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Alan Schram

Alan Schram

Posted: May 2, 2010 12:08 AM

Notes from Berkshire Hathaway Annual Shareholder Meeting

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Close to 40,000 enthusiastic shareholders made the pilgrimage to Omaha this year, coming from all over the world to attend "Woodstock for capitalists."

Following are the highlights of comments made by Warren Buffett and his vice chairman Charlie Munger, covering a broad range of issues, and picking a sample from over 1,500 questions submitted to them, in a Q&A session that lasted eight hours.

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The first issue to come up was the highly publicized $5 billion investment Berkshire made in Goldman Sachs. Berkshire bought its preferred stock in Goldman at the height of the crisis. That investment pays Berkshire an interest of $15 every second. So while the allegations made against Goldman harm the investment bank's reputation and employees' morale, Buffett loves the investment. He also mentioned Goldman has assisted Berkshire in building its business, starting in 1967 when they helped sell Berkshire's first bonds issuance.

Buffett gave a detailed explanation of the nature of the much discussed ABACUS transaction, for which Goldman has been sued by the SEC.

The customer was a large bank, ABN Amro, now part of RBS. They guaranteed the credit of ACA, which insured the bonds covered by said instrument, and consequently suffered a large loss. Berkshire itself often engages in similar transactions, and collects a fee for guaranteeing similar credit. Berkshire evaluates bonds and prices them, exactly as ACA did.

In this case, ABN Amro was paid $1.6 million to bear the risk on $900 million worth of bonds, which turned out to be worthless.

Buffett believes many municipal bonds insurers expanded into new business such as structured credits when the margins on their traditional muni bonds business narrowed. But they were much less familiar with the new complicated securities, with unsurprising dreadful results.

Buffett has little sympathy for the bank making dumb credit decisions. ACA has no reason to complain and no one else to blame for a bad business decision they made. Buffett does not think Goldman Sachs is responsible for the losses that ensued. Responding to a shareholder question, Buffett sees no reason to replace Goldman Sachs CEO Lloyd Blankfein. He believes the Wells notices Goldman received were not material enough and therefore did not have to be disclosed.

Outlook on US economy. Buffett and Munger were very optimistic about America's future. Berkshire sees plenty of opportunities in the US and sees no reason to shift the center of its investments to other countries.

The deficit reduction commission recently appointed by the President (former Senator Alan Simpson and erstwhile WH Chief of Staff Erskine Bowles) has few choices but to raise taxes and cut expenses. While deficit spending is not going to work for extended periods of time, the US is not at risk of defaulting because its currency is still the world's reserve currency.

Moreover, the country can handle unfunded liabilities as long as it experiences GDP growth.

Given that capitalism constantly looks for ways of doing things better and with less people, we need a social safety net. Society owes a minimum standard of living to people who are temporarily out of work.

Inflation. Risk of Inflation has significantly increased because of the policies we are pursuing, and that does not bode well for either cash or fixed income. However, Buffett notes the dollar devalued by about 95 percent since he was born, and the country still did fine. He also notes the stimulating response to the financial crisis may have been necessary, but weaning the country off the medicine of massive debt may be harder than the ailment itself.

They are generally bearish on all currencies, and believe equities are likely to give you a positive real return, and are superior to the unenticing alternatives (such as bonds and cash).

Financial Reform. Buffett and Munger believe the financial system has too much complexity and would like to see reform enacted much along the lines proposed by Paul Volcker. They believe too much in the financial world is counter-productive, and a reformed system should drastically limit what investment and commercial banks are allowed to do.

Derivatives. The usefulness of derivatives is overrated. They have some utility but have to be conducted safely, under responsible rules. Wall Street should have a socially important purpose, and not resemble a casino, where people are more concerned with valuing an option than valuing a business.

Congress is looking into imposing new retroactive regulation on derivatives (Berkshire has 250 derivative contracts, down from some 23,000 contracts ten years ago, with a notional value of 1 percent of that of some other large institutions).

Even if the bill passes, it would not impact Berkshire. Only in the unlikely event that Berkshire is found to be a threat to the system, the company would have to retroactively post collateral on contracts, which would require it to tie up capital. Inserting collateral requirements retroactively would be constitutionally dubious as it violates the sanctity of contracts, and would neither be fair nor smart, but the company can easily handle such requirement.

Succession. Always a hot issue with Berkshire shareholders, the question usually comes up. The potential successors to the position of Chief Investment Officer did well in 2009 (one of them returned 200 percent), after a difficult 2008. The list of four possible replacements has changed over the past year, which is unusual news.

Buffett and Munger believe the culture of Berkshire is self reinforcing, and will outlast the life of the founders. Berkshire is run so it can withstand any systemic shock. With over $60 billion in insurance float, Berkshire is the world's premier insurance company.

Oil. Buffett and Munger believe we will not be dependent on oil forever. The discovery of oil in the 1850's changed the world and enabled major growth. Within 150 years, humans exploited what took hundreds of millions of years for nature to create. That added tremendous value. But human ability to innovate should not be underestimated. With our emerging technologies, civilization is likely to soon no longer need to depend on limited supplies of oil to prosper, as solar power will become a cheaper and more feasible alternative.

Kraft Foods. Berkshire has a large stake in Kraft and has been vocally and publicly expressing its dissatisfaction with management's capital allocation decisions. The recent acquisition of Cadbury and the sale of their Pizza business (for what Buffett says was an effective multiple of 7 times pretax earnings) were called "dumb". He did say Kraft is selling at less the sum of its parts.

China. Buffett and Munger believe China will advance civilization. That country's potential is being unleashed in the last decade in a dramatic fashion, after hundreds of years of being held back by a deleterious system of government.

Further Investments. Berkshire is now placing large amounts of money in businesses that have lower return on capital, and regulated businesses that are capital intensive (Burlington Northern and Mid American Energy). Those limitations inevitably come with Berkshire's size.