These are notes taken by Matt Pauls from Berkshire Hathaway’s Annual Meeting, 2009.
Berkshire Hathaway Specifically
Berkshire’s property Casualty insurance and utilities businesses are probably the best in the world. Insurance business was growing especially for GEICO. Last year GEICO spent about $800 million on advertising. Advertising money at GEICO is well spent. It’s nearly impossible to calculate how much each dollar of advertising comes back in the way of insurance premiums. But Munger specifically said that if they spend $800 million and get more than $800 million in increased insurance businesses, then that’s $800 million pretax that doesn’t show up on the income statement.
Float increased as a consequence of GEICO’s additional business and from the acquisition of Swiss RE. (Swiss Re’s $2 billion Float is long duration float.)
Buffett commented that in 2000 Berkshire’s Stock price was substantially below intrinsic value, that currently the market price is moderately below Intrinsic Value, but not as large a discount as it was in 2000.
Berkshire will make good profits on the puts and likely suffer some losses on the swaps. Berkshire modified the puts to a 10-year term down from 18-years and reduced the strike price to 994 from 1514.
Munger commented that entering such derivatives contracts should have limits but that they were and are well short of that limit. He also said he thought the derivatives business is silly, unnecessary, and poor business practice. “Derivatives brokers basically sold bad products to clients.”
Buffett and Munger both said with conviction that there’s a huge need for an overhaul of margin requirements. Buffett said that the creation of the derivatives markets basically undid the margin requirements put in place during the depression. Margin requirements were put in place for good reasons and the laws remain relatively unchanged. Few people would argue in favor of eliminating margin requirements. Derivatives however have allowed people to legally ignore margin requirements. Munger commented that our civilization has done unbelievably well without them (derivatives), that they (derivatives) are unnecessary and that they desperately need massive oversight. Munger said he supported hugely increased regulation of derivatives markets.
To put this into context: Derivatives are ok when strictly used for example, by producers to lock the future cost of some raw material. Otherwise they are a risk to the system and allow, rather promote, the use of huge leverage.
Buffett highly recommended people interested in an overview of the mess, to read Jamie Diamond’s annual letter (JP Morgan Chase). I second his recommendation. It is a wonderful letter that I will highlight in a later article.
Wamu and other unnamed banks had many clear signs of trouble. They were hugely leveraged, doing business that they should not have been doing.
Credit card loss rates are (in general) apparently about 10% and they had in some cases increased the interest rates to 18%.
Wells didn’t want tarp: But the government’s reaction was well warranted. Wells will be stronger in the end. (Much more so had none of this happened.) Wells is the low cost producer in the banking industry, 1.12% on deposits.
The 4 largest banks had the same business model, but Wells Fargo followed a different model.
Gave an example that Clayton’s situation is similar to a situation at Goldman Sachs: unguaranteed loans (400 bp) vs guaranteed loans (100’s of bp less). So obvious disadvantages with respect to unguaranteed loans, but Clayton will adapt-for example, by partnering with certain institutions that have access to this much cheaper capital.
Munger: “It’s terribly awful that accounting principles allow financial institutions to record increases in earnings as a consequence of their having significant reductions in credit quality.”
That is, downgrades in bank credit ratings and general market uncertainty led to falling market prices for these banks bonds. Banks that had cash could buy their own debt at very large discounts to face value-allowing them to record an accounting profit.
Buffett: Overall the Government did a good job considering the scale of the problems and speed with which they needed to react. There’s no way anyone could have satisfied all parties, and while there may have been better solutions (in hindsight) people (politicians and the public generally,) should be satisfied with the current outcome.
Ratings Agencies: Housing (appreciation) optimism was built into the system. Credit agencies didn’t account for the possibility of loss. Their one size fits all checklist rating approach has obvious defects.
AIG outrage over compensation was disproportionate to the realities of that situation.
Health Care System
Munger: Thinks something at least close to European Style is inevitable and that didn’t particularly horrify him (Analogy: Private vs. Public School). Munger did however wish that it would be put off for at least a year so energy can be focused on correcting the financial system.
Mid American owns the largest Real estate Broker in Southern California. The numbers are beginning to show some stabilization in medium to lower priced real estate. Higher priced real estate markets still erratic.
The general situation:
The US had been increasing households by 1,300,000 per year, but housing starts were increasing at 2,000,000 per year. Currently we have overcapacity of about 1,500,000 million houses. About 2/3 of all owner occupied houses have a mortgage. Natural population and household growth relative to new housing starts (which is down, but far from zero) will reduce overcapacity by about 500,000 units per year. Meaning housing nationally will take a few years to fully stabilize. Buffett singled out his concern for real estate in South Florida, which he thought would have problems for some time. I’m of the impression that this has to do with Southern Florida’s lower average population growth (or household formations) with respect to the regions overcapacity.
Similarly, neither Buffett nor Munger thought there would be a quick turnaround in retail or manufacturing especially those related to the housing markets.
Buffett commented that Retail/Commercial Real Estate purchased at 5% premium Cap Rates will likely turn out to be silly purchases.
The Cap Rate or Capitalization Rate is the income generated from the real estate property relative to the cost of the property (e.g. Annual net operating income / cost). The higher the price paid for the property the lower will be the cap rate. Purchasers who justified their purchase with a 5% cap rate were (likely) assuming that the value of their “prime” location would experience a greater than average increase in property value, which would make up for the low cap rate.
Buffett and Munger are intrigued by discussions and accusations that include the catch phrase, “Tax Payer dollars”. Taxes haven’t changed and no one has paid anything more than they had been. In reality, China and other purchasers of our governments fixed income securities (treasuries) will be the ones who will ultimately pay, not so much the “Tax Payer”.
Inflation: We will have some
Best guard against inflation is (i) your own purchasing power and (ii) owning or investing in good businesses. If you are the best at whatever your do, you will command a greater share of relative purchasing power.
Inflation is unpredictable. But over the next 5, 10, 15 years the dollar will buy less or substantially less. We are however not alone. To offset the contraction of demand, the UK is running a deficit of nearly 12% of GDP and Germany is running a deficit of about 6% of GDP.
That said a little inflation is not bad, just look at the last few hundred years.
Some moats that were thought, not too long ago, to be quite large and very sustainable, are deteriorating or have altogether disappeared. That is they’re filling up with sand. Example, Newspaper business: Reading the paper has lost its essential need with the coming generation and therefore businesses no longer find it an essential place to advertise.
Board & Executive Compensation
What’s needed? -Owners that are knowledgeable representatives.
Buffett said, “Truth is that the Board has little affect on compensation, the CEO basically sets his own package.” Both Munger and Buffett suggested that compensation committees should be eliminated.
Munger voiced that liberal pay to directors is counter-productive. It becomes club-like and the directors would do a better job if they were not paid at all.
If the compensation is a large part of the directors well being (income) the director is not independent.
Munger compared directorship to public positions (like congress). “No man is fit to be in such a position if he isn’t willing to leave it.
Buffett, said to watch out for companies that need 100 pages to explain their compensation package. He also cited Chesapeake Energy as an example of egregious unwarranted compensation.
Buffett” Compensation committees operate on the honor system: “Shareholders have the honor, Management, the system”
BYD and China
Munger called BYD “A damn miracle.”
Business aspects: They are in rechargeable batteries, cell phone components, and Automobiles.
To understand the capability of the company and specifically Wang Chuan-Fu, consider that they started literally from zero, with little to no capital, manufacture everything for their cars except the glass for the windows yet blew away the huge auto manufacturers with all their capital, resources, distribution channels, etc.
New (lithium) battery technology is desperately needed not only for cars and obvious electronic devices, but also by utility companies-true domestically and globally. BYD, “Hit the sweet spot on that one.”
Wang Chuan-Fu hand picks the best Chinese engineers, 17,000 or so to date. “The basic quality of the Chinese people is astounding.“
Munger said that the current Chinese economic policies are very much on point. “The most successful in the world. It’s a governments job to make their country hard to compete with and China has done that very well.”
Synthesis Partners, L.P.
4 North Park Drive Suite 106
Hunt Valley, Maryland
These are notes taken by Matt Pauls from Berkshire Hathaway’s Annual Meeting, 2009.