

And then what are the resources that are available to keep adding to that collection of businesses? What are the kind of businesses we are looking to add?

And I think — you know, I think you’ll find the information that you need to evaluate Berkshire, and it’s not a — you know, you don’t carry it out to four decimal places.

Charlie and I, if we had to stick a number down on a piece of paper right now as to some pinpoint number — we wouldn’t do it because we know that’s impossible. But if we had to stick a number down, it would be a different number between the two of us.

It would be a different number if I did it today from tomorrow, probably. But we’d be in the same ballpark, and we’d be looking at the same things. And the things we would be looking at we report to you in that report.

I would focus — you know, the real question of what Berkshire is going to be worth 10 years from now will depend on the — earnings that we have developed — annual earnings that we’ve developed by that time, the quality of those earnings, the possibilities going forward from that point of those businesses, and the liquid assets we have.

And we’ve worked on increasing both of those elements over the years, and we’ll keep working on it. And it’s a lot tougher, in terms of percentage gains, from this point forward than it was in the past.

There’s no way in the world that we can replicate what’s happened in the past. It just won’t happen. The question is whether we can do a reasonable job or not.

Charlie?

CHARLIE MUNGER: Yeah. I generally try and approach a complex task, like the one you presented, by quickly disposing of what I call the no-brainer decisions and — meaning the easy ones.

I think, if you go through all the operating insurance that don’t involve surplus cash, and the insurance operations, that that’s the easiest valuation process in Berkshire.

And the insurance operation is very interesting, and so is the process by which the huge amounts of excess cash are continually redeployed. But I would go at it in that sequence: taking the no-brainers first.

17. Buffett’s key insurance question

WARREN BUFFETT: Number 12.

AUDIENCE MEMBER: David Winters, Mountain Lakes, New Jersey.

Would you please discuss how your underwriting standards have changed as the weather patterns seem to become more severe, the challenges of global terrorism seem to escalate, and unforeseen super-cat events, such as earthquakes and pandemics, go into your thinking, and just what the prospects are for the development of the float?

WARREN BUFFETT: Well, the development of the float is a different question. That really depends on how much business we write in the future and the nature of the business, whether it’s long-tail or short-tail.

I think it will be very hard to increase our float of 48 or -9 billion at a big clip in the future. I mean, I’ve been amazed as what’s happened in the past. And it’s done way better than Charlie and I ever would’ve dreamt.

But, you know, we have — we’re getting to where we’re close to 10 percent of the float of the entire American insurance — property-casualty insurance industry — and some of it’s abroad that we have.

But it just can’t — it can’t grow at very rapid rates. But it can be very attractive, and so far, it has been.

In terms of the questions about underwriting in terms of pandemics or terrorism and all of that, I mean, you know, I’m aware of them. You’re aware of them.

We get propositions offered to us virtually every day, and in the end I — mostly Ajit, I mean, in this particular case, in terms of big-type contracts — financial-type contracts I would evaluate. He would —

But we talk about what we think the probabilities are of $50 billion events and up, or $20 billion events and up. And, he’s the fellow that does most of — he applies it, but we kick around the possibilities.

But that’s all there is to it. I mean, it’s a question of making judgments about whether you’re getting paid enough. And if we have a lot of money, you know, 30 years from now, it will mean that our judgments overall were decent.

And if we have a big loss on one this year, it does not mean that our judgment’s wrong because it — it’s going to lead to peaks and valleys. But there’s no magic to it.

There’s probably — I would feel that the earthquake experience of the last 100 or 200 years has more validity than the windstorm or the hurricane experience of the last hundred or 200 years. I don’t know that for sure, but I would bet real money that way, and we have.

What is — what will hurricane experience be like 10 years from now, in terms of the number of those that hit the United States and the ferocity of the ones that do hit? You know, I don’t know. But I’ll keep thinking about it every day.

Charlie?

CHARLIE MUNGER: Well, I think the laws of thermodynamics are such that if the oceans get warmer — I think they are getting warmer — the weather is going to be — have more high-energy uproar in it.

So I think we’d be out of our minds if we wrote weather-related insurance on the theory that global warming would have no effect at all. And the natural reaction is to raise your prices, as the risks go up.

And whether you’ve raised them enough, and carefully controlled your risks enough, that’s the art of the business.

WARREN BUFFETT: Yeah. And you have this possibility that, you know, 1 percent changes or 2 percent changes in something can produce 100 percent of probabilistic changes in cost.

It’s an explosive sort of equation that you’re dealing with. And, you know, but that’s the game we’re in, and we don’t have to play it ever.

If we don’t like what we’re being offered — and we didn’t like what we were being offered a while back in many areas — somebody else can take our place in line. We’ll be happy to have them.

18. Health care is in Berkshire’s “too hard” pile

WARREN BUFFETT: Number 1.

AUDIENCE MEMBER: Dear Warren and Charlie, my name is Dr. Rashad Patel (PH). I’m a family physician from Taunton, Massachusetts. Two years ago I wrote you a letter; you responded with me back quickly. Thank you for that.

My question is, what are the criteria or principles to find a person like you in health care? It seems that a person moves up the ladder in this ethical business, they are more prone to become more unethical, get more options, sell shares, open a shop next door.

How do you find those checkpoints? Can you please express your view, on this soon $2 trillion economy, how to find the leaders so we don’t get a surprise in dog-eat-dog world?

WARREN BUFFETT: Charlie, did you get that? (Laughter)

CHARLIE MUNGER: Well, I will try that. I’m not sure I understood the whole — I think she’s asking about the health care business —

WARREN BUFFETT: That part I got.

CHARLIE MUNGER: — and whether or not, with the — much bad ethics being present — we have anything to contribute about doing well in that sector. Is that about right?

AUDIENCE MEMBER: Yes.

CHARLIE MUNGER: Yeah. Oh no.

WARREN BUFFETT: Now I understand the question, I still —it’s still yours. (Laughter)

I’d be glad to answer it, but I’m eating candy at the moment. (Laughter)

CHARLIE MUNGER: That has tended to go into the too hard pile — (laughter) — at Berkshire. (Applause)

A lot of people have made a lot of money writing health insurance. And I’ve watched the behavior of some of those people, wearing my hat as the chairman of a big central city hospital.

And you are right, there’s a lot of bad ethics in health care. There’s also a lot of good ethics. It’s a very, very complex field with a lot of change, a lot of technological differences.

And in terms of investments, I think the policy has generally been that it all goes into the too hard pile. We don’t — unless Warren has something he’s keeping secret from me.

WARREN BUFFETT: No. We have not owned much in health care. My only expertise is in diet. (Laughter)

But I appreciate the seriousness of the question. You know, there — it is just — it is a very, very tough problem on which I have no particular insights.

CHARLIE MUNGER: And you’re right. The worst of the ethics is really bad.

19. “A complicated bankruptcy can offer opportunities for profit”

WARREN BUFFETT: Number 2.

AUDIENCE MEMBER: Hello. My name is Barry Steinhart (PH), shareholder from New York. My question relates to the Chapter 11 bankruptcy process.

I know you have been active in the past in some activity in the bankruptcy court. And if you had thoughts on possible reforms in that area, if you believe that any reforms are necessary?

WARREN BUFFETT: Well, that’s a good question. Charlie is probably better qualified to answer than I am. I mean, we have bought Fruit of the Loom out of bankruptcy.

And we have had some involvement in owning junk bonds. You know, we get — we think about the bankruptcy process. But in terms of the practicalities of improving on it, what do you think, Charlie?

CHARLIE MUNGER: Well, I think much of that is pretty horrible.

You have a competition there, where the courts themselves have gone into bidding contests to get bankruptcy business attracted. Meaning that the —

There are various courts that can handle bankruptcy cases. And they have found that if they develop a culture where they overpay a lot of people egregiously, they can attract more business: lawyers, trustees, consultants, et cetera, et cetera.

I find it so unpleasant to watch that I don’t pay as much attention to bankruptcy as I probably should. You know, I’m an old man, and I don’t like to have an upset stomach. (Laughter)

WARREN BUFFETT: But we will — we look at — at least I do, I’m not sure about Charlie — but he — you know, bankruptcies will be something that we will — one way or another, over the next 20 years — we’ll have various ways of participating.

And we have bought — well, we bought certain of the bonds, for example, of Enron after they entered bankruptcy — we bought something called the Ospreys.

And a complicated bankruptcy can offer opportunities for profit. Now, there’s so many people looking at bankruptcies currently, or potential bankruptcies, it’s a field that I would say does not have a lot of promise right now, but it has had promise in the past.

We actually, in the Fruit of the Loom situation, I first went into that just by buying some Fruit of the Loom bonds, but — when I had no notion that we might conceivably end up with the company. But, you know, I knew enough about it to buy the bonds.

And Enron comes along, and it’s a big mess. The Penn Central came along 20-odd years ago, and it was a big mess, and there was a lot of money made in the Penn Central, simply because it was such a complicated mess.

So anytime there’s something big, complicated, there’s certainly a good chance of mispricing. Now, lately the mispricing may be more on the high side than on the low side. But, over time, you’re going to find some — there will be some attractive things to do in bankruptcy situations.

We’ve had other bankruptcy situations where we’ve gotten involved in the process and then been outbid. It happened at Burlington and it happened at Seitel. And — but we owned all the bonds at Seitel, so we came out fine.

It’s something to understand if you’re in the business of buying investments or businesses. And I would say that, you know, if we’re around for another 10 or 15 years that we’ll do something or other, maybe substantial, in the bankruptcy field.

The Enrons — the payment is still being made in various ways. But the Ospreys, which were kind of a complicated situation — the whole thing was complicated.

But, you know, we didn’t buy at the bottom or anything like that. But, you know, we considerably more than tripled our money in something that you could have put a fair amount of money in. So they can be interesting.

Charlie, do you want to —

CHARLIE MUNGER: Well, I remember the Eastern Airlines bankruptcy, where there were a lot of employees that would’ve — and communities that would’ve been affected. And the courts in that case, I would say, abused the senior creditors horribly.

And so you could have read a law book and reached one conclusion, and if you’d bought the wrong securities, why, you would have found out you’d guessed wrong. It’s a very interesting field.

WARREN BUFFETT: Yeah. It — and it can be very unpredictable. In the Penn Central case, you had an incredible variety of claims. I mean, you had leased lines and you had all kinds of first and second liens and everything.

And the judge, as I remember — I may be wrong a little bit on this on the details — but as I remember, the judge just looked at this incredible — probably the most complicated bankruptcy that had come down the pike in the history of bankruptcy to that point — and he just said, “This is just too damn complicated. I’m just, sort of, going to ignore the various priorities and all this. I’m just going to” — perhaps you might call it substantive consolidation, or something — “I’m just going to put this all together, and I’m going to give you a quick, fast solution.”

And I think it was a very smart way to handle things, because otherwise I think Penn Central might still be going. But it wasn’t what the book said would be done at —

Judges can determine things in a very big way. I remember when we were in Cincinnati on that newspaper case I mentioned earlier, I said to Charlie — a judge had stayed an order, I think, for a week or something like that.

And I said to Charlie — I said, “How much power does a federal judge have?” And Charlie says, “Well, for a while, as much as he thinks he has.” (Laughter)

I learned a lot out of that.

20. Buffett endorses Procter & Gamble-Gillette merger

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Good afternoon, gentlemen. Long-time listener, first-time caller here. This is my first shareholder meeting. Thanks for hosting. You guys do a great job. I’m looking forward to coming back for several more years.

My name is Craig Beachler. I’m from Cincinnati, where my paychecks are signed by Uncle Procter and Mr. Gamble.

Thinking about that, I know that when the P&G-Gillette merger was announced, you called it a, quote, “dream deal.”

Considering that P&G is primarily thought of as a consumer products company, what are your thoughts on the short- and long-term fit for P&G’s pharmaceutical business?

WARREN BUFFETT: For just the pharmaceutical business or, did you say, or —

AUDIENCE MEMBER: Long-term growth of P&G as a whole.

WARREN BUFFETT: As a whole. Yeah. Well, you know, I think it’s clear that P&G is a consumer powerhouse of sorts. And I think Gillette — in its field, they have just about as strong a consumer position as anybody will ever have.

And when you get into blades and razors, stronger than the — most of the P&G brands, strong as they may be. And I do think that the big retailers are becoming — and more so all the time — brands of their own. And they are become — and there’s more and more concentration going on.

So I think the struggle between the manufacturers of brands and retailers will go on and on and on and become more intensified. So I would think, if I were on either side of that equation, I would want to be strengthening my hand.

And I think that — I think the future of both Gillette and P&G are better as a combined enterprise than they would have been as a separate enterprise.

And I think that’s particularly true because of the strengths of the Walmarts and the Costcos and — you name it — around the world. I don’t know.

How do you see it, Charlie?

CHARLIE MUNGER: He also wants you to tell him how P&G will be affected by its pharmaceutical business.

WARREN BUFFETT: I don’t know a thing about that.

CHARLIE MUNGER: That makes two of us. (Laughter)

WARREN BUFFETT: I really don’t. I’d help if I could, but I can’t.

21. “A strategic buyer is some guy that pays too much”

WARREN BUFFETT: Number 4?

AUDIENCE MEMBER: Hi. My name is Andy Von Dorn (PH), and I’m here from Omaha.

I’m currently employed by Oriental Trading Company, and they just announced that they were putting themselves up for sale.

I was just wondering if Berkshire would have any interest in a company like Oriental Trading Company as an acquisition.

WARREN BUFFETT: That’s interesting, and I didn’t know they put themselves up for sale. But I looked at it — whenever it was — four or five years ago when Terry Watanabe sold it.

And I haven’t really followed it since then, but just from listening to what you say — and I have no knowledge of it at all — but it sounds to me as if some private group bought it and now they’re reselling it.

And we get approached on that sort of thing all the time, where a financial group has bought the business and then wants to resell it fairly quickly. And they almost — well, they invariably, I would say — auction the business.

They seek what they call a strategic buyer. A strategic buyer is some guy that pays too much. (Laughter) Because — you know, and he wants to justify it, so he says it’s strategic. I mean, I have never understood being a strategic buyer.

Every time somebody calls me up and says, you know, “We think, maybe, you’re the logical strategic buyer for that,” you know, I hang up faster than Charlie would. (Laughter)

The — and I’m not talking to the specifics of this one at all because I really don’t know on Oriental Trading.

But the idea that we’re going to find a business to buy from some guy who, from the moment he bought it a few years ago, has been thinking, “How do I get out of this thing?”

You know, “What do I do to make it earn — have those figures for a couple years look a certain way so that I can get the maximum amount in a couple years?” You know, that — we’re just not going to make any attractive buys there. We won’t trust the figures.

You know, we — it just — it’s — what we like is a business that — where the guy before was running with the idea of running it a hundred years, and taking care of the business in every way possible and was not contemplating sale, but, for one reason or another, finally needs to monetize the company.

We won’t — we will not get any sensible buys, really, from the resellers.

Some of the — it’s amazing to me what’s going on. Some of these things, literally, you know, Fund A is selling to Fund B to Fund C.

I mean, I’ve seen some that have changed hands three or four times. They’re just marking them up, and everybody’s getting two — they’re getting 20 percent of the profit so they mark it up.

And probably Fund C or Fund D may be owned by the same pension funds that own Fund A, except that everybody’s just taking a big 20 percent slice out of it every time they move it from one place to another.

We’re not buyers of anything the financial buyers have been in in recent — you know, and currently own.

Charlie?

CHARLIE MUNGER: In the 1930s there was a stretch when certain kinds of real estate — when with certain kinds of real estate — you could borrow more against the real estate than you could sell it for.

And I think that’s happened in some of these private equity deals, and it’s weird. It’s weird. This is not our field. (Laughter)

22. Looking for bright spots in U.S. trade imbalance

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: Hi. I’m John Golob from Kansas City.

I’d like to get you back to the current account deficit. I was looking for reasons not to despair, so I have a couple of factoids I’d like to throw at you and see how you react.

If you add up all of the current account deficits over the last couple of decades, you get about $4 1/2 trillion. Now, you’d think that means our net indebtedness to a foreign investor should be minus 4 1/2 trillion, but it’s not.

It’s only 2 1/2 trillion because capital gains for domestic investors has exceeded those for foreign investors. So, essentially, $2 trillion of our current account deficit has been financed by cap gains.

Now, the other factoid is that if you look at the income on assets, the U.S. investors are still in a net positive position. That is —

WARREN BUFFETT: They went negative in the last quarter, actually.

AUDIENCE MEMBER: Oh, excuse me. So it’s been close. So I guess my question is, do these facts influence your concern or maybe mitigate your concern about the current account deficit?

And the second part of the question is, do you have any cultural reasons why the U.S. should earn more on investments abroad than foreign investors earn on domestic investments?

And, of course, the dollars explain a little bit of it because we’re not paying any interest on those dollars. But I’d like your comments.

WARREN BUFFETT: Yeah. Well, those are a couple interesting points. But, we have earned more on American assets owned outside this country than people outside this country have earned on assets in this country. I mentioned that in the annual report this year.

It did flip. The net balance flipped in the other direction in the most recent quarter, and my guess is it keeps going in that direction. There are a lot of reasons for that.

One important reason a year or two ago was the fact that foreigners owning our Treasury bonds were getting as little as — you know, a little over 1 percent.

So if the rest of the world owned a trillion of our bonds and got 1 percent, that was 10 billion, and if we owned a trillion of their bonds and got 4 percent, you know, that would have been 40 billion.

And the higher — the lower interest rates in this country, the higher interest rates abroad — just simply meant that you got paid — that you were going to have — with a balance of investment — you were going to have a favorable net balance in interest income in this year. We were earning more on our assets abroad than they were earning here.

That is turning somewhat. I mean, our interest rates have been increased.

Now, they didn’t all own short maturities or anything of the short — sort. And it may well be that our direct investment — as opposed to our marketable securities investment — our direct investment abroad was made in earlier times and returning higher returns. But, over time, it’s going against us.

Now, when you get into the net debtor position that we’re in, which you — is now over 3 trillion, that varies with what the dollar is doing.

Because, say, in recent weeks, the dollar has weakened, and that means that brings down, actually, our net debtor position. That’s why inflation could be something that becomes a real attractive possibility to politicians in the future.

But I wouldn’t — it’s not a huge factor. I know what you’re talking about in terms of those year-to-year variances in the net debtor position.

They’re affected much more by the actual currency that’s — change that’s been made — because they’re expressed in dollars. And if the dollar gets weaker, it makes us look better for the time being.

Overall, that will not be what determines the consequences three, five, or 10 years from now, in terms of the current account problems, or in terms of the possibility of them — of currency — exacerbating some other kind of chaos in markets.

Charlie?

CHARLIE MUNGER: This is not a field to which I’ve devoted the same attention as Warren. And — but I do share his general pessimism that, eventually, there will be a price to pay for the course we’re on.

Where I’ve disagreed a little with Warren is I’ve always feel there’s more ruinous behavior that could be tolerated in a great place, probably, than he does.

It’s just amazing how much ruinous behavior you can get by with if you’re a successful governor — government.

Now, if you start with a lousy reputation as a government, it doesn’t work that well. But when you start with the reputation the United States had, the people who expected instant calamity, I think, were wrong. It —

WARREN BUFFETT: Yeah. If you landed from Mars, you’d probably still rather land in the United States than anyplace else.

CHARLIE MUNGER: If you stop to think about this subject, do you want to invest in Europe where, you know, 10 or 12 percent of the young people are unemployed because of their crazy employee security policies?

And a lot of 28-year-olds are living at home and going to university because it’s a fairly comfortable way to, kind of, while away the time with the state paying for most of it?

Do you want to go into a place with fabulous assets, like Brazil, with a lot of political instability that you fear, or Venezuela?

So it isn’t as through all the other options look wonderful compared to us. And so, I don’t think it’s just totally irrational that everybody still likes the United States in spite of its faults.

And so that gives me some feeling that what happened with regard to fiscal misbehavior on our part could go on quite a long time without paying the due price.

WARREN BUFFETT: Yeah. And I agree with that, although there’s always the potential, when you’re doing something dangerous, that it can get accelerated.

Generally speaking, if you had to bet on anybody to get away with misbehavior fiscally for a long time, you’d bet on the United States.

And we still think it’s by far the best place to be, and we have a majority of our assets in it. We just recognize certain things going on that could cause significant problems, particularly in markets.

23. Key distinction between insurance and gambling

WARREN BUFFETT: Number 6.

AUDIENCE MEMBER: Hi. It’s Peter Webb here from London, UK.

Your views on gambling are well-known, and I think most people would agree that gambling is for the fiscally challenged.

But when I look at the insurance industry, what I see is an industry — I can’t even say it — I see an industry that’s based upon probabilities, and people not knowing those true probabilities, and money being made for the house in the same way as you see in a gambling market.

So the question I have for you is, how do you reconcile your views with gambling versus the insurance industry, and is the insurance industry for the fiscally challenged?

WARREN BUFFETT: Well, gambling, I think — I think the distinction that usually is made is that gambling involves creating risks that don’t need to be created.

I mean, if the — you want to go out and gamble on where a little ball is going to fall on a wheel that’s revolving, that is not something that — that is a created risk.

Whereas, if you’ve got a home or a business, you know, on a coastal area, the risk is there.

It wasn’t created intentionally — I mean, you say you built in that place, but — and then the question is who bears it. So there’s a transfer of — in the case of cat coverage — large existing risks as opposed to the creation of a risk that is not required.

I mean, you can watch a football game without betting on it. But you can’t live in a house, you know, on a Florida coast without having a risk that your entire investment disappears.

So that’s the distinction, basically. I hope you’re right that the house wins in both cases. (Laughter)

Charlie?

CHARLIE MUNGER: Well, I don’t think I can add to that either. The whole concept of house advantage is a very interesting one in modern commerce.

A lot of the investment management operations, which were not ordinarily spoken of in the past in croupier terms — but the terms of a lot of private equity investment now —

I think the proprietors of the partnerships are taking a house edge that looks a lot like the rake of the croupier in Monte Carlo, except it’s bigger. (Laughter)

WARREN BUFFETT: Is there anyone we’ve forgotten to insult? (Laughter)

Want to make sure we don’t miss anyone here. (Laughs)

24. Selling short isn’t unethical, but it’s tough to make money

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: I’m Tom Nelson (PH) from North Oaks, Minnesota.

What are your thoughts on the issue of illegal naked short selling?

WARREN BUFFETT: Well, as you know, I — you may know — I have a friend that’s been fairly outspoken on that. And we — from our standpoint — we have no objection to anybody selling Berkshire short at all.

The more shorts, the better, because they have to buy the stock later on. And some of our shareholders may make some money lending — we — Charlie and I can’t do it, but there’s nothing I would love better, if it were legal, than to lend my stock to shorts and have them pay me something for doing it.

I might want to get prepaid, in certain cases. The — (Laughter)

There’s nothing evil, per se, about — in my view — about selling things short.

I would say that it’s a very, very tough way to make a living.

It’s not only often painful financially, it’s very painful emotionally because it — a stock that you sell short — a stock that you buy at 20 can go down 20 points, and a stock that you sell short at 20 can go up an infinite amount.

And you don’t think about that until you’ve gone short and it goes up 10 or 15 points, and then you don’t sleep very well. So it’s a very tough way to make a living.

There are people on the short side that have done, and that do things, to try to make stocks go down, some of which are appropriate and some of which are inappropriate. There are people on the long side that have done the same exact — the same sort of things go on.

So I don’t see any — I have no ax to grind in the least against short sellers.

And in terms of — it’s called naked shorting, which you — which means that you don’t have the stock lined up to be borrowed and maybe you have a whole bunch of fails-to-deliver and that sort of thing.

I don’t have a great problem with that. If anybody wants to do that with Berkshire, you know, they — more power to them.

Short sellers — the situations in which there have been huge short interests very often — very often have been later revealed to be frauds or semi-frauds. Now, the one my friend runs is not at all.

But the — the batting average — I mean, I’ve — over the years, I’ve probably had a hundred ideas of things that should be shorted, and I would say that almost every one of them have turned out to be correct.

And I’ll bet if I’d tried to do it and make money out of it, I probably would have lost money, I would have had no fun, and the opportunity cost, as Charlie said, would have been enormous.

Because if somebody’s running something that’s semi-fraudulent, they’re probably pretty good at it and they’re working full time at it and they’ve succeeded for a while and they may keep succeeding.

And if they succeed and you go in at X and it goes to 5X, you know, all you’re hoping after a while it that it goes back to X again or something of the sort.

It’s a very tough psychological game to play. Few people may be well-suited for it.

I would never put any money with a short fund, but not because I would think it would be ethically wrong. I just think they’re unlikely to make money.

Charlie, do you have any thoughts on short selling or naked short selling?

CHARLIE MUNGER: Well, I think you’re absolutely right there — in the sense that it’s — that would be one of the most irritating experiences in the world, to figure out something is crooked and foolish and so forth and then short it at X and have it go to 3X.

Now you’re watching all these happy crooks splashing around in your money while you’re meeting margin calls. (Laughter)

Why would you want to go in hailing distance of an experience like that?

WARREN BUFFETT: Well, we’ve hit 3 o’clock. We’re going to adjourn until 3:15. We will then have the business meeting of Berkshire. And you’re all welcome to stay, you’re all welcome to shop, you’re all welcome to enjoy Omaha, and thanks for coming. (Applause)

25. Berkshire formal business meeting

WARREN BUFFETT: OK. We’ll now convene the business part of the meeting. I introduced the directors to you before.

Also with us today are partners in the firm of Deloitte & Touche, our auditors. They’re available to respond to appropriate questions you may have concerning the firm — their firm’s — audit of the accounts of Berkshire.

Mr. Forrest Krutter, the secretary of Berkshire, will make a written record of the proceedings. Miss Becki Amick has been appointed inspector of elections at this meeting. She will certify to the count of votes cast in the election for directors.

The named proxy holders for this meeting are Walter Scott and Marc Hamburg.

Does the secretary have a report of the number of Berkshire shares outstanding, entitled to vote, and represented at this meeting?

FORREST KRUTTER: Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent to all shareholders of record on March 8, 2006 — being the record date for this meeting — there were 1,260,704 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote on motions considered at the meeting, and 8,407,392 shares of Class B Berkshire Hathaway stock outstanding, with each share entitled to 1/200th of one vote on motions considered at the meeting.

Of that number, 1,096,383 are represented at this meeting by proxies returned through Thursday evening, May 4.

WARREN BUFFETT: Thank you. That number represents a quorum, and we will therefore directly proceed with the meeting.

First order of the meeting will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott, who will place a motion before the meeting.

WALTER SCOTT: I move that the reading of the minutes of the last meeting of shareholders be dispensed with and the minutes be approved.

WARREN BUFFETT: Do I hear a second?

VOICE: I second the motion.

WARREN BUFFETT: Motion has been moved and seconded. Are there any comments and questions?

We will vote on this motion by voice vote. All those in favor, say “aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed? Motion is carried.

26. Election of Berkshire directors

WARREN BUFFETT: The only item of business before this meeting is to elect directors.

If a shareholder is present who wishes to withdraw a proxy previously sent in and vote in person on the election of directors, he or she may do so.

Also, if any shareholder that is present has not turned in a proxy and desires a ballot in order to vote in person, you may do so. If you wish to do this, please identify yourself to meeting officials in the aisle, who will furnish a ballot to you.

Those persons desiring ballots, please identify themselves so that we may distribute them.

I now recognize Mr. Walter Scott to place a motion before the meeting with respect to election of directors.

WARREN BUFFETT: I move that Warren Buffett, Charles Munger, Howard Buffett, Malcolm Chace, William Gates, David Gottesman, Charlotte Guyman, Don Keough, Thomas Murphy, Ron Olson, and Walter Scott be elected as directors.

VOICE: Second the motion.

WARREN BUFFETT: It’s been moved and seconded that Warren Buffett, Charles Munger, Howard Buffett, Malcolm Chace, William Gates, David Gottesman, Charlotte Guyman, Donald Keough, Thomas Murphy, Ronald Olson, and Walter Scott be elected as directors.

Are there any other nomination? Is there any discussion?

Nominations are ready to be acted upon. If there are any shareholders voting in person, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of elections.

Would the proxy holders please also submit to the inspector of elections the ballot on the election of directors voting and the proxies in accordance with the instructions they have received.

Miss Amick, when you are ready, you may give your report.

BECKI AMICK: My report is ready. The ballots of the proxy holders in response to proxies that were received through last Thursday evening cast not less than 1,125,034 votes for each nominee.

That number far exceeds the majority of the number of the total votes related to all Class A and Class B shares outstanding.

The certification required by Delaware law of the precise count of the votes, including the additional votes to be cast by the proxy holders in response to proxies delivered at this meeting, as well as any cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Miss Amick.

Warren Buffett, Charles Munger, Howard Buffett, Malcolm Chace, William Gates, David Gottesman, Charlotte Guyman, Donald Keough, Thomas Murphy, Ronald Olson, and Walter Scott have been elected as directors.

27. Formal business meeting adjourns

WARREN BUFFETT: Does anyone have any further business to come before this meeting before we adjourn? If not, I recognize Mr. Scott to place a motion before the meeting.

WALTER SCOTT: I move that this meeting be adjourned.

VOICE: Second.

WARREN BUFFETT: Motion to adjourn has been made and seconded. We will vote by voice. Is there any discussion? If not, all in favor say “aye.”

VOICES: Aye.

WARREN BUFFETT: All opposed say “no.” The meeting is adjourned. Thank you. (Applause)